Thursday, May 04, 2006

Investor Pitch: Flaws with Top Down Market Sizing

Top down is the most common and least convincing way to size a market. The top down approach relies on analysts market research from firms like Gartner, Forrester, Frost & Sullivan, Yankee Group, Jupiter and others. Most investors will not consider a top down sizing of the market to be a sufficient if they are calling it into question.

There are two main problems with this approach. First, analyst predictions often don't windup meeting expectations and it seems that every market has been predicted to $5 billion plus within 5 years by at least one research firm. Investors just don't put much stock these research firms assessments.

The second, more problematic issue, is that even when accurate, the market research figures represent the total market, which isn't necessarily relevant to the startup. For example, Gartner estimated that the security software market was worth $5.3 billion in 2004. Yet, at Cryptine we are not creating VPN, encryption, firewall, IPS or many other sub-categories included in Gartner's $5.3 billion figure so it is a gross exaggeration of our market. The important number is not what Gartner quotes but rather the total addressable market (TAM) and the total serviceable market. TAM and total serviceable market are used somewhat interchangeable by different people, which is kind of confusing. Yet, it doesn't really matter how these terms are described, rather that the market is effectively sized, but here is what logically makes sense to me:
  • Total Addressable Market = 100% of the market for type of product you sell
  • Total Serviceable Market = 100% of the market you could actually sell to
For example the TAM for encryption software would be the global sales of comparable encryption products. However, the total serviceable market would be encryption software sales in the region, verticals and segments the product is targets. For example the total serviceable market might be North American encryption software sales to mid-sized health care and financial services companies. Per my descriptions, entrepreneurs should use the total serviceable market because this is what investors use to determine whether or not a compelling liquidity event could be achieved. Occasionally, market research firms will provide this type of detail but when they don't a bottoms up approach provides a more credible sizing of the market, which I'll describe in one of my next postings.


At November 09, 2006 8:55 AM, Anonymous Anonymous said...

You get the point across. But when it comes to real issues, the issue is still murky.

I am an inventor of a fast (instantaneous) flatbed document scan device. The total market is the flatbed scan device (that scan window on top of each machine) on all the digital copiers (analog copiers are not included), all-in-one machines, and scanners. By this count, there will be over 30 million new devices annually could potentially use the type of mechanism I invented. If each device I charge $1 patent royalty, there will be $30 million patent royalty fee a year! Great. Nearly all of this money is net income, since there is no "production cost".

In this particular case, what is the TAM? SAM? SOM?

yuping yang

At February 27, 2007 2:58 PM, Anonymous getvendors said...

Excellent point Andrew.. Yuping, in your case you should find - exactly who can achieve significant savings without much capital (or for that matter any type of) investment (e.g. new equipment, process changes, training, manufacturing conditions etc. etc). Further, if the market is fragmented then there will be different alternatives available.. a few product segments will prefer alternatives because of different reasons. If you do further analysis then you will definitely refine the numbers..remember it is not the $1 royalty that will stop people from adopting your technology is the "other" factors find out those "other" factors and you will get the significance of TAM/SAM..


Post a Comment

<< Home

Powered by Blogger