At the same VCs often they pass if they feel that the market is TOO SMALL.
Here is everything you ever need to know about MARKET SIZING.
Market size is the amount of money your prospective customers spend.
For example, cloud computing market is $1,600 BN by 2030 => https://www.globenewswire.com/en/news-release/2022/05/13/2443081/0/en/Cloud-Computing-Market-Size-to-Hit-US-1-614-1-Billion-by-2030.html
Or Healthcare & Heath Ins in USA is $1.1 T https://t.co/zj2xMZK7U1.
VCs want to only invest in big markets. The reason is simple:
– Venture scale return company is > $100M in Revenue
– Say you are in $1B market, to get to $100M in revenue you need to capture 10% of this market
– That’s hard
– Also most markets are NOT winner take all. Think Uber and Lyft — they compete. Space X and Blue Origin — compete, etc
– Most markets are CROWDED
– In a crowded market, revenue opportunity shrinks – pie is split
– VCs don’t want to invest into a small market because it will likely be a small outcome.
– VCs rely on power law – big outliers – to make their math work
– Small outcomes aren’t good for them!
There are two ways people look at the market size – TOP DOWN and BOTTOM UP.
TOP DOWN is what founders mostly put in their decks and it is typically incorrect for two reasons.
A) Its way too big
B) Its not even their market
Say you are launching a new cloud based database for machine learning.
If you put entire $1,600 BN market for cloud tools as your market size, this is INCORRECT – you are WAY OVERESTIMATING it.
You are NOT proving all cloud tools.
Similarly, if you put $189B – size of ML tools, you are still over estimating it.
There are MANY tools for ML and data layer is only 1 piece of the puzzle, one slice of the market!
Even worse than over estimating is claiming totally wrong market.
For example, if you selling digital software to healthcare industry, NEVER put $1.1 T spent on Healthcare in US in your deck. NEVER.
It is completely IRRELEVANT!
If you selling digital software to healthcare industry, even $185B for Digital Health market IS NOT YOUR MARKET SIZE.
Your market is Medical Software which is somewhere between $10B and $20B, and thats not all…
Ultimately your startup is going after a sliver of that market.
So you need to really drill down!
For example, if you are selling to dentists it is $1 – $2B market for entire amount they spend on managing their practice.
In general, TOP DOWN MARKET SIZE is NOT VERY USEFUL, but …
– Google YOUR SPECIFIC MARKET
– Research revenue / market cap of larger companies in the space
– Trim down and be conservative
Estimate you can capture 1-10% MAX!
Bottom up is MUCH BETTER approach, especially for early stage founders who need to build credibility with investors.
It is also A LOT simpler.
Market size = # Of Customers X Revenue Per Customer.
There are 180,000 dental practices in US.
If you sell them software for $500 MRR or $6K ARR you are going after 180,000 X $6,000 = $1B opportunity.
To get to $100M in ARR you need to sell to 10% or 18,000 dental practices – and keep them!
Let’s look at another example – Netflix.
$20 a month or $240 ARR, assuming they sell to each of 120M households in US, Netflix can get $28.8B. Sanity check, it is currently at $7B in US or about 1/4 of total market.
So what looks like a small market?
Say we are selling SaaS tools to Universities in US at $100K ARR — which is nice size contract.
There are 5,000 universities so $500M market.
Most if not all VCs will consider it too small.
Go back to the formula:
Market size = # Of Customers X Revenue per Customer
Either there are A LOT OF CUSTOMERS who PAY A LITTLE or
A FEW CUSTOMERS who PAY LOT.
Hack – use Netflix as a baseline
100,000,000 households paying $10 a month
Order of magnitude for Netflix is $10B – venture size market.
Learn to shift zeros from left to right.
100,000 restaurants in US =>
Each would need to pay you $10K a month to get the same $10B market – Impossible!
VCs love > $10B+ markets.
VCs don’t like < $1B markets.
If you know how many customers you COULD HAVE (Google it!) and you know how much they would pay (ASK THEM!!!) then you know exactly where you would fall.
There is NO EXCUSE whatsoever to not get the BOTTOM UP MARKET SIZE right.
Stop using TAM / some crazy out of this world numbers that have NOTHING TO DO with your business numbers in your decks.
Use BOTTOM UP MARKET SIZE & get it right!
Also to know about the markets is are they EXPANDING.
For example, EV Market => Expanding, Gasoline based vehicles — shrinking!
VCs love quickly growing markets – forward looking.
VCs dislike shrinking markets – backward looking.
This gets tricky…
Digital Health – Growing!
Traditional Health — Likely Shrinking!
Overall education – Growing!
Traditional education – Likely Shrinking!
VCs are going to get into the weeds!
Some founders get upset hearing that their market is too small, but the best founders DO NOT CARE!
Best founders are on a MISSION to solve a problem, not to generate venture scale returns. Those two don’t always align!
If you are passionate about small market you should still go and build a business!
You can still raise capital, structure it smartly, and grow through the best $ out there – CUSTOMER REVENUE!
VCs are NOTORIOUSLY WRONG about market size. Even Uber and Airbnb initially were told their markets are too small 😂.
The best founders can EXPAND MARKETS. They see the future the way others can’t.
Don’t be deterred!
– VCs are RIGHT to care about MARKET SIZE
– Avoid HUGE RANDOM TAM # into your deck
– Do research & use BOTTOM UP MARKET SIZE
– Even the market is small but your are passionate – GO FOR IT! What VCs think DOES NOT MATTER!
Good luck & follow @2048vc for more!