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If TAM, SAM and CAGR mean nothing to you, you have a problem. Whether you are creating or disrupting a market, knowing how big it is, and what segments are most ripe for the picking are critical. – TM
There is a common sin that marketers frequently commit. In their rush to build a website or create an attractive logo, they forget something very important: who is the buyer? These marketers are firing without aiming. They are being tactical and not strategic. Sometimes they are simply shooting to make it seem as if they are doing something.
To build an effective marketing strategy, you need to understand who will be buying your product. This means, among other things, that you need to calculate how big the potential market is for your product or service and how much of that market will be contested by your competitors. And, if you are really good, you will learn not just who those buyers are but why they purchase the goods and services they do.
A market is a place where trade takes place. Markets are dependent on two major participants—buyers and sellers. Market segmentation is what the name suggests—understanding the overall potential market for your product and determining which subsets, or segments, of that market are most likely to buy from you.
Market segmentation varies somewhat depending on whether you are selling B2C or B2B. Regardless, most of the core concepts are the same. You will just be segmenting using different criteria.
For B2B markets, there are three fundamental characteristics of the customer that your company should know: location, company size, and industry. Let’s take a closer look at each one.
Location – Where is the company located? Most commonly, marketers perform this segmentation at the country level. For smaller businesses with less reach, or for certain types of products or services, however, segmentation can be performed on the level of a state, a province, or even a city. In some cases, segmentation considers whether the target company is located in a major metropolitan area, a suburb, an exurb, or a rural area, although this level of segmentation is more common for B2C markets.
Company size – Is the company a small business, a midsized business, or a large enterprise? This information is valuable, because it helps the seller determine whether its products meet the target company’s needs and the target company can afford them. Although definitions of these three segments vary, the most common breakdown is:
- small businesses have fewer than 100 employees;
- midsized businesses have 101 to 1000 employees;
- enterprises have more than 1000 employees.
Some marketers divide one or more of these categories into subsegments. For example, the small office / home office (SOHO) segment is a small business with fewer than ten employees. Other marketers add segments; for example, large enterprises for companies with more than five thousand employees. (FYI: all of the Forbes Global 2000 fall within this subsegment.) Which system you adopt depends on the nature of your organization, its products and/or services, and its goals and strategies. The most basic rule is to use segments that make sense for your business.
Industry – Different industries have different needs, and knowing which industries need your products and services is a critical aspect of segmentation. You can obtain lists of industries—and subindustries—from a number of sources. The most common source is the Standard Industrial Classification (SIC) code. The US government created the SIC codes in 1937 to establish a standard system that all federal agencies and departments would use to classify industries. All SIC codes consist of four digits. For example, the industry SIC code for Metal Mining is 1000. Within this industry are numerous subindustries, such as Gold and Silver Ores (1040) and Miscellaneous Metal Ores (1090).
Clearly, identifying the viable markets and market segments for your products and/or services is essential to your company’s success. Regardless of the markets in which you operate, however, it is essential that you have an accurate knowledge of their size.
It’s probably safe to assume that everyone wants to do business in a large and fast-growing market. However, it is possible to make money in a niche or a nascent market. You can also be successful if you introduce a revolutionary product that is just the tonic for customers who are fleeing a declining market. The point is, you can make money in all types of markets.
How can you determine how large your target market is? There are several standard metrics you can use to measure markets.
Total available market (TAM) – This is the total size of the market. It is also referred to as total addressable market.
Served available market (SAM) – Also known as served addressable market, the SAM is the total size of the market that is currently being served, or sold to. It is a portion of the TAM, and therefore it is always smaller. For example, according to the research firm IDC, 659.8 million smartphones were shipped in 2012, up 33.5 percent from the 494.2 million units shipped in 2011. (International Data Corporation. “Worldwide Smartphone 2012–2016 Forecast and Analysis,” March 2012) Assuming all of these are sold, then the SAM is 659.8 million, plus the smartphones previously sold, minus the number taken out of service. A big number, but nothing compared with a potential TAM in the billions if every adult in the world owned one.
Share of market (SOM) – More commonly referred to as market share, this is the percentage of the market that a given company owns.
Market growth – This is the rate by which the TAM is growing. It is typically calculated on an annual basis and expressed as compound annual growth rate (CAGR, pronounced “ka-grr”).
Figure 1 Market sizing graph – composite TAM, SAM, SOM, and CAGR
You can obtain many of these numbers from analysts who follow your industry or product. If you are selling something new, you may need to extrapolate or combine research to create an approximation, or “comp,” of your market.
A bit of advice to those of you who create marketing plans: Never walk into the boardroom with only the TAM. From personal experience, I can tell you this is one of the fastest ways to get thrown out of said boardroom. You need to understand the market dynamics—what your competitors are doing, price pressures, the strength of your brand—better than that. Also, never say the following: “This market is so big; if we captured only one percent of it, we’d all be rich.” I know more than one venture capitalist who stops listening to your pitch at that point. No one goes into business to get a 1 percent share, and presenting this argument suggests that you don’t have a very sound strategy.
An accurate knowledge of market size is critical to understanding the dynamics of a market—current or new—and assessing whether there is room for growth. Good markets are typically large and have a gap between the TAM and the SAM. This gap represents sales opportunity for your business. Opportunity also arises when the vendor with the largest SOM is vulnerable and your company feels it can take away market share based on an advantage in your product, price, or distribution. Another strategy for stealing market share is aggressive promotion. One of the best examples of this strategy is the market share gained by online insurance companies such as GEICO and Progressive. With essentially the same product, offered for a bit less via direct sales as opposed to agents, aggressive promotion via television advertising enabled these companies to dramatically increase their market share. As of 2011, GEICO is the third largest auto insurance provider in the United States, and grew at 7 percent, while the CAGR for the overall auto insurance market is only 1 percent. GEICO is stealing market share.
The best way to size markets is to perform both a top-down and a bottom-up analysis. Find analyst reports that provide the TAM, growth rate, and market share, if they are available. Then, balance that top-down approach with your own bottom-up calculations based on your price, manufacturing capacity, and sales reach.
Startup essentials is a series of excerpts from The Professional Marketer. I’ve pulled out what I think are the most essential skills a founder or a marketer at a startup would need.