Is my idea big enough? Assessing market size and industry structure

We love to hear founders talk about where their ideas come from. Often, they stem from a problem founders face themselves, an astute observation of a particular problem faced by people around them, or an intuitive insight into a change in consumer behaviour or need.

During the ﬁrst week of Surge, we ask founders to talk about their ‘aha’ moment and share their vision for their company – and then challenge them to dream even bigger. To 10x their plans. To think hard about how to build their company into something that will really scale.

A big business can’t be built on a small idea. So when you develop your idea, you’ll want to assess whether it has legs. Ask yourself: Is this problem big enough, and the market large enough, to allow my company to really hit scale? Do I believe my idea could grow into a $100 million revenue company? What does the industry structure look like – what are the layers, who are the players, and where are the revenue pools?
In this post, we’ll walk through how to assess both market size and industry structure.

Assessing Market Size

Once you’ve zeroed in on a problem faced by a speciﬁc set of customers, zoom back out to see if a large enough group of people have the same problem. Is that segment big enough to comprise a market? Is your product a must-have or a nice-to-have? Will people’s willingness to pay for it increase or decrease over time? There might be one million people willing to pay to solve this problem today, but if it’s something that will become less of an issue in their lives tomorrow, then it’s probably not worth going after. In short: is this a wide enough problem in a market that’s large enough to build a really big company?

Calculating TAM

To answer this question, start by calculating the TAM, or Total Addressable Market. This refers to the total demand for a product or service in that particular market. TAM is an estimation of the maximum revenue that all competing businesses in this speciﬁc market can generate, on an annualized basis.

There are two ways to calculate TAM: top-down or bottom-up.

The top-down approach uses macro data to estimate total market size. This typically comes from ofﬁcial sources, like the World Bank, National Statistics agencies and industry associations, as well as research reports by consulting ﬁrms, like Gartner, Forrester, McKinsey or Bain, or investment banks. A founder applies demographic, economic and geographic assumptions to narrow down their target market to a speciﬁc segment.

For example, a ride-hailing startup in an emerging market that’s taking a top-down approach to calculating TAM, might look at national data on GDP per capita and auto sales to calculate what percentage of the total population can afford to buy a car, as well as what percentage of the population is not quite there but can afford to pay for a cab on a regular basis, to understand if there’s both adequate supply and solid demand for their platform.

A founder taking a bottom-up approach would analyse a subset of data in a speciﬁc location and extrapolate those ﬁgures to get a view of the wider market opportunity. The bottom-up approach relies on primary data, such as customer interviews, to calculate how much demand there is for their product or service.

If the ride-hailing company took a bottom-up approach, they might calculate what percentage of workers in an ofﬁce building in a certain business district would use a ride-hailing service and how often they’d use it, based on in-depth interviews. They would then multiply that ﬁgure by the number of ofﬁce buildings in a particular city to come up with projections – and then extrapolate that data at a national level.

We like it when founders lean into the bottom-up data. The bottom-up approach is rooted in consumer insight; it helps you deﬁne your core market and generates a more detailed, granular picture of how many such customers exist and what their pain points are. A bottom-up assessment also gives you clarity on the volume of units you can sell, and the price people are willing to pay.

Once you’ve done the bottom-up work, do a top-down assessment as a ‘sanity check’ to ensure your calculations align with the bigger picture data and larger trends, such as projected changes in income levels and smart phone penetration, and other industry tailwinds. A market assessment should be more than a point-in-time snapshot. To understand if this market is worth tackling, you need to know how fast it’s growing in order to understand how big your company can be in ﬁve to 10 years.

SAM and SOM

Once you’ve calculated the TAM, it helps to break it down into the SAM and SOM.

SAM, or Serviceable Addressable Market, is a subset of TAM that is served by your particular product – the way sneaker sales, for example, are a subset of total shoe sales. It refers to the total sales volume of a particular product within a speciﬁc geography that your startup aims to service. If there are already competitors in your target space, or an adjacent space you aim to disrupt, looking at their combined sales data will help you calculate the portion of TAM you can aim to target.

