Starting a startup is always a challenging and exciting journey, but truly successful businesses are built not only on good ideas but also on thorough market analysis. Understanding why market sizing is critical before launching a startup can make all the difference. It shows whether there is real demand for the product or service and reveals the realistic size of the market your startup can reach. In this post, we explore the different levels of market sizing — TAM, SAM, and SOM — and discuss how these figures can help persuade investors.
Recommended for: Startup founders
Why is it important to determine the market size for an early-stage startup?
Starting a new startup is an exciting and hopeful time, but success requires more than just a good idea — it requires thorough market research to forecast viability. Is there actual demand for the product or service? If so, how large is that market? Is it worth investing time, money, and energy into the envisioned project? These questions are crucial for every startup founder. According to the U.S. Bureau of Labor Statistics (BLS), 23.2% of private-sector businesses fail within the first year. One of the keys to helping a business successfully survive the initial challenges is accurately estimating the market size.
How can we measure market size?
The process of market sizing involves several steps. First, it’s essential to capture and understand the market, then identify different segments to get a clear picture of who makes up the target audience. What are their buying preferences? What portion of the market can we directly target? Next, analyzing competitors is crucial: who is already in the market, and what services do they offer? What challenges or risks do they present, and how can these be minimized? Perhaps there are factors that could make us stand out or give us a strong competitive advantage.
The data gathered from measuring the market reveals not only potential revenue opportunities but also insights into consumer behavior in the target market. It uncovers various aspects that can be critical for developing a successful strategy.
Why is this important for investors?
While understanding market size is fundamental for founders, it’s also crucial from an investor’s perspective. One of the key slides in a startup’s pitch deck is the “Market Opportunity” slide, which answers a vital question: what is the size of your potential reachable market? This figure demonstrates the return an investor can expect on their money. Let’s be honest — most investors are in it for substantial returns. Big markets mean big opportunities. That’s what they want to see.
Understanding your market size is just the beginning, the next step is knowing how to communicate it effectively. Our CMO Partner service helps startups turn data and analysis into clear, consistent marketing communication, ensuring that your message resonates with both customers and investors.
The benefits of market sizing
Market sizing provides a long-term strategic advantage for the startup, as it reveals not only current opportunities but also future growth potential. This foresight helps to identify pitfalls early, optimize resources, and plan product development or marketing strategies more precisely. Accurately estimating market size supports setting realistic and measurable growth goals, enabling both founders and investors to make decisions on a more secure foundation.
Ultimately, if the market is indeed large enough, why couldn’t the startup become a successful business? And if it’s not, is there potential to expand the target audience or even explore new markets? A good market size estimate is often more than just numbers: it provides a deeper understanding of market demands, reachable customers, and competitors. That’s why it’s the foundational step for every successful business.
How is market size structured?
When determining market size, we aim to quantify all potential buyers and their anticipated purchasing intent. This is typically analyzed across three levels to gain a clearer picture of market opportunities and potential revenue.
Let’s take a closer look at these in detail:
1. TAM - Total Addressable Market
TAM is the largest, most comprehensive figure, covering all potential buyers who might be interested in the product or service, regardless of factors like accessibility, price, or other elements that could impact purchase intent. For example, if a company launches an online food ordering service, TAM represents the entire global food ordering market, including all countries and potential buyers. It’s important to note that TAM doesn’t indicate the actual reachable market but rather all possible buyers.
2. SAM - Serviceable Available Market
SAM is a narrower portion of TAM, limited to the markets we can realistically reach, taking into account the business model, geographic location, and other restrictive factors. For instance, in the previous food ordering example, SAM might represent the size of the food ordering market available within a specific country if the company currently only operates locally within that country. SAM helps us get closer to our actual market but still within the maximum scope of possibilities.
3. SOM - Serviceable Obtainable Market
SOM is a further narrowing of SAM and represents the portion of the market that the business can realistically reach in the near term, considering current resources, competitive landscape, and consumer habits. Returning to the food ordering example, SOM would be the number of potential buyers in a specific city or region that the company is currently able to serve with its existing logistics and marketing capacity. While SAM shows the maximum potential of a particular market, SOM reflects the company’s actual reach, serving as a starting point for growth and market share.
The TAM, SAM, and SOM trio essentially represents the process of narrowing down and segmenting from all possible buyers to the number of customers that are actually reachable for the business.
How should we think about market potential?
Three approaches from an investor’s perspective
To accurately determine what’s worth measuring and which areas to focus on, it’s helpful to think like an investor. What criteria guide them? How do they assess the value or growth potential of a market? Below, we present three common yet effective approaches that can aid in realistic evaluation and strategic decision-making.
- The “$1 Billion Heuristic”
Among market players and investors, the big dream has always been to create a unicorn, a company valued at over a billion dollars. Is your market large enough to reach this milestone within the next 3-6 years, even under the most conservative projections? If the answer is yes, you’re already off to a promising start.
