Pitfalls in Market Sizing (part 6 continued)

Posted on Jun 16, 2009 | 5 comments


In my last post I outlined a way to think about market sizing for your VC pitch and emphasized what I think you should do.  In this much shorter post and with no title alliterations (and some emoticons ;-) I will highlight 3 common mistakes that I often see and that I suggest you avoid.

1. 1% of China  chinese_flag

The first problem I call metaphorically the 1% of China problem because it uses a large number and small market share to make it sound like a “no brainer” that you’re business will be successful.  We are only charging $3 / month so if we capture just 1% of China that’s a $430 million market opportunity for us.

In reality I see people pitch it this way, “we’re going after the $2o0 billion US market for local contractor services annually.  We think that third-party websites that help broker these relationships can capture 5% of the value, making it a $10 billion opportunity.  If we capture just 2% of this market (not a tough ask, right?) we will be doing $200 million in sales.  Your market sizing (and frankly your income statement) needs to reflect realism about how the market is disaggregated and therefore the real value you can capture.

You probably need to start by figuring out that of the $200 billion 40% is the value of the products they install, 40% is their labor and 20% is their margin.  Therefore a more realistic market size might be $40 billion to start with.  It is even more useful to know how much local construction firms pay per year in marketing their services because is probably a much better market analogy for what you’ll be trying to replace.  If they spend $2 billion on local advertising then you need to know who they spend that with.  You can make a case that you capture part of this TAM and now your presentation is distinctive because you’ll be talking about the differences in your solution to the Yellow Pages, ReachLocal, radio, ValuePak, etc.  Even better if you can then show that in the top 10 DMAs that you’ll be targeting in the first 3 years they spend $300 million.  I learned from doing this the wrong way.  In 1999 I used lots of 1% of China examples.  It was so 1999.

2. Conservative Estimates

One of my biggest pet peeves is the dreaded “conservative estimate” as in, “we’ve modelled out the market for the next 5 years and we’ve used very conservative estimates to show how we’ll capture 15% of the market and be doing $120 million in sales by year 4.”  First, 90+% of businesses never achieve the targets that they show in their Series A investor presentations and 70+% seem to announce that they’ve used conservative estimates leading to a healthy dose of estimation cynicism by many investors.  So the first thought I have when people give me “conservative estimates” is “yeah, right”.  The second thought I have is, “if these are conservative estimates then WTF don’t you just give me the real estimates?”.  Simple advice – don’t ever tell a VC you’re giving them conservative estimates.

3. Loosely defined industry

The last obvious pitfall I see is the loosely defined industry.   “I’m addressing the $300 billion US energy market.  We want to have people 10% on energy.  Therefore our market size is $30 billion” or “I’m addressing the $2.3 trillion US services market.  It is a huge market.”  You’ve already lost credibility so whatever you say next almost doesn’t matter.  Define your market sizing as tightly as you can.  Nobody will fault you for coming up reasonable estimates.  They will fault you for no thought about your market size or too loosely defined a market.

Next post: How to talk about the competition

  • http://www.smartxrf.com Paul

    I pitched a VC this week using financials based on bottom-up estimates of market size, etc that — I believe — really are VERY conservative. We narrowed an initial market of 22 million U.S. houeholds (with a child 6 or under) down to about 5 million (who we estimated to be better educated and focused on child raising). Then we built our models around the possibility of reaching 1% of that market within 5 years. I picked 1% out of my own little brain; however suprisingly, I never had heard of other people using that percentage so regularly. (Among other things, I’m not a B-school grad.)

    When I shipped my latest glorious business plan off to the a kind VC director who asked to take a look at it this week, I did not 1 but 2 of the things you describe as pitfalls above, namely, using the 1% figure and telling him that my financials are conservative.

    Did I screw up? I was deathly afraid that he would think I was pulling optimistic numbers out of my rear end, but maybe simply by doing these 2 things that you cite as pitfalls, I have ruined my credibility anyway.

    Is the point not to use conservative numbers, or is simply not to point out that you are doing so?

  • marksuster

    My 2 cents: you can show data on marketing sizing and your growth rate. You can show 2 models called “base case” and “aggressive case” and your model is built on the base case. Your pitch is: “this is what we believe will happen in the market and we’ve tried to use “realistic” numbers to model. The reality is that we can never predict at this early stage in our business what will happen but we’re know we’re 1) addressing a serious problem that people have, 2) we have differentiated IP and 3) the market size is large.” Something like that. Good luck! P.S. MBA’s are overrated – I wouldn’t sweat that ;-)

  • http://www.smartxrf.com Paul

    Thank you Mark. Very helpful. Plus, terrific blog. (I’ve read all of it in the last 24 hours.) Kind regards.

  • http://venturesarajoy.wordpress.com SaraJoy

    Really helpful information, interesting perspective. Just dipping toes into this world myself, a little inside info is certainly appreciated.
    It would help your credibility if you were more careful about proofreading, though. The typos and usage mistakes are distracting.

  • marksuster

    OK. I’ll try to watch my typos. It’s just that usually I write after my kids and my wife have gone to sleep, which means I write from 11:00pm – 1:00am. So I’m usually more interested in getting the content out than the perfect spelling. If you notice any typos or misused words by all means please point them out and I’ll happily update. Thank you for your comments.

  • Pingback: Standing on the Shoulders of Giants–at least for an hour! « Ventures

  • Pingback: Pitfalls in Market Sizing (part 6 continued) | CloudAve