SOM, which stands for Serviceable Obtainable Market, is the percentage of SAM that your startup can realistically achieve in the next five or so years.

TAM shows the potential of your idea at scale; SAM indicates the target market share and SOM highlights the short-term sales potential.

While calculating TAM, SAM, and SOM helps founders understand the size of the market and the revenue opportunity, this exercise can also help crystalize their startup’s future product roadmap – and put competitors on the radar early on.

Founders often ask us where the threshold is – when is a market worth going after? As a rule of thumb, a $10 billion TAM with $1 billion SAM is a pretty good place to start. Assuming your company could capture 10% of that SAM, you have the potential to build a $100 million revenue business. It’s important to determine, at the start, whether you’re in a market that can support that goal.

Assessing Industry Structure

To understand if you can win a market or not, you need to have a clear handle on the structure of your industry – and where your startup will ﬁt in the value chain.

Successful founders typically track every possible competitor and their suppliers – auditing everything from price, target market, social media channels, content, and even newsletters, while also making efforts to get to know their competitor’s customers. By distilling this information into a competitive matrix, they’re able to think more broadly about where they ﬁt – and about how wide and deep they can go.

Many startups set out to disrupt a speciﬁc industry only to ﬁnd that there’s a larger opportunity up or down the value chain or in adjacent industries. Identifying these value pools early on in your journey can dramatically alter your startup’s trajectory.

While most startup founders think they have a clear idea of what industry they’re in, the ground can quickly move as they start to dig deeper. By asking yourself who your users are and what they’re trying to achieve, you can pinpoint – and continually ﬁne-tune – which neighbourhood you can, or should, play in.

Square, for example, started off as a payments company for small businesses. When Jack Dorsey saw all the services that other stakeholders and actors were providing to small merchants, it became clear there were many value pools the company could tap into. Square, which has since built an entire suite of tools to help small businesses, rapidly evolved from a payments company to a merchant success platform.
In summary, to get a clear picture of the industry you want to target, ask yourself these questions:

Disintermediate or enable

Getting a clear picture of the industry structure will impact many design choices. By developing a deep understanding of all the participants, the problems they face, and the power equation between them, you’ll be able to make better decisions on what part of the neighbourhood to play in – as well make strategic decisions, like whether you’re going to disrupt or enable those players.

Think about a farm to consumer grocery e-commerce company; the industry spans the farmer, the wholesalers, the retailer, and consumers or restaurants. One option is to disintermediate the middlemen by selling farm produce straight to the consumer. The value pool may look deep, but this model comes with complexities: this company will have to pay for and manage inventory across multiple warehouses. Another model is to enable the distributors and wholesalers by creating a platform model that allows all different parties to transact with each other, improving their margins and extending their reach. There’s an opportunity to build large companies based on both models.

Create a map of the competitive landscape and highlight all the value pools. If the part of the industry you’re going after is worth 5% of the entire industry, but the company in an area adjacent to you is targeting 10%, it’s worth exploring if you can expand into that part of the pond too.

These are choices you can only make once you’ve mapped out the market and understand who every stakeholder is, what their problems are, where the value pools lay, and how fractious a ﬁght it will be. That choice will inﬂuence what product you build.

Industry tailwinds are another vector to add to your industry landscape map. What changes are taking place that make your target consumer or target sector particularly compelling, right now? If there’s been a shift – say in technology adoption or consumer behaviour – that’s going to bring about rapid change in your industry or in a particular part of the value chain, and you may need to move quickly to capture the opportunity before the window closes.

Summary:

Take your idea and THINK BIG! Set your sights on transforming an industry or creating a new one.
Assess the market size by calculating TAM, SAM, and SOM. TAM shows the potential of your idea at scale; SAM indicates the target market share, and SOM highlights the short-term sales potential.
Assess the industry structure to understand where the value pools are. Develop a deep understanding of all the participants, the problems they face and the power equation between them.

This post is part of the Surge Founder Starter Pack: Company Building Essentials for Early Stage Startups. To download the rest of the pack, click here.