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Market sizing and estimating revenue

Estimating the size of the market, and then predicting how much revenue the startup can achieve and at what
growth rate is indeed a tricky exercise. But going wrong on this could either kill your company, or if in a rare case
you have underestimated your revenues, you may end up diluting more equity at a funding round than would
have been necessary.
It is therefore very, very critical that entrepreneurs focus on working and reworking on the market size and
revenue potential based on sound assumptions and with minute detailing.
Many startups make the mistake of taking broad brush reports from large consulting or research firms, and
estimate the size of their market on the basis of those reports. Often we hear entrepreneurs mention According
to Gartner, healthcare is a 80 bn USD industry with a 23% growth rate. Now, while this could be broadly true, for
an investor, and even for the startups, these figures have little relevance. Heres why
In most market segments, the investors would be broadly aware of the scale potential. At a startup stage,
investors will most likely invite a startup for a meeting only AFTER they have assessed that the concept does
have a potential to address a large market. Hence, stating the obvious, especially in segments that are very
obviously large does not add any value. E.g. For a education domain startup, highlighting in minute details the
number of number of schools, number of students and growth rate in India is wasting precious time in the first
meeting with investors. Assume that investors who are meeting a startup in the education space know the
potential of the opportunities in the domain.

How then do you estimate the market potential?


Simply, by being specific about your segment and making some assumptions on the specific segments and the
revenues per customer/consumer. E.g. Instead of saying education in India is a USD 18 billion market, for a
premium home tuitions startups it will be prudent to state With over 250,000 students in the top 10 cities in
schools with fees above Rs.10,000 a month, at Rs.2500 per student, the market potential is roughly over Rs.500
Rs.600 cr. P.a. At an all India level, the same translates to a market potential of well over Rs.1000 cr.

Some points to consider when estimating market potential

Clearly define what problem you are solving and for whom this will give you a good idea of the number of
customers with that problem in the geographies that you plan to be available in.

Estimate the practical reach e.g. while there may be a 100,000 people in your target audience spread across
50 cities, you may want to take the top 5 or top 10 cities and see how many people you have within your
target audience. This of course gives you the total market potential IF 100% of potential customers were to
buy.

Now, apply some filters i.e. ability to pay, ability to reach via media, etc. E.g. while there may be 60,000
potential customers in the top 10 cities you identified, and you may be panning to use a combination of
media, if the total reach of these media vehicles is 50%, the total potential of the market is really 30,000
customers.

You could also apply some price filters to test the elasticity of the demand in comparison to price. I.e. work up
alternate scenarios to reflect the increase / decrease in demand in case the price were to be moved up or
down and then evaluate which scenario makes a better business case. [Note: For different situations you may
have very different parameters for a good business case. In some cases, rapidly acquiring customers, even if
margins are lower, would be a key criteria often relevant in new concept that make sense for the first mover to
land grab and lock in potential customers on whom profitability can be increased later.

Now, if the product is of a repeat purchase nature, you would need to make some assumptions on the
number of times the customers would buy the product / service in a year. In doing this, it is critical to map the
reality or in case of new product categories, to do some qualitative and/or qualitative research to validate your
assumptions on the number of repeat purchases within a year.

All the above, and perhaps some more as relevant to your category/product/service, will need to be worked
and reworked often to arrive at what seems like a practical market estimation.

How do you estimate your revenue and growth?


This is a rather tough part, and the accuracy of these guestimates is largely dependent on how accurate your
assumptions are.

