Sorry Guys – It’s the Size of the Wave, Not the Motion of the Ocean

Part 6 in my VC pitch series:

If you haven’t read any previous posts in this series consider starting here at the start but it isn’t really required to get the gist of the post.  If you want to go to the post immediately prior to this one it is here.

surfSo by now I know your bio and why you eat nails for breakfast.  I understand the problem you’re trying to solve and why your solution is just the fix.  You’ve shown me your killer demo and I’m excited.  MAN!  Who could have thought you could do THAT with Ajax ;-)

But now comes the time for one of the biggest VC roadblocks that many VCs will tell you they aren’t obsessed with and I guarantee you that 98% are (and the other 2% are liars).   “How big can this get?”  It is one of those vague objections that is used to kill off many deals.  The reason that many companies fail on this question is that they don’t put enough effort into this analysis (and frankly, if more people did do this analysis some businesses might actually not get started).

My own hypothesis on why more market sizing doesn’t happen is that many entrepreneurs are in love with product features rather than thinking through how much they could charge for their product, how many people would actually buy it, how many competitors they will have and therefore how big the market might be.  It leads to what a friend of mine at First Round Capital termed FNAC (Feature, Not a Company).  But even if you are a “company” how big is your market?  If you’ve never done market sizing before try to find a friend through LinkedIn that knows someone at McKinsey, Bain or BCG.  They churn this stuff out for breakfast.

Market Sizing

1.  TAM – The starting point in market sizing is something we call TAM or Total Addressable Market.  It usually starts by your defining the industry you’re in.  For example: The US apparel industry is worth $280 billion per year.   You might even have a stacked bar showing the breakdown by shoes, athletic wear, formal wear, casual, etc. … if that sort of breakdown were relevant.  But PLEASE don’t for a second imply that you’re going after a $280 billion opportunity.  Many people make the mistake of alluding to this massive market size, which sets off the VC wondering about your sense of realism.

Next you need state that the online market for retail is between $18-22 Billion and you might have a stacked bar to the right of the apparel bar (you don’t have to format it this way, but I do recommend some sort of graph / visual to walk through this exercise is possible).  If you have the breakdown by either category or major vendors (or both) that would be helpful.  I recommend that you have a very small footnote in the bottom left of the slide in a really small font that denotes your data source.  If your VC is an ex consultant or banker he/she will be feeling really good right now.

But wait, are you really going after the entire online apparel industry?  Or just a sub-segment?  I’m guessing the latter.  Better define it.  You might be going after the high-end, fashion forward segment and that might be $1 billion of the online market and $20 billion of the total market.  Now we’re talking.  You’re going after the $20 billion, high-end online apparel market of which only $1 billion is sold online today.  [while you estimate that 8% of all apparel in the US is currently bought online – only 5% of high-end is bought online … hopefully that was part of your problem statement]

2. Bottom Up – For some industries it may by easy to do a bottom up slide also, but even if you don’t please give it some thought in case you’re asked.  If presented with the information above and I know a small amount about online retail I might say, OK, let’s see … BlueFly does about $100 million in sales, Nordstrom must do at least that much, then there’s ShopBop, RedEnvelope and all of the “private sale” sites like HauteLook, Gilt and Ruelala.  OK, $1 billion sounds reasonable.  Maybe even light?  You’d be surprised how many market sizing discussions blow up here.  A partner asks, “so how big is the largest player in this segment today” in order to try and do the back-of-the-envelop calculation to see whether your market sizing is right.  “I don’t know” isn’t going to earn you kudos.  Credibility starts to wane.  If you don’t know how big (or at least a guestimate) the largest player in your segment is that’s not a good sign.  Maybe you haven’t really thought through this whole go-to-market thing as clearly as I had thought when I saw that sexy demo?

3. Market Growth – OK, so it’s only a $1 billion market today but it IS the fastest growing segment of the eCommerce market today.  Show me the 5-year projections how this will grow to $9 billion in just 5 years and make sure you do all your math because you know that we will.  VC’s are really good on the fly at these kinds of calculations.  We watch these presentations day-in and day-out.  You do them once / year TOPS (hopefully).  So … $9 billion in 5 years and it’s a $20 billion market segment growing to $22 billion.  That’s about 40% of all high-end fashion being bought online in 5 years.  Is that reasonable?  I don’t know.  But you better.  And you better be prepared with the reasons why.  You don’t have to lead with the percentages and explanations – but be ready to answer it if asked.

