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A market is simply how much money people have collectively spent in a given year to solve that problem. People may also refer to the number of customers in the market or transactions in a year. Typically, though, they're referring to the value of the market, which is a dollar amount.
While playing in a large market is potentially very lucrative, it isn't very relevant for you as an early-stage startup. You'll likely address only a segment of that large market initially. It's okay if it's a small market, but you can expand into broader markets as your company grows. Here we have some vocabulary to help you better articulate your specific market opportunity:
Total Addressable Market (TAM): The potential market if everyone buys your product. Ex: Pet food market
Serviceable Addressable Market (SAM): Reachable part of TAM that benefits from our main value proposition. Ex: Online pet food market
Target Initial Market (TIM): Who will be the most likely buyers in years one, two, three? Customer segment. Ex: organic online pet food market
To understand the potential interest in your product, you can also look at how big that market is right now, according to existing research. This method isn't as accurate as doing ads and other tests. It is helpful, though, to be informed about the market right now, even if you plan to disrupt it.
Market size data is a requirement if you're looking to fundraise from venture investors, who are expecting you to show you're in a multi-billion dollar market that is snowballing.
Top Down
Start with the total addressable market for your product or service, then establish a realistic estimate for your market share or percentage of the market.
Your Market = Total Addressable Market x % of Your Market Share
Ex: Pet Food Market. Globally, people spent $91 billion on pet foods in 2018 -- of which $9 billion in sales happened online. If you're targeting US online buyers of organic dog foods, you're probably only going to have to consider the % of US online sales, % dog food, and % organic or premium foods. That estimate will be the initial target market that you're trying to capture in years 1-3.
Bottoms Up
Start with an estimate of the customer's annual spending and multiply that by the number of potential customers. The customer numbers might be from different customer groups and might even have different spending patterns.
Your Market = Individual Spend x Number of Customers
Ex: Pet Food Market. In 2018 the average annual food expenditure on a dog was $235. 60% of families owned dogs. Then you would have to consider the % that shop online for dog food and the % that buy organic premium foods. That estimate will be the initial target market.
What if I'm in a whole new market?
For startups creating markets that previously did not exist, where there is not much existing data to pull from, it can be challenging to find information to calculate the market size. In this case, we recommend finding data from similar or adjacent markets and products and using the bottom-up method.
Ex: When Airbnb first came along, people were skeptical about staying in strangers' houses or renting out their homes to strangers. But Airbnb was able to prove that there was a market by using two resources: Craigslist and Couchsurfing. They used Craigslist to show the number of temporary housing listings in a single week, which was 50,000. Furthermore, they looked at this site
which had 660,000 users.