5 Quick Ways to Evaluate Your Market Size

June 21, 2013

Back-of-the-envelope methods VCs use to measure market size of startups.

If you are in the consulting business or into technology startups, you are probably very familiar with the concept of sizing a market. This is a key factor that venture capitalists use to gauge the economic potential of a startup, and is also often used to justify outsized acquisition or mergers in the market. Ultimately, for VCs, it is important to know the market size because it correlates with the potential exit value of a company (assuming that it stays in the same market and becomes a dominant player), because this exit value is the driver of venture capital returns multiples and profits.
Given that this is such an important factor in their considerations, VCs are always thinking about market size when they are evaluating an investment opportunity, and it is good for entrepreneurs to have a good handle on the market size/value of their company, as well.
However, it is possible to go to the extreme and put too much faith into a market size calculation. I have written in a previous post about how using a single number (in $) to represent a company’s potential market size is not very helpful, because it typically fails to account for the complexities of a company’s economic model and market dynamics, as well as customers’ appetite and budgets, which ultimately determines whether and how much the company can generate from its market.
Nevertheless, it is important for VCs to be able to at least get an approximation of the total economic potential / value creation of a startup in a fast, simple manner, because that will help speed up the VC investment and decision making process tremendously.
So, in a crunch and not having a lot of resources, what are the ways that VCs can evaluate the market size for a new technology company?
1. Public Comparables: In this process, the VCs quickly identify a set of public companies that operate in the same or closely related market, and calculate their aggregate annual revenue and market capitalization based on online financial data sources such as Yahoo! Finance, Google Finance, etc. If that is a relatively stable, mature market, then the aggregate numbers should represent total demand and total value of the market in question.
2. M&A Transactions: Major tech acquisitions are well known, and most VCs are familiar with recent transactions, especially in the segments that they are interested in. The value of an acquisition or that of a merger are important signposts for market size, as they represent a quantification of the value the acquired company is creating and capturing. For example, if a particular technology market is abuzz with mergers and acquisitions with large transaction values, then you can infer that there is a big enough potential in that market at the moment, assuming that capital markets are efficient.
3. Quick Bottom Up Calculation: You can also do a simple calculation to evaluate the market size, which is “number of potential customers” x “average annual selling price to each customer.” This is considered a “bottom up” approach because the number of potential customers must be counted or estimated. This is easy if the potential customers fall into a well defined category, such as Fortune 2000 companies, or accredited higher educational institutions, as the count of these organizations are well known and well documented. However, it is not a suitable approach if the prospect universe is not as well defined or as easily counted. For those cases, we need to do some additional extrapolation, as described in the next method.
 4. Extrapolating Local Market Size to a National Level: This is really a variation of the quick bottom up calculation, but makes it even simpler: instead of estimating the number of qualified prospects nationally, one can just focus on the most familiar setting, one own’s city or town or county, and use local knowledge to make an estimation for the number of prospects, and hence market size, of that location. The next step is to count or project the number of such local regions nationwide, making adjustments for different population size and urban vs. rural characteristics, and use that as a multiplier to get to the total market opportunity. This approach is suitable in the cases where the technology tends to serve local customers and thus creates the most value in its local market, a formula that can be repeated in other localities as well.
5. Interviewing People: Sometimes the easiest way to calculate a market size is to pick up the phone, reach out to your contact, or run a survey online to get people’s opinion on the market opportunity. Some of the people you interview actually use their domain expertise of the four methods above to calculate a quick market size for you. Some others will provide you with their own analysis and conclusions, and those are extremely helpful as well.
Are there other market sizing ideas or methods that you can share with us?

Chief Business Officer at UserTesting

Tien Anh joined UserTesting in 2015 after extensive financial and strategic experiences at OpenView, where he was an investor and advisor to a global portfolio of fast-growing enterprise SaaS companies. Until 2021, he led the Finance, IT, and Business Intelligence team as CFO of UserTesting. He currently leads initiatives for long term growth investments as Chief Business Officer at UserTesting.