Calculating Market Size: Bottom-Up versus Top-Down Approaches
One area in which BioInformant specializes is market size determination.
“How big is the market” is a vital question, because knowing the market size empowers decision-makers to:
- Determine whether a market opportunity merits investment
- Determine the growth capacity possible within a market
- Identify market segments of interest
- Set sales performance goals
Also, segmentation of a market can refine a company’s strategies and goals by identifying promising geographies, customer types, and areas of application. Given the importance of market size estimations, it is critical that they be as accurate as humanly possible.
Unfortunately, we have noticed that the methods used by other market research companies to quantify market size are often vague, confusing, or poorly described.
For this reason, we decided to write this post about how market size estimations should be performed.
It is our hope that it will educate you about proper methodologies for market size determination, so that you can make informed decisions about figures that you may come across in the future. Importantly, the information in this post will also empower you to do your own market size calculations, so that you can compare your estimates to market size figures that you may see published by third-party sources.
Specifically, there are two primary methods for market size determinations, which are a “Bottom-Up Approach” and a “Top-Down Approach.” Read on to learn more about the differences between these two methodologies.
At its core, a bottom-up approach to market size determination seeks to add up all market participants. There are three different techniques for executing a bottom-up analysis, and each of them must be considered in order to select the methodology best suited to assessing a specific market of interest.
For use as an example, let’s say that we need to determine the size of the dental stem cell storage market worldwide.
1. Roll-Up All Market Participant Sales (Effective for Small Markets or Slowly Changing Markets)
One way to perform a market size determination is to roll-up the total annual sales of all market participants.
In this approach, all independent contributors to a market of interest are summed to determine a total market value.
For situations in which the sales of all industry participants is known and can be aggregated, this is considered an effective approach for market size determination. However, it typically does not work well when there are large numbers of industry participants or if a market if rapidly evolving.
For instance, to determine the market size for amniotic stem cell storage worldwide, we would add up the sales of all companies worldwide that provide amniotic stem cell storage services. For pure-play companies that specialize in amniotic stem cell storage, this would be a relatively easy calculation, because we could either contact company leaders to inquire about total revenue figures or we could seek out these numbers online. However, for companies that offer multiple stem cell storage services, only the sales they generate from amniotic stem cell storage services would be included.
I am using the market size for amniotic stem cell storage market as an example for this technique, because it is a relatively small market at this time. You cannot use this approach effectively if a market is too large or evolving too rapidly, because the market value will have already changed by the time that you aggregate the data. It is a “rookie” mistake to take this approach in within high-tech, exponential growth marketplaces.
Also, as a “rule of thumb,” it is relatively easy to find total revenue figures for a company, but substantially more difficult to find data about a company’s sale by product line. Keep this in mind when selecting this approach to market size determination.
2. Weighted Analysis of Industry Leaders (Effective for Large or Rapidly-Evolving Markets)
Unfortunately, in large or rapidly-evolving markets with many small participants, it is often not possible to roll-up all competitor sales.
In these cases, the single best alternative is to estimate market size by determining sales of the largest players and then estimating the aggregate share of all other, smaller players.
This is generally an excellent approach for fast-growth markets, like the broader stem cell or cord blood industry.
For example, if we need to determine the market size for dental stem cell storage worldwide, we would add up the sales from 5-8 of the largest market participants and then estimate the combined sales contributed by all of the other smaller market participants, in order to calculate a total market figure.
This methodology is often an intelligence approach to market size determination, because market leaders historically publish greater amounts of information about sales volumes and revenue figures. The reason is that market leaders often use sales figures to assert market share. Additionally, public companies are required by law to make certain sales metrics public in SEC filings and similar public statements.
3. Survey Customers for How Much They Spend in the Market
Asking customers how much they spend within the market of interest can also be used to determine market size via a bottom-up approach.
For this approach, a population of customers is asked how much they spend each year on the products composing the market, and the results are extrapolated for the market at large.
Please note that this approach is always less accurate than the “Silver Standard,” because it relies on accuracy of reporting by the surveyed participants (which cannot be confirmed) and adequate sample size. However, it can be a moderately effective approach in situations that require it.
In comparison, a top-down analysis is a procedure in which a larger reference market is used and the percentage of that market that a company expects to capture is estimated. There are two different techniques for top-down analysis, as described below.
1. Using a Known Reference Market (Effective for Verifying a Market Size Calculated Using Another Approach)
In this method, the size of a known reference market is required and then the amount of that market that is contributed by a specific segment of interest is estimated.
For the example given in which we want to determine the size of the global market for dental stem cell storage services, we would have to know the size of a larger reference market, such as the size of the total stem cell storage market.
Then, we could estimate the percent contributed by the market segment of interest, in this example, the size of the dental stem cell storage market. This can be an effective approach, but its limitation is that it requires a known metric as a starting point.
Therefore, BioInformant only relies on this approach for corroboration of findings determined via a bottom-up approach. It is not an ideal starting point for market size determination, because its accuracy relies on the accuracy of the reference number, which can often not be confirmed.
However, in instances where a known reference market that has been carefully studied and quantified, it can be a valid approach for determining the size of a sub-segment of interest within that market.
2. Using Population Metrics (Nearly ALWAYS Misleading)
In this method, the size of a specific population is used and then a company estimates the percentage of that population that it can capture with its services.
Therefore, a common top-down analysis would look like this: “Since there are approximately 320 million people in the U.S., even if we can only capture 1% market share per year with our dental stem cell storage service, we would be serving 3.2 million people. Because our product costs $750 per sale, that means we could make $2.4 billion in annual sales ($750 x 3.2 million people).”
Does this sound inaccurate? Does it sound way too optimistic? In our experience, it nearly always is.
We generally dislike this method of market size analysis, because it is rarely, if ever accurate. I would suggest that you be extremely hesitant to believe top-down market size estimations based on population metrics.
Summary of Market Size Methodologies
In summary, there are a range of different market size methodologies that can be used, each of which varies in accuracy. Use the information in this post to empower yourself when you come across market size estimations. It will allow also you to understand how market size figures are derived and to assess the relative accuracy of each approach.
If you have seen a market size figure that you would like us to cross-check for accuracy, feel free to shoot us an email at [email protected], and we will take a look.
Go forth and be empowered!