There is a fundamental flaw in the thinking process of many entrepreneurs out there in the midst of building their companies and seeking angel or venture capitalist investment: simply put, their market projections cannot be defended. The total available market (TAM), around which the typical entrepreneur plans to build their pro forma business model, is often defined by figures pulled from some random analyst report off the Internet. Many times, the research performed by an entrepreneur is nothing more than an evening of cutting and pasting data culled from the factoid-enriched information superhighway.
So maybe you’ve read through a number of presentations, possibly talked to some domain experts in the industry, or even conducted your own field study to determine the size and depth of the opportunity. Most don’t go to this extent. In school, it was called plagiarism, and yet many entrepreneurs are guilty of this same practice.
But what if there are no clearly defined market boundaries? Where do you find the data you need? What if no analyst has invested the time to research your new and not yet mainstream field of technology? What do you do if all the available information you find online and through the major research firms is vague, with wildly varying estimates, and is, in effect, useless for your planning purposes? What then? How can you possibly construct a reasonably sound financial model capable of resisting the scrutiny of a potential investor?
Definition: The Software Modeling Approach
In my twenty-plus years working in technology and writing on business and management best practices, I have often used software modeling as an analogy of how entrepreneurs and companies should approach their business problems. The fundamental problem with most business planning – and market sizing, specifically – is that the underlying business model and the components of the “system” are ill defined and not truly understood. In parallel, a problem among software engineers is the urge (for some, arrogance) to code before properly outlining the problem and potential solutions. But how often is this same mistake made in business? Quite often, in fact.
Do you understand your product or service? What I mean is, do you truly understand your market, your target customer, and your competition? Before you answer ‘yes’ consider this technique:
A (simplified) modeling approach is to outline what you know about your offerings, and to develop use cases that help you define each of your offerings as an individual product, and to define their uses and constraints. Try to fully document the features, functions, and constraints of each offering. Once you have this outlined, you can then begin to develop scenarios for these use cases, which will help you to visualize how your customers will use your offerings. Scenarios might describe uses of a single offering, or combinations of two or more offerings. The goal is to model out every conceivable use for your offerings. These scenarios can help you to define or create new uses, or to identify customer groups not considered in your original plans. The trick is to be creative, to “think outside of the box,” and to let the ideas flow freely, abstracting your scenarios enough that you do not blind yourself from new uses, new user groups, or new industries that may find your offerings useful.
Outlining each of your business components, and then brainstorming the various scenarios for using those components is a “holistic” method of business planning and market strategy. Understand what your product is, and you’ll better understand how to position it in the market.
Sizing: Understanding Your Limits
Now that you have your product or service definition in hand, it’s time to start thinking about building your “defendable swag.” Some of you may be asking, “What is a swag, anyway?” For those unfamiliar with the term, it is jargon for “Scientific (or Silly) Wild-Ass Guess,” used when establishing high level sizings for large projects.
Your financial model and underlying business strategy for execution and measurement of your model are nothing more than an educated guess, especially when your product or technology is untested, or in a bleeding-edge industry. How do you defend a financial model when you’re proposing a business around a product nobody has yet seen? There are some basic questions you can ask that will help you build a more accurate and realistic market model:
- What is your Total Applicable (or Available) Market?
In general, there is data available for the TAM of any product or service, even if your product is revolutionary. For example, software as a category can be broken down into business or consumer applications, and then even further as operating systems software, games, business productivity software, and so forth. Rely on the work you did developing your use cases and scenarios to help you define the proper industries to include in this larger figure. Many entrepreneurs only use the TAM in their calculations – this is a BIG mistake, and shows they have not done their homework. The TAM shows the larger industry trends, but that’s about it.
- What is your Served Available Market?
This is the slice of your TAM, which actually applies to your product group. If there are competitive products on the market, the SAM is the market which all of them currently serve. If your product or service is new, and there is nothing like it on the market, then you need to define the value of like-services, that is, the value of products or services that individuals and companies use today because they do not have your product. You may need to get creative here, but if you understand your offerings, this is not as difficult as it sounds.
- What is your geographic reach?
You’ve just created a product, and now you’re going to sell it worldwide? Is that a reasonable plan? Not likely. Understand the limitations of product and your customer footprint. Modifying packaging and providing support for expansion into foreign markets can be expensive, not to mention the costs of international sales and marketing, putting partnerships and sales channels in place, etc. Don’t write off foreign markets – just plan for them later, building off the success of markets you know.
- What are your primary channels of distribution within that reach?
Once you have defined where you will sell your offerings, you must define how you’ll move product within that geography. Is your website enough to support your projected sales and growth? Probably not. How are comparable products being sold?
- Who are your key partners for sales and marketing within those channels?
Scalability is critical to growth and market share. Do you have the necessary relationships in place to develop those channels of distribution, and get your product in front of the customer?
- What will it cost for you to capture 10 to 20 percent of that market?
Now that you’ve defined the size of your market, your channels of distribution, and the partnerships to get you there, what will it all cost for the next 3 to 5 years to make this plan happen? It’s a good practice to know the weighted cost of each employee you bring on, and the number of resources you’ll need to achieve the market penetration you’ve outlined in your prospectus. Understand the numbers behind the numbers you present to investors, and how the level of investment you need, increases or decreases based on changes to your penetration numbers. Investors will want to understand whether another million more, for example, could increase penetration from 20 percent to 40 percent, or if due to other factors (market conditions, competition) it would only increase it to 22 percent. If you can answer this kind of question, you will shine.
Just remember, it’s all a swag. Nobody expects you to hit the exact numbers proposed in your executive summary financial plan. Based on the answers to these questions, you’ll understand the actual costs, the market factors behind your proposal, and therefore how much money to raise to accomplish your early goals. And, more importantly, by understanding each of these answers, and the data behind them, you’ll be able to defend your assertions in front of investors. And that’s the key: it’s all about the “defendable swag.”
(Originally published on About.com in 2004)