4. Market Share – So, the market is $1 billion growing the $9 billion.  What is a reasonable share for your NewCo to grab given entrenched competitors?  Maybe year one you think you can do $500k in sales growing to $100 million in year 5.  This still represents just 1.1% of the market share.  You will address later on a different slide how you can get to $100 million but in a category like this I’ve seen it happen in even a shorter period of time.  (in face, showing examples of similar company growth projections adds to your credibility).  In any case, beware of the large market share problem.  Doesn’t apply in this example, but there are times where people assume too big a share – like 50% in year 5.  Even 35% share in many instances will seem high.  On the other hand if you’re only 1% after 5 years perhaps you need to define your market more granularly.

5. Market Value (Gross/Net) – Don’t be tripped up by gross / net.  If you think that you’ll be doing $100 million of “gross” sales through your website in year 5, how much of those sales are attributable to you?  If you’re Land’s End selling your own product the answer is 100%.  If you’re PrivateSaleCo selling OPP (Other People’s Product, that is) then you’re true value might be just 30-50% of the value of the goods if you, in fact, don’t take inventory.  If this is the case you’re probably better off reporting your “net” revenue.  Same applies for categories like hotel rooms, flights, etc.

6. International Expansion / Segment Expansion – Many people add in growth plan comments at the end of their market sizing exercise and I recommend it.  In our example you could say, US high-end apparel is $9 billion in 5 years.  But don’t forget that Europe will be $11 billion and Asia will be $5 billion.  We won’t be going after these markets in the near term but as we increase our success we will obviously look to other markets.  Also, while we’re starting in high-end fashion we will likely extend down into the next product category down in fashion terms, which is a $25 billion segment.  We haven’t modelled that into our numbers yet but we believe that this market can be addressable once we’ve built the brand.

Your goal here is just to stretch my imagination and get me excited by the future potential.  You need to get over that all important VC hurdle … this is a BIG market.

OK, so I’ve droned on for too long in this post.  My next post will tell you the biggest 3 pitfalls that I often see in market sizing.

Do you have some feedback on this post?  Questions?  Are you an ex McKinsey guy who can give me some tips to make this advice better?  Please leave some comments.  Love to get all input and get the discussion going.


25 Responses to Sorry Guys – It’s the Size of the Wave, Not the Motion of the Ocean

  1. Joe Seibel says:

    Great post, keep them coming. I have one question. If you are having trouble with coming up with a bottom up analysis, is it possible to combine some known statistics to get an idea of the market.

    For example, I have been working on trying to come up with a good representation of the Cloud IaaS market. To do this I have found what is believed to be the number of servers throughout the U.S. and applied the average pricing of some of the top competitors offering IaaS to get a possible market size.

    What are your thoughts on this method?

  2. marksuster says:


    Thanks for the feedback and question. Yes, by definition you always need to approximate the “bottom up” analysis. So taking what existing supplier prices are multiplied by your guestimate of the amount of customers they have signed up with at least give you their revenue – the basis for bottom up.

    Good luck.

  3. Solid. I’m going back to read 1-5 :)

  4. Congrats on the superb blog. It brings memories of my consulting days… ha.

    Sometimes you need to get creative fact-finding and getting figures to estimate any market size. On a bottom-up this is important because you start fairly granular and add your figures up.

    Even if you don’t have the specific data, you can related to something that you know, and adjust as you get more data. You may not know how many hot-dog stands there are in New York, but you can count the streets and estimate how many per corner.

  5. Great post, and great tips Mark. I do think that sometimes there’s a risk of market-sizing blinding entrepreneurs (and vc’s) to truly disruptive, market-creating companies (e.g. Microsoft Windows’ goal was to get a PC on everyone’s desk before that market existed)… that said, the vast majority of companies don’t fall into this category and would benefit tremendously from following these steps.

    • marksuster says:

      Somewhat agree. There are very few Microsofts or Bill Gates. If you have a Phd from Stanford in a super hot science area and have close access to people with big checkbooks or if you were employee 5 at Facebook and have huge street cred you might get away with no market sizing. I suspect Twitter initially had none. There are rare cases when people will look at track record of entrepreneur or size of idea and forgo market sizing information. For everybody else … there’s the dreaded business plan.

