Market Size

Market size is a measurement of the total volume of a given market. When determining market size, it is very important to define the measurement as precisely as possible.

A statement like, "The market for recorders is over $100 million per year," leaves a lot to be desired. What is wrong with that statement? Just like engineering, when monitoring or measuring a dynamic variable, the measurement must be well defined and all external variables considered. For example, if you were testing a jet engine for its vibrational characteristics, you would not just document the vibration level of the engine during operation. In a test of this nature you might also like to note the status of other parameters such as:

  • Engine speed
  • Fuel mixture
  • Wind speed
  • Wind temperature
  • Time
  • Oil temperature
  • Weather conditions
  • Altitude

It is obvious that fluctuations in these measurement variables could influence the engine's vibrational dynamics. For the same reason, when a market manager confidently states that the market for recording equipment is $100 million, we should request documentation on how this measurement was taken and determine the status of all other relevant parameters to gauge their impact on the forecast. For example:

What is the time period?

  • One year (usually assumed)
  • Six months
  • One month

What was the date?

  • 1986?
  • 1989?
  • 1991?

What geographic regions does the market cover?

  • U.S.
  • World
  • Europe/Japan
  • Nepal

What is the size based on?

  • Production
  • Consumption

How was the market estimate generated?

  • Secondary data sources
  • Competitor interviews
  • End-user surveys
  • Experience

What is the unit of measurement?

  • Currency
  • Units
  • Volume

What groups are included in your product definition?

  • Video recorders
  • X/Y chart recorders
  • Floppy disks
  • Hard disks
  • Film recorders
  • Tape recorders
  • Cassette tape recorders

Methods of Measurement

We cannot exaggerate the importance of making accurate measurements of market size. Virtually all companies make a rough estimate of that parameter and let it go at that. Some of the larger companies in broader product segments have a dedicated market engineering staff that accurately tracks the size of various market segments within market segments of the particular industry. Consider them lucky. However, less-significant product segments that the research community tends to ignore must rely on experienced "old boy" guesswork or (worse yet) on government statistics.

There are many methods by which you can calculate market size. These methods can be categorized into two subgroups - the wrong methods and the right methods.

How Not to Determine Market Size

  • Based on customer demands extrapolated from a small sample size
  • Based on potential
  • Based on current rates of production or production capacity
  • Based on government statistics
  • Based on a competitor's guess or your boss's guess

Each of these five methodologies will most likely give you an incorrect measurement. Market size measurements based on customer demand and market potential tend to be on the high side because both methods extrapolate for all customers from a small sample what an ideal customer should buy.

Production is also a poor indication of customer demand because production and actual sales are rarely perfectly coordinated. Government statistics are calculated with very poor methodology and little regard for accuracy; be careful if you base anything on those numbers.

Typically, market size estimates are based on rumor and expert opinion. For example, we were talking to the chief executive officer (CEO) of a large manufacturer of industrial equipment. He asked us to tell him the market size for his product line. We told him we did not know, but he insisted that he had read an article of ours that discussed the numbers. We finally gave him an estimate, which he later used in an interview with the Wall Street Journal. For the next two years, that was the market size the entire industry used as a benchmark.

How to Measure Market Size

There are three ways to measure market size, two of which are based on competition and one of which is based on customers.

  • Competitive sales (bottom-up approach)
  • Competitive sales (top-down approach)
  • End-user purchases

Of the top-down and bottom-up methods, the bottom-up approach is far more time-consuming but is more accurate. In essence, it uses a series of interviews with all suppliers to determine quantities sold by each company in the period. These are added together to give the total market size.

The top-down approach, which is used most often by research firms, is based on a series of competitive interviews where each competitor is asked for an estimate of the market size. These estimates are sometimes weighted and then averaged for the market size calculation.

The last way of calculating market size is based on end-user purchases during the period. If there are few end-users, this is an accurate measurement. However, as the end-user base increases, the cost rises and the accuracy of the measurement falls. A smaller sample will have to be taken and extrapolated to approximate the entire user population.

What Does Market Size Really Tell You?

Market size is one of the fundamental measurements that must be taken on the market. It is the standard measurement ruler against which all of a company's activities should be measured.

For example, expenses for an R&D project should be related to market size. The same is true for sales force and marketing expenses. On one hand, you do not want to over-invest based on market size. On the other hand, you do not want to under-invest in large, fast-moving markets.

Case Study: Measurement Instrumentation

This client was a 25-year-old manufacturing company founded by three engineers who were then fresh out of engineering school. Over the years, the firm evolved into a three-division company, as shown in Figure 1:

Figure 1 - Market Size: Case Study Company Structure

Division Sales (%) Salespeople (#) R&D Expense ($ Million)
Pressure Sensors 34 24 12
Humidity Inst. 36 25 15
Navigational Inst. 30 20 14

Note: All figures are rounded. Source: Frost & Sullivan

The owners came to us frustrated with the low growth of their company. New products were not selling fast enough, and the only way they could see to encourage growth of the company was through acquisition. This represented a problem, however, as one of the three partners was 100 percent opposed to acquisition, another wanted the firm to "stick to its knitting," and the third wanted to start development projects into newer and exciting markets such as office automation and telecommunications.

The fundamental problem they had was that none of them really knew where their relative strengths and weaknesses lay. They had no marketing department per se, although they did have sales managers and a literature development group. Each division had its own sales support structure, and was of roughly equal size based on contribution to total sales.

We started on a quick market engineering overview of the company to determine where it was positioned in the market. As each division was in a radically different product area, we had to develop three distinct overviews.

The first and perhaps the most important parameter that we determined was the firm's size in each of the markets in which its divisions competed. Of course, knowing the market size and volume of sales of each of the divisions, we could immediately calculate market share, as shown in Figure 2:

Figure 2 - Market Size: Market Share Calculations

Division Sales ($ Million) Market Size ($ Million) Market Share (%)
Pressure Sensors 40 600 6.6
Humidity Inst. 43 50 86.0
Navigational Inst. 36 110 32.7

Note: All figures are rounded. Source: Frost & Sullivan

This certainly was an eye-opener. It immediately showed us that the firm was looking for greener pastures while completely overlooking the green grass in its own backyard. It was quite obvious that the growth we were looking for would most likely be found in the pressure sensor market.

As we previously indicated, each of the company's three divisions was run by one of three partners. Unfortunately, the non-aggressive partner was responsible for the pressure sensor market.

A few simple calculations illustrated the immense potential that lay in the pressure sensor market, as shown in Chart 1 and Chart 2.

This analysis brought us to the conclusion that if the company had as many salespeople per market size in the pressure sensor market as it did in the humidity market, there would be 12 times as many salespeople to address that market. Moreover, R&D spending would be increased by $200 million as well, if it were in proportion to the humidity market.

The Response

  • The company stopped its investigations into acquisitions and product development outside its areas of expertise.
  • The company formed a management committee to oversee all product lines rather than segmenting the firm into three discrete divisions. The division strategy made no sense based on market size.
  • The company began increasing the number of salespeople in the pressure sensor market. The company decided to increase the sales force by 10 percent per year for three years and to observe the level of sales per salesperson to determine if they remained stable.
  • The firm allocated additional funds for product development to grow the pressure sensor market in line with the two other segments the company addressed.

The Result

  • The company grew by an average of 11 percent per year over the next three years, approximately 6 percent higher than over the previous three-year period.
  • Sales from the pressure instrument division now account for 51 percent of company sales, and this figure is projected to increase to 75 percent over the next seven years.
  • Management harmony has increased considerably as management now chooses to base its decisions on market figures instead of personalities.

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