4 dollar values that matter while sizing a market in an interview or a business plan
You can read this blog as a preparation for market sizing questions in a PM interview or you can also read this to actually prepare your numbers for your start up before pitching to a venture capitalist.
The 4 numbers that you should be very clear about while performing market sizing are:
- Profit = Revenue — Cost
Imagine you want to open a pizza shop in New York. You are kind of excited to make a pizza that humanity has not tasted before. Kudos to you.
You have enough funding to open the first store but what is your plan of action to expand. How big is the market? What if you are very popular in town? What is your growth strategy? How do you expand to the rest of the country?
Let us delve deep into this Pizza use case and find the total market size.
If you prefer viewing, instead of reading then watch this workshop on how we estimate the size of the pizza market.
You may want to watch this 11 min #sharktank pitch to better understand how entrepreneurs inflate their valuation.
- Total addressable market
This is the big bang number or the total size of your market. This number is the largest of all the numbers in your business plan.
Another way to think is that this is the total revenue that you can potentially generate if you had 100% of the entire market for your service or product.
E.g., for our pizza shop, the total addressable market is every single person in America who eats a pizza. My back of the envelope calculation says that:
- Population of America: 330mn
- People who eat pizza = 10% of all Americans = 30mn
- People will order a pizza at least once a week = 52 * 30mn pizzas
- Each pizza = $10
- Total addressable market = 52*30mn*$10 ~ $15 bn
A lot of business plans contains only this number and you will see almost all calculations showing billions of dollars of addressable market.
2. Serviceable available market
This is slightly lower than TAM and only caters to the market opportunity that exists within your firm’s existing core competencies and/or past performance. This could be constrained by geography, your customer segment, or other factors that are unique to your service or product.
For example, even though the total market for pizza is $15 bn, you are just catering to New York therefore your market will be segmented. Using all the above assumptions,
- Population of New York: 8mn
- People who eat pizza = 10% of all NY residents and visitors= 800k
- People will order a pizza at least once a week = 52 * 800k pizzas
- Each pizza = $10
- Serviceable addressable market = 52*800k*$10 ~ $400mn
3. Serviceable obtainable market
As the name suggests, this is the market that you can obtain. It is an estimate of the portion of revenue within a specific product segment that a company is able to capture. You can drill down this number to find the most accurate description of the market that you can actually obtain.
For example, even though we see a potential market in NY of $400mn, there are several other constraints that need to be considered before we think about the market that we can cater. For example:
- SAM = $400mn
- People eating frozen pizza = 50%
- People eating from shops = 50%
- Our market share = 10% (we are not the only pizza shop in NY)
- Serviceable obtainable market = 50% *10%*400mn = $20mn
Great, so you can make at least $20mn per annum. This means you need to serve at least 2mn pizzas per year that averages to around 10,000 pizzas a day, assuming only 12 hours of operation. This boils down to 1k pizzas a hour.
But all of this is revenue or top line. What about your cost? How much money will you make on this?
This is simply your revenue potential minus the cost to obtain this revenue. If you are making 1k pizzas a hour there are several cost components.
You need a shop, pizza ovens, and a lot of hands, and raw material. Again, the back of the envelope calculation says:
- You can make 10 pizzas a minute in the oven therefore you need at least 2 ovens shelling out 6000 pizzas each in 10 hours and one backup oven. Assume each oven costs $100k and $5k in maintenance per year. The total cost would be around $315k
- You will need at least 6 folks in the shop. Two cashiers, 3 in the kitchen, and 1 manager who can double up as any other roles. Assuming, staff pay at $60/hour, it would cost around
$60/hour*12 hours*365 days *6 people= $1.5mn.
- If I pay $1500/ day in rent then, the total cost could be around $0.5 mn.
- Raw material for each pizza could be approximately $5 etc. Therefore, for 2mn pizzas, you need around $10mn.
- Add another $0.5mn for incidentals such as electricity, water charges, garbage collection, license cost, food inspection etc.
- Taking all our cost calculations, we spend a total of $10mn+$0.5mn+$1.5mn+$250k+$0.5mn~$13mn
Now profit is around $20mn [SOM] — $13mn[Cost] = $7mn. Assuming 30% tax, the total profit would come to around $4mn.
Profit before tax = 35% [$7mn/$20mn]
Profit after tax =25% [$5mn/$20mn]
In all these calculations I checked the population on New York on the internet and everything is an assumption. And that is the essence of this blog as well. Make smart assumptions and be clear on why you are making these assumptions as you proceed.
Hope this helps you as a PM while creating a business plan or while preparing for a PM interview. Don’t forget to leave your $20mn worth of clap if you felt this blog was profitable for your knowledge.