  6. Good stuff. As a CFO in the health care industry I look at these numbers several times a year. How start-up companies and small business get by without looking at this data I don’t know. I’d bet there’s a big market in consulting fees for helping small business and start-ups hunt down these numbers. If they could just be sold on it as good as this post sell’s it. This say’s it nearly perfectly

    “And frankly, if more people did do this analysis some businesses might actually not get started.

    I’d just add, “And avoid the pain associated with launching into a no-market market.”

    • marksuster says:

      Yes, thank you. That is what I was trying to imply. I spent a lot of time with a friend who was looking at creating a sparking drink business (not a soda) for kids. When we did the market sizing, COGS / unit and units required to make any real amount of money we ran fast. Especially when we considered acquisition multiples. We eventually settled on a totally different business that we felt was large enough and has great margins. Years and much $$$ avoided. I angel funded this company.

  7. David says:

    Hi Mark, I’m really loving this series of posts. Above all, I appreciate the frankness, which is very refreshing.

    Here’s my question: we’ve created a system which allows web devs to directly monetize their work (scripts, css, even html) on a per-use basis. The potential market is objectively huge. But how do you even begin to measure it, especially when no-one else is currently doing this?

    In other words, if there is a prima-facie case for the size of the TAM, is there any point trying to justify it with necessarily vague estimates?


    • marksuster says:

      Thank you, David. Different people have different views. Some say it is enough to just have a great idea, great demo, great tech and great bio. To some extent this can be true if it is truly a breakthrough idea and you’re talking to the rare VC who has a product management or engineering background AND has the authority to convince his partnership not to care about the market size. For everyone else I recommend at least estimating. In your case it might be to start with the total number of developers then begin segmenting them. Ways to slice will be depending on your knowledge of the market but typical ways include: 1) geography, 2) start-up developers vs. mid-sized firms vs. large corporate 3) early adoptions vs. majority vs. laggards, 4) java vs. ruby vs. .NET … whatever. But the key is … given your market who do you think will adopt your product first. And give some bottom up estimate of how many there are. And then how much do you believe you can charge for the type of product you provide. And how quickly will the market adopt. (then be prepared to defend price points with examples of similar stuff they pay for). This should be the basis for at least and estimate and some knowledge demonstrated to a VC that you’ve thought about your market rather than just building cool product. Good luck!

  8. PhilSugar says:

    Great post, spot on.

    I totally agree that VC’s are (and have to be) obsessed with “how big can this get”

    When you say if the did this analysis frankly more wouldn’t get started, I disagree…

    More would realize that looking for vc money is not the right avenue to build their business, and they wouldn’t waste everybody’s time most importantly their own.

    I believe the entrepreneurial communities in most cities don’t stress this. The concept is have idea, raise $3M. If you don’t raise the money you fail. This might be the type of idea that scrounge together a hundred thousand dollars and build a “lifestyle” business.

    Sure a “lifestyle” business sucks for a vc (and I could write pages about the waste that happens when vc funded business unfortunately turns out to be one)

    But it that’s what the business is it can be great for the entrepreneur if its structured right….and should be celebrated.

    • marksuster says:

      Phil, I agree mostly. 95% of business are not VC businesses and I tell most people “you’d be crazy to raise VC” because I think you can build a great business and profit financially on a personal basis by not having VC. Obviously there are some businesses where VC is the right answer. Only exception I take is that understanding the market size always matters. It just might imply non-VC vs. VC. And some businesses if they knew the economics might focus the business differently.

      • PhilSugar says:

        I agree completely with saying understanding the market size always matters.

        And it really matters performing the analysis like you say objectively, instead of starting with the premise that I need to raise VC and working backwards (which is why you see so many bad ones)…..but if you think the only way to start a tech business is with VC then you work backwards which as you point out means you don’t focus the business correctly.

        It matters in the beginning because as you correctly point out only 1 in 20 are VC businesses. There is nothing wrong with owning 37 Signals. My point to people is they can start high tech businesses and participate in the high tech entrepreneurial community and be happy/proud to do so without VC funding. Go start the business, solve customers problems, make money, work for yourself.

        And it matters not just out the outset, but down the road after both time and effort enable the ability to understand and measure the market much better.

        Here if the market tells you its not a breakaway, then you can’t force it by firing founders, throwing more money at the problem, etc.

