When most companies forecast their sales targets, they first calculate their total addressable market, that is, the total market demand for products or services in their industry. Put simply, this is the maximum revenue a company could generate if it were to capture its entire market.
However, unless you are a monopolist, you most likely cannot capture the entire addressable market for your product or service. Even if you only have one competitor, it would be extremely difficult to convince an entire market to just buy your product or service.
For this reason, it is important to calculate the maximum revenue you can get from selling your products or services to customers who would realistically benefit from buying your solutions.
This potential revenue is known as the market size, or usable addressable market, and you can use it to accurately measure your company’s growth potential.
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Your market size, or Serviceable Addressable Market (SAM), is the maximum revenue that you can potentially generate from selling your products or services to potential customers who would realistically benefit from purchasing your solutions. With this metric you can precisely measure the growth potential of your company.
How to calculate the market size
- Start with the total addressable market (TAM) and then identify your target market within that total number, which varies based on geography and other logistical factors.
- Take your target market and determine the penetration potential of your target market.
- Multiply the target market by the penetration rate to find your market size.
Example of market size
Let’s go through an example to examine how you would determine market size.
A startup wine company
Let’s say you wanted to start your wine business. How to Calculate Market Size: First, you want to determine how many liquor stores there are in the United States – this will help you determine the overall market that you are in could theoretically sell your product.
After doing your research, you find that there are 50,000 liquor stores in the United States. From this complete list, you want to sell to the New England area only – including Massachusetts, Maine, and Rhode Island.
You determine that your target market includes the 1,000 liquor stores in the New England area. From here, do your research and speak to alcohol vendors to find that the wine distribution success rate is around 40%.
Using this example, we would calculate the market size using the following formula:
1,000 liquor stores x 40% = 400 liquor stores
Then, assuming that each liquor store is grossing $ 20,000, you can use the following formula to determine potential sales:
400 liquor stores x $ 20,000 = $ 8,000,000
This means that you can earn $ 8 million by capturing 40% of the total market in the New England area – but that doesn’t take into account your competitors’ wine or any other liquor available in a liquor store. Because of this, you should be conservative in estimating how much of the market size you will gain.
How to use the estimated market size
Okay, you have your estimated market size – now what?
Market size helps your company answer the following questions:
- How much potential sales can we get in that particular market? In other words … is it even worth our time and energy?
- Is the market big enough to interest us?
- Is the market growing? Be there quiet Chances of generating income from this market in 3, 5, 10 years?
Market size is a critical number to know when looking for funding. Investors need to know how much money you can make in a given market. Additionally, it’s important to realize if the potential revenue that you can generate outweighs the cost of your business.
Once you have the market size, you should also consider how saturated the market is already with your competitors’ products. Ultimately, you can’t hit the entire addressable market (TAM) – some of these people will prefer their competitors’ products to theirs. So you need to determine if you have a chance of making enough consumers on the TAM to make this a worthwhile endeavor.