How to test your startup's market size
One of the most important questions for any startup founder is, “Is this idea worth pursuing?”
A large part of the answer comes down to market size. If the market you’re targeting isn’t big enough, even a great product won’t make your startup viable.
Measuring market size is a skill every founder needs to develop.
It’s not as complicated as it seems, and the process can guide you to better understand if your startup is on the right path.
Let’s break this into three steps: understanding market size, calculating it, and interpreting the results.
Why market size matters for your startup
Market size is the total potential revenue – or number of customers – your startup could reach.
It tells you how big the opportunity is for your startup and whether there’s enough demand to build a successful business.
Market size matters because it shows whether your idea can grow into a successful company.
A large market means enough customers to generate significant revenue. If the market is too small, even a great product won’t make enough money to sustain your startup.
A large market is scalable. It gives your business room to grow over time. You might start small, but a bigger market gives you space to expand as your product improves and your team gets stronger.
You’ll find that as you grow, investors care a great deal about market size. Larger markets offer the chance for their investment to grow exponentially. If your market isn’t large or growing, it’s harder to attract their attention.
Market size also helps you focus. It shows where the real opportunities are and keeps you from wasting time on areas that won’t pay off. Knowing your market size keeps your efforts aligned with the best potential outcomes.
Knowing your market size also shows you how much room there is to compete. If a market is crowded or shrinking, it’s much harder to succeed. A larger, growing market gives you a better chance of carving out a significant share.
Market size is like a map. It tells you where the opportunities are and whether they’re worth pursuing. Without it, you’re guessing. With it, you’re making informed decisions about the future of your startup.
Step 1: Break down your market
Market size isn’t just a big number. It’s a way of understanding the potential value of your idea.
To make it practical, divide market size into three layers:
Level 1. Total Addressable Market (TAM): This is the largest possible market for your product. Imagine if you could sell to everyone in the world who might need what you’re offering. TAM is the theoretical upper limit, often calculated in billions of dollars.
Level 2. Serviceable Addressable Market (SAM): SAM is a subset of TAM. It represents the customers you could realistically reach with your product or service, given the current state of your business.
Level 3. Serviceable Obtainable Market (SOM): SOM is the portion of SAM you can realistically capture in the short term. It’s influenced by your team, resources, competition, and market conditions.
When you split the market into these layers, you can shift from abstract thinking to actionable planning.
Step 2: Calculate market size
Now that you can divide it up, the next step is to calculate it. There are two main methods: top-down and bottom-up.
Each has its strengths, and together they give you a more accurate picture.
Method 1. The Top-Down Method
The top-down method starts with broad industry data and narrows it down to your market.
Use credible sources like government reports, market research firms (e.g., IBISWorld, Gartner), and industry publications.
Here’s how to apply the top-down method:
1. Find the TAM: Look for data that shows the total revenue in your industry. For example, if you’re building a fitness app, find out the annual revenue of the global fitness industry.
2. Define the SAM: Narrow this number by focusing on your target segment. For a fitness app targeting women aged 25–40, estimate what percentage of the global fitness market this group represents.
3. Estimate the SOM: Consider factors like geographic limitations, competition, and customer acquisition costs. How many of those target customers can you realistically reach in the next 1–3 years?
While top-down estimates are useful for seeing the big picture, they can be overly optimistic. That’s where the bottom-up method comes in.
Method 2. The Bottom-Up Method
The bottom-up method starts small and builds up. It uses specific data points, such as the number of potential customers or average revenue per customer.
Here’s how to approach the bottom-up method for your startup:
1. Start with your ideal customer profile: Define your target customer in detail. If you’re selling a SaaS tool for small businesses, your ideal customer might be companies with fewer than 50 employees in Australia.
2. Estimate the number of these customers: Use data from sources like census reports, trade associations, or business directories. For example, if there are 2.5 million small businesses in Australia, and 2 million fit your ideal profile, this becomes your starting point.
3. Multiply by revenue per customer: If your product costs $500 per year and you estimate a 10% adoption rate, your SOM would be $100 million (200,000 customers x $500).
Bottom-up estimates are often more realistic. This is because they’re grounded in specific details about your product, pricing, and market segment.
Step 3: Interpret the results
Calculating market size is only useful if you know what to do with the numbers. Here’s how to interpret the results:
1. Is TAM big enough? Investors typically look for TAMs in the billions because they’re betting on high-growth potential. A TAM of $1 billion or more suggests your idea has room to grow. If your TAM is smaller, it might still work, but the path to success will likely be narrower.
2. Does SAM fit your startup? Even if TAM is huge, SAM matters more in the early stages. Can your product realistically reach this market segment? If not, revisit your customer assumptions or consider a different market.
3. How realistic is SOM? This is where optimism meets reality. SOM should account for your resources, team, and competition. If it feels too small, consider pivoting to a larger or more accessible market.
Market size is a lot more than a theoretical exercise. It’s a way to test your assumptions and refine your strategy. Use your calculations to guide decisions, not just to impress investors.
Common mistakes to avoid
Even with a clear framework, there are pitfalls to watch out for. Here are the most common mistakes founders make when measuring market size:
Overestimating TAM: A $100 billion industry sounds great, but it’s irrelevant if your product only targets a tiny niche within it.
Ignoring competitors: Just because a market is big doesn’t mean it’s accessible. Competitors can limit your ability to capture a significant share.
Using vague assumptions: “Everyone will use this” is not a market size calculation. Be specific and back your numbers with data.
Focusing only on TAM: SAM and SOM are more actionable. TAM is a starting point, not the end goal.
Neglecting growth potential: Markets evolve. Look for trends that indicate growth, such as emerging technologies or changing consumer habits.
Be careful to watch out for these as you develop your market assessment.
Final thoughts
Measuring market size is one of the most practical tools for testing a startup’s viability.
Use the top-down and bottom-up methods, avoid common mistakes, and interpret your results with a clear strategy in mind.
As you calculate your market size, remember: A good startup doesn’t need to serve everyone, but it does need to serve enough people to grow.
When you break your market into layers, ground your estimates in real data, and align your strategy with your findings, you can make smarter decisions.
Market size isn’t the final answer to your startup’s success, but it’s a solid starting point. If you take the time to measure it well, you’ll not only test your idea’s viability—you’ll build the foundation for a scalable, successful business.