I received an email from somebody asking me how to calculate TAM, which is “total addressable market,” (don’t feel bad if you didn’t know the acronym, because I didn’t either; I had to look it up). I’ve always called that simply “potential market.” As far as I’m concerned, these are the same thing. I’m going to call it potential market here, in this post. Regardless of what term you use, understand that these numbers are stories, possibilities, and hopes, not facts. They’re useful because they give a business plan a sense of scale. People want to know how big this opportunity is and how big it can get. But market size is relative, markets change quickly, definitions are very fluid, so market numbers are educated guesses at best. Market Forecast and Potential MarketFor a general review of what a market forecast it, and how to do one, I’d recommend this link to an article I wrote called what is a market forecast*. A market forecast is almost always looking at potential market, not market share, realized market, or sales; potential market is almost always a large number. Identifying Your Potential Market – Industry ExamplesNormally to calculate potential market you start with a large number and then narrow it down. It’s a lot like taking a pie and slicing pieces off of it. The potential market for business planning software, for example, would start with all people who have access to computers that can run the software. You’d have to quickly cut out people who are too young or too old, people whose computers don’t have the right operating system, people who can deal with the languages supported by the software. And then you’d want to narrow that down to people who are interested in business and, still cutting off pieces, people who want to do business planning using software. When I was writing for Business Week out of Mexico City, years ago, the head of an American pharmaceutical company operating in Mexico told me that his marketing team believed that less than half of the population of the country (that was 30 years ago) was really part of the market for aspirin. The rest either couldn’t afford them or would never take a pill for a headache. So the potential market for shoes is people who wear shoes and have money to buy them, but the potential market for athletic shoes is a subset of that, and the potential market for high heels, or ski boots, or children’s shoes, are also subsets.Some web marketing companies like to think their potential is the whole world; but it’s really people who have access to the web, who can order with shipping, who can read the website, and have credit cards. Right? Potential Market versus Market ShareIn all these cases you start with the large pie and cut off slices that don’t apply. And in all these cases you can see that the potential market is always way bigger than the actual served market, or market share, or actual sales. Nobody ever gets a large percentage of any potential market. Take a minute to think of the largest, most successful marketing brand you’ve ever heard of, and then think of the potential market, and then how much of it they actually get. Take McDonald’s, for example, with all the billions of hamburgers they’ve served, with a potential market equal to roughly that portion of the entire world’s population that can get to a McDonald’s restaurant, how much of that do they actually get? It’s tiny, wouldn’t you agree? When it comes to potential market, proceed with cautionAll of which argues for taking potential market numbers with a great deal of skepticism. While the big potential market number is nice to have, it rarely has much relevance to real business, and particularly not startups. Markets are relative. Whatever the potential market for video game software is, for example, it’s obviously way bigger than the market for business planning software. When a new venture comes up with something that everybody can use, and wants to use, that’s obviously way bigger than the venture that solves the problem of, say, working with quadratic equations in spreadsheets. Whey potential market doesn’t always impress investorsIronically, when you take the concept of potential market into battle as part of a business plan or presentation, what works best is more story than number. The phrase “a $4.3 billion market” means so much less to investors than “we’re going to change the way people buy shoes” or “we’re going to end sore feet.” Focus on how you’ll get a piece of the marketAnd the least useful market sizing trick is the one that focuses on a new company getting a small piece of a very big market. I see this one way too often in investment pitches and business plan competitions. Don’t ever tell investors you’re going to get a very small piece of a very large market. Instead, build your sales forecast from the details up, channel by channel, search term by search term, store by store, or customer by customer, to make them credible. A large market is great, but when you get into defining total potential market, every business has a large market. What you’re going to do to get a piece of it is much more interesting.
Out in the real world, in small business and entrepreneurship where growth comes more as a result of hard work and following through than because of broad strategies, it's too easy to lose site of the big picture and instead focus on the driving route and never ending details. My suggestion for 2011 is: step back for a bit, take a look at the big picture, and focus on growing smarter, not harder.
The illustration here shows the basic wisdom of the Ansoff Matrix Model, developed at Harvard a couple of generations ago, yet still worth considering as part of a growth strategy. I still see the impact of it in the real world, a lot.
The idea is to think of your growth in terms of two key factors: product (which could of course be service as well; for this analysis, i-s the same thing) and market. You can also think of it as what you sell (product), and to whom you sell it (market).
If you step away from the business and think in broad terms, the product element of growth is either existing product (selling the same thing you always have) or new product (selling something brand new). And the market element is either selling to existing markets (the same buyers yo-ve been selling to) or new markets (new and different kinds of buyers, buyers from different groups, new types of buyers, new target markets).
As it turns out, some kinds of growth are a lot more expensive than others. It's generally accepted that the least expensive growth is what I show in green here, the lower left quadrant, focusing on selling more of the same thing to more of the same kinds of buyers. That's selling existing product to existing people. And by least expensive I mean that on average this takes the least capital, the least time, and the least effort.
