One of the most common mistakes entrepreneurs make in their investor pitch is an inadequate or incomplete description of their target market. Defining and sizing your market, and stating your assumptions, is an important part your investor presentation. Your financial forecasts need to be based on some set of assumptions that hold together under a reasonable amount of scrutiny.
What Is Your Target Market?
The first part of a market analysis is to define your target market. A market is simply a collection of customers that have a common set of needs and buying behaviors. The first step in sizing your market opportunity is to define the common customer problem that you are solving.
When you define your target market, you will begin to understand the opportunity for your solution. How big of a niche do you want to go after? This is a relatively simple question, but the answer can be quite complex. You need to consider things like the scalability of your solution, the number of customers, and those customers' buying habits. You need to clearly define what that target market looks like, how you will reach that market in terms of sales channels, and the value of your solution for this product-market segment.
As a startup, it is best to define a defensible niche that you can dominate that has the potential to lead to a massive and rapidly growing opportunity as you expand into adjacent markets. Most investors are reluctant to invest in companies that want to "boil the ocean," which is a term for going after an extremely broad horizontal market.
Targeted marketing is the intersection of your product with a specific set of customers who have a clear need for a solution to an important problem for them. Your product solves that problem in a unique way that is very valuable to the customers. No matter what you are selling, your solution needs to fulfill an unmet need or desire of the target customers.
Key Elements of Market Analysis
Ultimately, you want to size the market by looking at both the total available market, or TAM, which includes all substitute products and adjacent products in your target market, and the served available market, or SAM, including your direct competition, which is a subset of the TAM.
Ideally, you want to size the market over a three-year timeframe to support your revenue forecast. This can be difficult in the startup world, since you are frequently going after a market that does not currently exist. However, if you look a little deeper, you can usually see a current market that you are trying to replace, or a set of emerging factors that will allow your market to emerge and grow.
Identifying Emerging Markets
Smart entrepreneurs want to find the best path to deliver the maximum results with the least amount of effort. This requires that they identify markets that are ripe for growth, but where "ripeness" is not apparent to the casual observer. In emerging markets it is important to be a little early, and never be late.
The best way to identify these markets is by looking at the broader ecosystem. You want to identify market opportunities where the ecosystem is already in place to support rapid expansion. Think of Uber where mobile devices with GPS location services were already in existence, or the Ford Motor Company, where roads were already in place for horses with buggies.
"Tops-Down" Market Modeling and "Bottoms-Up" Forecasting
Developing a so-called "tops-down" market model that supports your revenue projections will add significant credibility to your forecasts. The best way to do this is to leverage the "infrastructure" data that your company's emerging market is reliant upon, and extrapolate the market size from this data.
Supporting the "tops-down" model with actual forecasts based on customers in your sales funnel will add even more credibility to your financial projections. This is called "bottoms-up" forecasting.
Market Share Projections
Once you have a handle on your target market's size and growth, you will need to forecast your company's three-year revenue and market share. If you are a first mover in your target markets, you will start with 100 percent share. As the market evolves and competition enters, you will end up with somewhere between 60 percent and 70 percent market share over time if you are the market leader, and the product is not a commodity. This is a good assumption for tops-down modeling purposes.
Having a market model to support your business model and financial projections, and meeting those projections, goes a long way to establishing credibility with prospective investors, and will help your company get funded.