Convergencevc.com – As an entrepreneur, you should be able to identify your market, both in qualitative and quantitative terms. Understanding your target market in a holistic manner can get you far. Not only it is helpful when pitching to investors or talking to the public about your product, but also is powerful when coming up with strategic plans for the future of your company.
There are two types of market definition: theoretical market and addressable market. A strong founder should know the estimation of the two by heart and be able to elaborate them when asked.
Theoretical market can be defined as the characteristics of people with desire and ability to buy your products or services. Essentially, this is when you ask, “Given the specific problem my technology start-up is trying to solve, who will be my target customer?”
According to MaRS Discovery District, a non-profit organization that aims to promote entrepreneurship and private-public partnership in Canada, to define your target customer you must determine a profile of typical/expected customer who are most likely to buy from you. This can be done through asking yourself the below questions:
- Are your target customers male or female? How old are they?
- Where do they live?
- What do they do for a living and how much money do they make? This is especially important if you’re selling relatively expensive items.
- What other socio-graphic or behavioral factors matter? If you are running a home and living products marketplace, your target customers most probably rent an apartment or own a home.
- Who are your early adopters? According the Geoffrey Moore in his book “Crossing The Chasm”, early adopters are those first cohort of buyers who seek to get ahead of the herd by being the first users of new but unproven technology.
Today’s start-ups are encouraged to resist from being too general when identifying their target market. This is true especially that consumers today are more marketing-savvy and are most likely to be more particular when choosing products and services to purchase. For example, instead of defining your target market as “every young professional who loves shopping”, pin-point it down to be “middle, upper and affluent class female young professionals between 21- and 35-years old who purchase imported cosmetics and beauty products”.
Find a niche market. No one can afford to please everyone!
The task is not finished yet. Remember, identifying your theoretical target market is just the first step.
Addressable market requires a more thorough analysis and calculation, as it defines the size of the market in monetary value. To put it in simple terms, after figuring out the profile of your likely consumers, ask again, “OK. It seems like there are a lot of people who fit my target customer’s criteria. If they have spending power to buy my product, how much would the whole “universe of customers” be valued in dollar?”
There are 3 steps to estimate the size of your market in dollar value. Refer to the diagram below as a guide.
Imagine a hypothetical situation where you run an e-commerce start-up, selling women cosmetics and beauty product.
Step 1: Estimate the number of Total Available Market (TAM)
Approximate the total number of customers in your “universe” as a whole (100%) — this means the total market demand for your product or service. Given that your business revolves around e-commerce, your Total Available Market would therefore be the total Indonesia e-Commerce market, which is expected to grow 80% Y-o-Y (similar to 2015) in 2016 to USD 7 bn, according to Macquarie Report. To find the figure, you can use publicly available industry databases/resources such as those offered by Badan Pusat Statistik (Central Agency on Statistics), Euromonitor, Statista, analyst’ research report, or other Government bodies’ database.
Step 2: Calculate the Served Available Market (SAM)
This segment is also known as the potential market size. To determine this, you need to refine your market size by narrowing it down to target customers for your category of product. This is when you get deeper into estimating your potential market volume. Coming back to the example that your business is a cosmetics and beauty product e-commerce, the Served Available Market in this case would then be the % of online shoppers who are female and who buy beauty products online, multiplied by average annual dollar spending per person on beauty products online shopping. This calculation will result in monetary value of your potential market volume, or also known as Served Available Market. For simplicity purposes, in this case, according to Statista.com, Indonesia reached USD 2.4 Billion in Cosmetics & Female Fashion Market.
Step 3: Identify the Target Market and Potential Revenue
As you can see from the diagram above, this is the smallest chunk of the “universe”. It is ultimately a combination of your company’s estimated market share and revenue model. For example, if you assume your start-up will earn 20% market share within the Served Available Market and you expect 10% margin through your business, you will get your potential revenue by multiplying the Served Available Market with 20% and 10%.
Note that the above steps will only be valid if accompanied by reasonable projections and assumptions depending on the nature of your business, especially on industry growth and other variables necessary to be included. The growth projection for e-commerce market will be different than that for payments market. At the time you create the first estimation, ensure you understand the underlying assumption and what could change going forward. Over time, you should monitor the accuracy of your initial assumptions and adjust accordingly.
Estimating your market size can take time, research and tweaking, however, it can give valuable insights into how passionate and knowledgeable you are in building your start-up.
Edited by: Adrian Li & Gary Khoeng