For example, a computer store growing in this more conservative way might focus on selling more computers, more RAM memory, more hard disk space, and more networking hardware to its existing small business client base. That would be growth in existing product to existing markets, in the green quadrant.
The other extreme, the red quadrant, is usually the most capital intensive, hardest, and most expensive. That's about expanding into different products and markets at the same time. With the computer store example, that might be growing by selling new technologies (product) into different markets (government, large companies, or whatever hadn't been their market before).
And, as you might guess, growth in the blue quadrants, along the diagonals, is somewhere in between. Introduce something new to your existing markets, or take what you now sell into new markets. The general rule is i's harder and more expensive than the green quadrant, but less than the red quadrant.
And what does this mean for next year's strategy. Here are a few concrete suggestions:
- Look first for the untapped low-hanging-fruit opportunities - ways to sell more per buyer to your existing buyers. Wha's your equivalent of selling extra RAM and hard disk storage to your existing clients? Tha's the easiest growth.
- Then look for those nearby opportunities, the diagonals, expanding into something new to sell to the existing customer base, or finding a way to take what you now sell to new customers. This is more expensive, yes, but it's also a way to broaden and diversify the business and reduce risk.
- Don't rule out the long jumps into the new areas. Thatâ€™s more risky, and harder, but also more rewarding if you can do it.
How to decide? Plan. That's just another reason to make sure you have a good planning process in your business. Give your business a fresh new look. Scan for the right opportunities. Figure out the steps andresources required, and give yourself some new horizons for the new year.
*Not a government website.
Reality check: how many times have you eaten at a restaurant whose strategy was high end and delivery low end? How many times have you dealt with a business preaching customer service that did;t really offer you any? How often do you run into a business whose strategy aims to please, but its business, the people in it, and the decisions they make, do-t really aim to please?
Tha-s all about strategic alignment, which is a nice business-like way to talk about actually doing what you say yo're doing. Not just talking about strategy, but also, doing it.
For example, I once consulted with a computer store that wanted to focus on small businesses instead of walk-in computer hobbyists. At strategy meetings they agreed it was all about high-end service, installation, and becoming allies of the customers. But then they went back to work, back into the routine, and did everything exactly as they always had, with no changes.
With strategic alignment, they added a big service desk and had technicians wear white coats. They bought vans and sold products with installation bundled in. And they trained their payables person to ask clients why they were late, which turned up some additional installation problems.
The strategy made no difference -- that is, until they implemented it.
With that in mind, 'd like to suggest five questions you can ask yourself about your own strategic alignment.
1. Does your team understand your strategy?
This is't just a big-company issue, surprisingly. 'm amazed how often even in the 10-person company, sometimes even when there are just the two or three of you, the strategy is just lip service to some business buzzwords. Do the words (or slogans) mean the same thing to everybody? Is it obvious how the strategy affects daily business, your website, your pricing, your choice of products or services to offer, and your relationship with your customers?
In the computer store example, they had to rearrange the people and products in the store and deliver services companies needed. The payables clerk, the trainers, and the support people had to understand the new strategy. Not just the upper management.
2. Does your effort match your strategy?
Avoid the trap of strategy that lives only in meetings and business plans. Make it strategy that drives your business. Since strategy is focus, start watching where the energy goes after the meetings are over. Watch what you do all day every day. Does your daily business match the focus you put in your strategy?
If you do't think about it, sometimes you and the people around you attend to the parts of the business you like, that yo're most comfortable with, rather than the parts of the business that are going to have the most impact on strategy. Be honest about it.
In the computer store example, they had to put less effort on the retail store and the boxes and their prices, and more on outbound selling, seminars, installation, and training.
3. Does your spending match your strategy?
True, realistically, yo're still going to pay to get the wastebaskets emptied and the floor cleaned regardless of your strategy. But a lot of your spending should show the same focus as your strategy. Think of your marketing activities, for example, and look where your marketing dollars get spent. Then look at how you generate the product or service you sell, and ask whether that spending matches your strategy. Do you buy high-end inputs to make a high-end product? Do you pay your people high-end salaries to match the high-end service the're supposed to offer?
4. How can you tell if it's working?
Do you have units of measurement available, so you can tell whether your strategy is working? We call this metrics. In the computer store example, they looked at the demographics of customers (individuals vs. companies) and the texture of the sales (installation, training, and support, multiple units, compared to just take-out boxes with computers in them.)
Put yourself a few months into the future: how will you know that your strategy is working?
5. What would your customers say?
The ultimate test of any company's strategy is in the market. Are the people you want to reach getting the message? Would the customers, if asked, understand your distinctive differences the same way you do in the strategy meetings? Word of mouth is extremely valuable. What do people say about you online? Does it match your strategy?
*Not a government website.
As I write this post ;m putting on my angel investor persona, as 2010 investor chair of the Willamette Angel Conference (WAC), a group of local-to-me angel investors that makes one six-figure investment per year. -m new to investing, -m a small player, and I do it in a group. Furthermore, my opinions here are my own, not those of the group.
