Top-down and bottom-up market size calculation for startups

When investors are looking at your startup’s pitch deck, there’s only one thing more important than your MVP, team, or forecast – your market. Investors come across dozens of “breakthrough” and “revolutionary” products daily, all of which purport to be developed by hordes of “seasoned” executives.

In the early stages of your startup, what matters most is the market into which you’re tapping. The investor might not be able to tell if your product is good right away, but their fluency in analyzing market potential will either have them showing you the door or offering you a ticket to due diligence.

Too humble with your market sizing? Not ready to elaborate on your TAM numbers? Not sure if the market is even big enough for your product? You’re out!

Performing market sizing professionally and scientifically defines your Why Now?/Opportunity narrative – the most important part of your pitch deck. Knowing how to properly complete market sizing doesn’t only show the investor your market is huge – it’s also an indicator that you know your market and your ICP and that your go-to-market strategy is a calculated marathon rather than a blindfolded sprint into darkness.

What is market sizing? How do you calculate TAM, SAM, and SOM? Which method should you choose for your calculations? How should you show your market size in your pitch deck?

Let’s dive in!

Market sizing: The what

Market sizing is exactly what it sounds like. It’s the process of trying to estimate the size of – *the drum roll* – the market that your startup will call home! 

It’s an industry standard now to include market sizing in startup pitch decks, regardless of the startup’s stage. The purpose behind this is really simple: 

• Investors LOVE startups that take off in big and dynamic markets.
• Investors NEED ambitious companies that will take a big share of a big market.
• Investors HATE when the team is not aware of the size and trends of their product’s market.

The classic framework that’s been used for decades has taken the form of a three-part approach to breaking down your total market size into three separate categories: 

Market sizing: The why

If all this number talk made you start thinking about hours of research and countless spreadsheets, don’t worry. The secret of a good market sizing calculation lies in your understanding of your business model, ICP, and go-to-market strategy – not pure math. 

The goal here is not to show that you’re good at maths and research, as we’ve seen dozens of early-stage startups trying to compensate for a lack of strategy with complex market sizing research. Did that help them impress their investors? No. 

The goal of a good TAM/SAM/SOM slide is to show the investor that you actually know your market as well as you know your product. On top of that, it’s also proof that your go-to-market strategy is scientifically benchmarked. 

Here’s a list of things you need to demonstrate when putting together the perfect Market Size slide:

1. The problem really exists. Your problem is your opportunity, and what’s the best way to sell an opportunity? In purely economic terms! Here, you must make sure you know the problem you’re solving and that your opportunity is clearly shown in $ terms.
2. There are people who are really ready to pay or already pay to solve the problem. What does market sizing prove? It proves that the market exists! It is direct proof of demand that you can present to the investor, especially in the early stages. This is one of the earliest indicators for product-market fit. 
3. There’s a way to monetize the market opportunity. We will explain more about how you can involve pricing and other customer metrics in your market sizing, but for now, keep in mind that a good Market Size slide is indicative of a certain price you can charge in that market.
4. You’re aware of how your market will be reached. As you will see later in the article, your Market Size slide is closely tied together with your go-to-market strategy; they’re codependent when you are developing them. A good Market Size slide shows the investor that you’re able to explain how you will materialize your SOM into reality. 

Here are some top examples of great Market Size slides we made that helped our clients achieve all of the above and raise funding successfully: 

Market sizing: The how

Now, let’s dive into the ways in which you can actually calculate your TAM, SAM, and SOM. There are really two main methods that you can follow: top-down or bottom-up. This section covers top-down vs. bottom-up market sizing, comparing the strengths and weaknesses of each.

Let’s start with the easier one!

Top-down approach

As the name indicates, top-down market sizing creates a macro analysis of the market. 

Here, you’re basically looking for pre-made estimates of the size of your market. Look out for reports and figures from big consulting firms, auditors, economic researchers, data vendors, and market research companies. 

1. Let’s start with TAM. Imagine you’re a smart mobility startup. Try Googling something along the lines of “global mobility market size” and choosing a relevant report with a figure – that’d be your TAM. 
2. For finding SAM, you can apply geographical constraints to tie the number search to the actual countries in which your product will be marketed. Try searching for “mobility market size in North America”.
3. Finally, for SOM, try estimating the weight of your initial/main market in relation to other markets in your SAM number. The process here is very close to being a complete sham since you’re either hypothesizing the market share you’ll take from your SAM or operating with incomplete data. Well, that’s why this method is way easier and faster!

Advantages:

• Quick and easy. This is because startups don’t need to dive deeply into every single part of their activities to calculate market size. All you need is to pull the data from a credible analytical report.
• Optimistic. Gives insight into what is possible in the market; that’s why, in most cases, it provides an optimistic number of the market size.
• Works well with established markets. This tends to work well for big markets where there is already plentiful data and existing analyses.

