go bottom up, not belly up

What a TAM!  If you’re an entrepreneur who’s tried to raise funds, or you’ve even glanced at an article about market sizing, then you’ve probably been asked to think about the size of your total addressable market.  How much money each year (from now through 2017…) will be spent on products or services in your space?  There are many crucial follow-up questions: how fragmented is the market?  How geographically dispersed are the customers?  How important are the check-writers?  (There are many convenient tools that explain these concepts in further detail, many of them are described by convenient acronyms such as SAM and SOM.)  Ultimately, how much of the TAM can be yours?

Unfortunately, this top down approach to market sizing tackles the who, what, where, and maybe hints at when and why.  It neglects the how altogether.  If you believe there’s a $5B market opportunity and you can capture 10% of it in five years with proper positioning and an effective go-to-market strategy, that’s splendid.  But Gartner quadrants and pie charts won’t help you do this. Presuming you’re no P&G, Microsoft, or Wal-Mart, then you need to define, understand, and measure how your obscure product or service rolls out in your intended market over time.

To demonstrate how you grow and scale, construct a basic bottom up analysis.  Timeframe varies by industry, but an 18-36 month window is typically sufficient for a new, lean technology company.  How much revenue do you forecast each year / quarter / month?  Now work backwards: what are the transaction sizes and customer numbers that get you there?  How many “trial users” or “free users” are needed to net each customer?  How many people or companies have to hear about you for just one to engage with your brand in some basic way?  Be conservative with these estimates.

A simple Excel sheet (with assumptions built into the first tab) does the trick for a basic bottom up analysis:

– Play around with assumptions and discover key sensitivities in the business model.  Find not-so-obvious areas of risk but also upside to your growth.

– Compare with metrics from the top down approach to see that customer and revenue targets remain roughly in line.  Brainstorm reasons for any discrepancies.

– Ensure that M-over-M, Q-over-Q, and Y-over-Y increases in your analysis are feasible.  Be aware that sudden increases require additional resources and introduce risk.

– Do not introduce changes in growth rates without justifiable, clearly-articulated reasons.  (Unless you have fundamental changes to your business model, your purchase conversion rate won’t increase from 1% now to 10% next year simply because more people have heard of you.)

Perhaps the most useful benefit of all is that your bottoms up analysis becomes a living, breathing document.  You can collect feedback from trusted board members and advisors.  You can compare future results with past estimates to refine your growth trajectories.  And you can explain how capturing 10% of a $5B opportunity in five years is achievable.

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