Here are some things that I want to see in a business plan submitted to our group for consideration for investment. And this is more-or less in order of importance, but that order is not as rigorous as a numbered list might imply.
1. Experienced team
I want people who have done startups before. They tend to know what the're doing and where the're going much better once the've been through that process. I do't mind that much if they were't the leader before, and not even that the previous startups failed. 'd like them to know the territory because it reduces risk.
I like a team more than the single entrepreneur. Building a business takes different skills, so ideally a team has people with diverse experience around different functions of the business: Sales, marketing, administration, and so forth.
2. Believable exits
Ther's some irony here, because we built our business without caring a bit about exits, but when I think like an investor, I want to know that the money I invest is going to generate money coming out of the company, going back into my bank account, later.
So i's not just a matter of having a good business. It's a good business that will grow well and become a business that gets acquired by a larger business in 3-5 years. A lot of good businesses will never be interesting to an acquirer. Is it scalable? Is it defensible? These things make huge differences. It's surprising to me how many people think they can get investors interested in a people-based service business, for which the assets walk out the door every night. Products are much better for exit than services.
3. Real growth prospects
The key to investment success is making the business worth a lot more later than what it's worth today. That takes growth. And growth is a matter of scalability and defensibility, which I included above under exits, plus the size of market, the nature of the need, and so forth.
4. Real planning
Like many investors, I can rule out some companies just from reading a summary memo or watching a pitch presentation. But if I'm still interested after hearing the pitch and reading the summary, then I want to see a plan. Pitches without plans are obvious, because they don't have the potential to drill down into the granularity when questions come up. And of course I like a plan that is easy to decipher and well written, but what I really look for is the pieces coming together. I want to see the conceptual links between product, marketing, sales, and financial plans. Are they aligned with each other? Do they indicate understanding the keys to success? Does this look like a plan that will be managed, that can be reviewed and revised, and will remain flexible? Or is this a plan that was done once and then forgotten. I want to see planning and management, not just a plan.
A final thought
None of this is completely predictable. Good investments will sometimes appear that don't have all of the characteristics I've listed here. Still, all things being equal, this is a good filter to start with.
*Not a government website.
It seems like the basic sales forecast is one of the hardest pieces of business planning for most people to deal with. I think if we dug deep enough w;d discover ther-s a fear of forecasting at the bottom of the problem. And -m hoping I can help with that by offering these five tips.
1. W're Not Really Supposed to Know the Future. W're Guessing.
Somewhere along the way I realized that a lot of people assume that somebody else knows better. As if having an MBA degree or CPA certification means somebody has a magic bag of tricks for forecasting, tricks that other people do't have. The truth, however, is more like good old fashioned educated guessing.
I do have an MBA degree, and I was also a vice president in a market research firm for several years. We produced a lot of forecasts. They were so much more educated guessing than anything else. It was't a matter of econometric modeling, surveys, or detailed research. Instead, w'd talk to product managers, compare opinions, do secondary research, and make educated guesses.
And quite often, the best forecasts were the educated guesses of people in the front lines of the business. Sure, we needed to research as much as we could, but that was to educate the guesses. They were still guesses.
2. You are't wrong for very long. Yo're Going to Revise
I's not like you have to forecast the future for that whole year in advance, although that's what a lot of people fear. Back in the real world, though, you forecast for a year but you follow the plan vs. actual results at the end of each month, and when things go different from the forecast - and they always do - you revise.
Look especially to where assumptions have changed. When assumptions change, your forecast changes.
You should never go longer than a month or two with a bad forecast. Revise it.
3. Break it Into Manageable Drivers
Don't just pull a forecast out of the air. Look at the components. Find the drivers. Almost any business, service or not, can be broken into sales equal to units times price. Units could be days, hours, jobs, trips ... you can still break sales into component parts.
For example, on all things web, look for drivers like page views, search terms and ad words. Then there are conversion rates, and unique visitors. Find a way to relate the numbers.
For a restaurant, figure out what's capacity - use the numbers of chairs and tables to determine how many meals, like breakfasts or lunches or dinners, you can sell in an average day. Then figure out how many days in a month you'll be at capacity.
For a limousine service, it's how many trips per day, week, or month. And what's the price of an average trip.
4. Find The Right Level of Granularity
Forecasting requires a sense of summarizing and aggregation. The bookstore forecasts by main lines of sales, not every book. The restaurant averages out the meals, the drinks, and so forth. If you sell hundreds of different things, find a way to summarize into main categories.
Don't forecast the whole business as one single row of sales. And don't break it into 50 rows of sales. Find the sweet spot, like 3, 5, 10 rows of sales. Find the level of granularity.
5. Don't Look for Answers. Generate Your Own.
One of the most common problems with forecasting is the idea that you're searching, during some hallowed research phase, for right answers. As if there is a standard growth rate, or standard forecast, which, if you find it, will make the whole thing make sense.
Sure, educate your guesses, but it's not a matter of searching online until you get the right study. It's a matter of developing a forecast you can live with, then tracking it, revising as assumptions change, and living with it over the long term.
*Not a government website.