Disadvantages:

• Wrong perception. The top-down calculation makes the entrepreneur seem lazy since it requires copying the market data from the analytical reports. Since you didn’t conduct this analysis yourself, you can’t prove or explain the numbers in a pitch.
• Inaccurate. It is based on the premise rather than on proven data. While optimistic forecasting may arose investors’ interest, they’ll want to see a credible operational plan for achieving it.
• Too generic. This might not always be correctly reflected in your sales expectations if you simply take X percentage of a market.
• Not appropriate for new markets and disruptive products. Top-down approaches often don’t consider that a startup can change the actual size of the market size.

Bottom-up approach

While top-down market analysis is usually easy to do, it can be misleading. Can you really reach that entire market? Even if you could, what costs would that involve? The good news is that bottom-up market sizing gives us the answers and a more accurate picture of those factors.

As the name implies, this estimation attempt is the complete reverse process from the top-down market analysis approach. 

A bottom-up analysis is all about getting a feel of your market on a customer-by-customer basis, defining your product’s price/ARPU/CLTV (make sure you know your metrics!), estimating the number of your ICPs (ideal customer profiles), and simply multiplying! 

This strategy is less concerned with the market at large. You concentrate on the business itself and the product you want to offer. That’s why we have to take your GTM strategy into account here.

In bottom-up market analysis, you start with the basic units of your business (e.g., your product, price, and customers) and estimate how far you can scale up those units. A bottom-up market size calculation will consider:

• How much have people paid (or are willing to pay) for the product or service
• Your potential target market segments
• The distribution channels and limitations

A market sizing bottom-up approach consists of determining the price of your product and finding the number of potential audiences. In just three steps, you can find out what your company can achieve in sales:

Step 1: Determine the product price. This step depends on whether your startup is just an idea or an existing business. If your startup is new, your price decision should be based on industry benchmarking, such as how much people can spend on your product, how much they spend for similar products from your competitors, etc. 

If you want to attract investments for an existing business, you can start with the company’s data you already have. Your estimations should be driven based on historical insights like revenue, expenses, and the number of current clients, among other factors.

Step 2: Estimate the size of the potential audience. Do some research and find the number of reachable prospects depending on your ideal customer profile. Consider these questions:

• Who is your specific client?
• How many of them are in the market?
• What part of them can you realistically reach?
• What price are they ready to spend for your product?
• Most importantly, how much or how often will they buy from you?

Step 3: Apply the formula. Bottom-up market analysis has a very simple formula:

Bottom-up market sizing example:

Let’s focus on a startup company with a mobile accounting app and annual subscriptions worth $100. 

Based on the effectiveness of the ads and the number of sales reps, their head of marketing calculated that they could realistically reach about 500,000 companies that need their app. That brings it to $50M:

$100 × 500,000 = $50M

Finally, complete the bottoms-up analysis by applying a logic similar to the one we used in a top-down approach. 

For TAM, take the total number of ICPs in the world, then apply geographical, strategic, and operational constraints according to your GTM strategy as you narrow it down to SAM and SOM!

Advantages:

• Accurate. This approach tends to result in better forecasting and more accurate data on a more granular level, helping you better understand how a particular factor will affect the whole.
• Good for new markets. It’s especially appropriate and helpful for new markets and markets where your product is likely to make a big, breakthrough impact.
• Clearly defines ICPs. This detailed view of the business financials gives you an understanding of the most profitable products. This kind of data assists you in making better re-investment decisions in your business.

Disadvantages:

• Time-consuming. It can take more time and involve more resources than top-down market sizing because a bottom-down approach requires a much more in-depth analysis of your startup.
• Demands precision. Any errors you make early on at the micro level become compounded as you work up to the macro level. It’s crucial to assure you’re doing everything right, or these mistakes and misunderstandings will take over your entire analysis.

In conclusion, which one should you choose?

Top-down and bottom-up approaches both have their place. That’s why they’re both still leading models in financial modelling. Understanding the pros and cons of both approaches and when to use each is key to the startup’s market sizing.

However, you should always consider the investor’s perspective.

Remember, every investor expects more accurate estimates from the founders. Investors want to see that you understand how the price of the product is determined, that you are oriented in your business niche, and that they can entrust you with their money.

That’s why, at Waveup, we always conduct bottom-up market sizing for our clients. We have seen countless apologetic pats on the back from investors who feel that startups were too humble with their markets. We know firsthand the pain of the “unambitious team” label. 

We always make sure that the market sizing in our pitch decks and models is always well-researched and accurately calculated; we also ensure that the market sizing is carried out hand in hand with how we develop your go-to-market strategy. That’s why bottoms-up analysis has never failed us.

We hope our explanation was easy enough, but, if you still struggle with determining the correct market size or want to evaluate your estimation, contact us. We’ll be happy to help you like we have helped other startups – check out our case studies here.