Of course, the numbers are enticing, but it’s also crucial to carefully develop the strategy to reach that goal. What competitive advantages and strategic steps can bring you closer to it? Is there already a niche market or innovation that can support exponential growth?
- The “Fund-Returner” Approach
Venture capital investors take on significant risks, and since only a few investments in their portfolios typically yield substantial profits, they are particularly sensitive to the potential for full fund returns. Such investors therefore look not only at the market size and opportunity but also at the likelihood that a particular investment could return the entire fund.
Venture capitalists often aim for a 3-5x return on their entire fund over roughly a decade. If a market is “just” solid and stable, that alone may not be enough to attract the largest VCs, who are interested in opportunities for massive returns. In these cases, it’s crucial for the business to present a plan that aligns with the growth rate investors expect.
- Betting on Future Growth
The market potential isn’t always immediately tangible. Your market might not show impressive numbers at present, but what if radical changes occur in the industry? Some markets experience explosive growth over time, signaled by trends like technological advancements, demographic shifts, or changing consumer preferences. It’s important to keep an eye on industry reports, adjacent sectors, and, not least, customer trends. Entrepreneurs who can recognize and leverage such opportunities may gain a significant competitive advantage over time.
The role of critical thinking in market sizing
Assessing market potential is a complex process, and each of the above approaches highlights the market’s value from a different perspective. The $1 Billion Heuristic reflects the desire for large-scale growth, the Fund-Returner approach emphasizes the potential for substantial returns for VCs, and betting on future growth carries an element of optimism. But how can you effectively navigate these perspectives and make a decision that serves the interests of both parties — the business and the investor?
If your market is large enough to be attractive to investors, and the data indicates sustainable growth in the long term, then you’re already on the right track.
How to assess your startup's market size?
How should we start this process? Desk research — analyzing available statistical data — can provide a valuable foundation, but it isn’t enough on its own. For help with this, you can refer to an earlier blog post that offers guidance on accessing free market research reports!
To truly understand the target market, we need to step away from the computer and talk to people: potential customers, target buyers, and industry experts.
Why is it worthwhile to gather direct feedback?
Mapping the market isn’t just about numbers; it’s a more personal process where you gather real feedback. Imagine the difference it makes when you directly hear your target customers’ problems and expectations. You also gain detailed insights into different customer segments, which helps in sizing the market. Conversations with customers and testing value propositions help refine your understanding of needs, providing knowledge that desk research alone can’t offer. The more data you gather about your potential buyers and positioning, the stronger you can build your business strategy.
But what if you have to face competition? Or if technology adoption is still low? Switching costs can also be high, all of which are risk factors that you need to consider. Integrating these challenges into your overall strategy provides a more solid foundation for your business plan.
How to calculate market size for startups?
To determine market size, we can use two main approaches: the bottom-up and the top-down methods. However, for more reliable results, it’s recommended to use both.
Bottom-Up Market Sizing Method:
The bottom-up approach is more precise but also more time-consuming. This method allows us to accurately define the target customer segment and gain a more detailed view of the market. We can proceed through the following steps:
- Defining the target customer segment – Identify who your primary target audience will be.
- Estimating average revenue per potential customer – Calculate the potential revenue each customer could bring.
- Evaluating the total target customer segment size – Estimate the number of customers that could belong to this segment.
- Determining market size – Define the market size based on your initial product and target customers.
- Calculating SOM (Serviceable Obtainable Market) – Calculate the targeted market share (SOM) based on the relevant revenue per customer.
If you aim to expand within a comprehensive product category, it’s important to analyze the size of the entire market, including all relevant customer segments and products.
Top-Down Market Sizing Method:
The top-down approach is faster but less precise. This method relies on industry estimates and market share data. It’s useful to proceed through the following steps:
- Selecting the target market – Identify which market you want to focus on.
- Defining TAM – The Total Addressable Market represents the total size of the industry or market.
- Defining SAM – The Serviceable Available Market is the portion of the TAM that you can reach with your current market strategy.
- Calculating target market share – The share of the SAM that you realistically aim to capture is your SOM.
It’s essential to make the market size a dynamic figure by adding trend data and information about growth potential to showcase future prospects. For investors, it’s also crucial that you have a realistic view of achievable goals: confidently demonstrate the level of growth you can realistically attain.
How to handle estimates and uncertainty in market sizing?
Ultimately, market sizing is expressed in concrete numbers, but it will never be entirely precise. There will be uncertainties, and that’s natural. In some cases, you’ll need to rely on well-founded assumptions, which is acceptable to investors if you support your estimates with as much available data as possible.
Market research isn’t just a calculation task; it’s also a part of your strategy. Investors will appreciate the soundness of your approach if you can clearly present your data, analyses, and the conclusions drawn from them. At the end of the day, this is the most important question: does this market truly hold enough potential to make it worth investing in?