        Here is where you again have to look objectively and say ok….lets have a new plan. This is where I’ve seen things get ugly, if people convinced themselves and a VC in the beginning because they thought it was a big market. It really might have looked that way at the time, but now it doesn’t. Everybody could have been totally genuine but it didn’t work.

        So I guess that’s a lot of words to say two major things:

        Because we are all loosely in the entrepreneurial community it makes sense to really push the point that there are great high tech businesses that don’t need VC (not that they are not worthy of it…but just don’t need it)….I don’t see this concept pushed often enough, and it makes sense for everybody.

        If you’ve taken VC and it turns out the market isn’t big enough…you really have to question whether it was the management or the market….and if it turns out it was the market…that is a tough place to end up, but its easier if you again step back and look at the market.

  9. Chaz says:

    Great post, really enjoyed the series. Just in general, where do you suggest as the best places to scope market size data. While some of us have access to McKinsey reports etc. I’d imagine most entrepreneurs who are more of the engineering rather than business types would be a bit preplexed. Not saying that they couldn’t find it, just places you’d recommend to speed up the process.

    • marksuster says:

      The Internet has much data. Trade associations are a great place. Check for docs on Docstoc, Scribd or Slideshare. Call friends at consulting firms, big co’s and bankers who have access to tons of reports. Need to be scrappy – the definition of an entrepreneur. Thanks for your comment. You’re right – many people don’t know where to look for data.

  10. Mark,
    Had to answer the call for the ex-McKinsey types, although entrepreneurial times have degraded my patience for market sizing– after all, we thought cell phones would only sell 100K units (and they would have been limited to that with the brick-phones available at the time of the analysis).

    Couple of additions off the top of my head for market sizing:
    – Replacement cost: How much are people spending today to solve your problem (in people, time, lost customers, etc). You can take most (or sometime even all) of this if you can make the problem go away
    – Benchmarks: What is the expected cost of your approach in a comparable market (ie, if Nielsen can take X% of the TV market by creating measurement currency, I can do the same in my market)

    For those taking a TAM, I do recommend the use of a funnel (at least behind the scenes) to double-check assumptions around customer conversion. I’ve posted an example here:

    • marksuster says:

      Hey Vijay. Thanks for the comments – some valuable additions. I knew some McKinsey alum would rush to fill in my voids ;-) And thinks for the linke to – I presume this is your new venture? Good luck – I’ll stay tuned to it.

  11. Mark, is a side project– got really used to overnight PPT production from India while at McKinsey and helping a group of graphics alums find former consultants who miss the service (its $20/hr to not wrestle with formatting, chart edits, and other such low-value work). Using it more as a teaching tool– let me know if there are slide types/ stories helpful as templates for entrepreneurs.

    Still plugging away at building a retail healthcare network with HealthShoppr, about to finish a competition design for a $10M+ healthcare X PRIZE competition to improve health while reducing cost, and helping my wife wrestle with massive growth (and open a store) at Bite Catering Couture.

    Would love to pick your brain on your health portfolio company and level of interest/ desired features for a Health Innovator’s ecosystem we’re designing for the competition.

  12. Another ex-McKinsey reader here. Especially for consumer-related products, there is a second type of “bottom up” analysis. Get down the the number of customers, price per unit and back up from there. I like to think about things you can touch.

  13. Shane says:

    Question: how do I, as an entrepreneur, make sure that I avoid falling into the “that’s ridiculous” trap? I realize that the only way to do this is to be objective in our analysis, but even if I am realistic, how do I best communicate that to a potential investor? Thank you again for this terrific series of posts, they are awesome.

    • marksuster says:

      It’s always a tough question. Your numbers need to be ambitious enough to warrant investors being interested and yet everybody knows the “out years” numbers are useless. My suggestion is to walk a very tight line, which is to have your next 12 months be very realistic and you can be slightly more ambitious in years 2,3 and even more ambitious is years 4,5. Everybody knows years 4,5 are irrelevant but they want to see that this “can be big” and they want to be sure that the logic of how it can be big holds. And just don’t make it sound like years 4,5 are either impossible to achieve or “conservative.” Good luck.

  14. […] leave some comments.  Love to get all input and get the discussion going.(Cross-posted @ Both Sides of the Table) Posted Under : General Tags startups entrepreneurship vc funding venture capital pitching a […]

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