Seven billion people, all of whom sleep, eat, and…
After defining the problem, customers, and solution, the next step is to ensure there are enough potential customers to turn your idea into a business. You can start this research using the web, libraries, and data and reports from market research firms. With this and the conversations you will be having with potential customers to define or sell your MVP, you should be able to estimate how many people need a product like yours (a.k.a. the “target market”).
How many customers need my product?
How many copies of my product will each customer buy?
Given the target market size, there are two methods for estimating how many customers will actually buy your product.
In a top-down model, you start with the target market size then estimate what percentage of these people will be your customers. To create a top-down model, start with a large, known measurement, such as the total population of your target country. Then do some research to find the percentage of those people who match some important aspect of your target customers, e.g., a specific gender, age range, income level, education level, etc. Then find some market research or make a best guess on the percentage of those people who have the problem you are solving. Continue narrowing down the number of people until you have what you believe is the “total addressable market” for your product.
For some businesses, there is no market research available to create a top-down model, and in many cases, gathering this data would be too expensive for you to do on your own. For these cases, or to double-check the results of any top-down model, you should instead create a bottom-up model.
A bottom-up market model is an estimate of the number of customers who will buy your product and how many copies they will buy. The upper estimate is often the number of potential customers your company will be able to reach through its marketing and sales efforts.
To create a bottom-up model, imagine your company has started, and imagine it has been operating for a few years. At this point, your company is no longer struggling to find the few initial customers but instead has a known brand and is steadily making sales. However, like most companies, customers are not lined up to buy your product. Like most companies, you have a sales team responsible for closing sales. For the bottom-up model, the key questions is: how many sales is each sales person closing?
The speed of your sales is based on the complexity of your product and its price, as well as the size of the organizations you are selling to and the importance of your solution to their business. The speed and complexity of your sales efforts provide the upper limit of how big or fast your business can grow.
Make your best estimates for all the values in your bottom-up model. Do not fret that the numbers are “all made up.” Yes, they are guesses, but they are educated guesses based on your market knowledge and above-mentioned research. For the bottom-up model, in your financial plan and onward into running your businesses, educated guesses form the backbone of managing a startup.
How many customers can each of my sales people close?
How long does each of those sales take?
At scale, how many customers do I expect will buy my product per year?
Ideally, you have sufficient information to build both top-down and bottom-up models, and ideally, the models will agree. If they do not agree, you can iterate through your assumptions to make them converge or fall back on one model, using the other model to justify its values. Usually, however, you will have enough information to use only one model or the other, not both.
Bird Watch—[Market size, Top-down model]: There are eighty active wildlife researchers in the United States. On average, each wildlife research project would require 100 tags and twenty base stations. (Note that this product has two components: tags and base stations.) There are no equivalent products in the market today, and thus it is reasonable to assume 5% market share after one year and 50% market share after three years.
After one year:
80 researchers x 100 tags x 5% market share = 400 tags.
80 researchers x 20 base stations x 5% share = 80 base stations.
After three years:
80 researchers x 100 tags x 50% market share = 4000 tags.
80 researchers x 20 base stations x 50% share = 800 base stations.
Total market need:
80 researchers x 100 tags = 8,000 tags.
80 researchers x 20 base stations = 1,600 base stations.
Concrete Battery—[Market size, Bottom-up model]: There are 500 wind and solar installations of significant size (more than 10MW) in the United States as of 2014. Starting with an unproven technology and unknown brand, a reasonable sales estimate would include five sales in year one, averaging two flywheels per sale, growing to fifteen sales in year three, averaging ten flywheels per sale.
After one year:
5 customers x 2 flywheels= 10 flywheels.
After three years:
15 customers x 10 flywheels = 150 flywheels.
Total market need:
500 customers x 20 flywheels = 10,000 flywheels.
Close to Home—[Market size, Top-down model]: In each of the past ten years, over 10,000 American homes were destroyed by tornadoes, hurricanes, floods, and forest fires. Nearly all of these were the primary residence of their occupants. Most were rebuilt by their owners, and most of the rest would likely have been rebuilt if the owners had not been forced to move away from their hometown. These rebuilding efforts typically take two years. Thus, there can be expected a total market need of around 10,000 homes per year.
Ensibuuko—[Market size, Top-down model]: There are 5,000 SACCOs in Uganda, serving the twenty-eight million farmers who collectively save over $500 million per year. In neighboring Kenya and Tanzania, there are another 300,000 CHAMAs.