Many entrepreneurs make the mistake of projecting revenues as a % of the market potential. Often we hear
entrepreneurs state Even if we were to capture just 2.5% of a Rs.1000 cr market, we are targeting a revenue of
Rs.25cr in year 2. This is obviously an oversimplification and without any basis for how the sales plan will be
implemented.
To prudent way of arriving at a estimation of revenue is to build a business case ground up. I.e. how much
revenue are you expecting per customer, how many customers can you get, how much does it cost to get each
customer, etc. At the startup stage, it is important to do a month-by-month detailing of how you see the
customer base increase based on what specifically you plan to do in your marketing & sales plan.
Needless to say that this is not a one-time exercise, and you will keep reworking on this till the business case
starts making sense.
While doing month-by-month revenue estimation, if you have multiple revenue streams, then make the revenue
estimates for all the revenue streams, which then total up to make the overall revenue for the company. E.g. if
you are starting a chain of restaurants, you may want to break up the revenue by breakfast, lunch, snacks and
dinner as these would cover different dynamics of your restaurant business. Similarly, if you were doing an ad-
supported Freemium product online, you would like to estimate separately your revenues from ads on the free
downloads and the subscription from the paid downloads.
Do remember that this is just a guestimate i.e. a well-thought-out estimate. This is just a reflection of how YOU
expect the market and the world around it to behave. And because there are no guarantees that the world will
behave as you predict it to, it is prudent to be very, very conservative with the revenue estimates. If you are too
optimistic, you are likely to allocate a proportionate marketing investments behind the revenue growth and if for
whatever reason the revenues do not happen as you have predicted, you will have a sufficiently fierce problem
on hand.

Note:In many a startup scenarios, revenues may NOT be the key parameter of
progress. E.g. in a startup which is establishing a new technology, proving the
concept and the business model may be the main objectives in the startup
stage.

Do remember that your growth and revenue numbers should be mapped to the marketing plans and marketing
investments, and should be rooted in reality. We are smarter and we know social media marketing really well
and hence our customer acquisition cost is much lower than others is not a statement that investors would be
keen to bet on [though if you state that they would be keen that you demonstrate your skills in lower cost
customer acquisition ].

As one of my mentors had said See the film in your mind for a startup, it is critical to be very clear on what
specifically is going to happen on the marketing front, product front and sales front in which month and therefore
what revenue and customer numbers that will likely translate into.

Some advice:

Try to achieve higher conversions than comparable others in the market, but estimate much lower
conversion. This way, even if you do not do better than market average, your plans dont go awry.
Validate your assumptions validate your assumptions validate your assumptions. Again and again and
with multiple sources. Going wrong in assumptions can be disastrous, even if the rest of the components of
your business do well. E.g. if you assume a 0.5% conversion, but it actually turns out to get 0.3%
conversions, you may be off by a considerable margin in your profitability and may also run out of cash
sooner.
Identify the key ratios that you need to measure. E.g. Gross margins, cost of customer acquisition, headcount
per unit [i.e. could be a set of customers], etc.

Key points to remember

1. Be conservative in revenue estimates


2. Validate your assumptions
3. Detail out the revenue plan on a month-by-month basis, and separately for each revenue stream

What is the right revenue estimate?

Well, there is obviously no right or wrong revenue estimate. It is often a reflection of the vision and aspiration of
the entrepreneurs.
However, among the many mistakes that many entrepreneurs make while estimating revenue, the two top ones
clearly are:

1. Estimating too little


2. Estimating too much

Heres an oversimplification of how you could think about the revenue targets that you aim for.
Obviously, this is an oversimplification but it does give you a good view of what you could potentially
aim for.
The hypothesis of this oversimplification is that investors like to back potential market leaders. If so, assuming the
market potential for the concept you are pursuing is around INR 1000 cr., and given that in most categories the
market leaders will have anywhere between 25 40% market share, it will be good for you to at least aim to be a
Rs.250 Rs.300 cr. company in a reasonable time frame.
This at least gives you a good shot at being among the top 3-4 players in that category.
On the other hand, if in a market with a potential of Rs.1000 cr revenue, your startup aims to have a revenue of
Rs.50 cr in the next 4-5 years, you are most likely to be a marginal player and hence will not be exciting for
investors.

Do also remember that in some categories there is a winner takes all scenario. E-comemrce in some categories,
especially in generic / multi-category retail, is a one-horse-game in many markets.

Is it ok to be a leader in a niche

But I aim to be a leader in a niche


Targeting a niche almost always seems like a winning strategy. There is always a temptation to carve out a niche
when any category matures or seems to be growing well.
However, just because you have identified a good niche does NOT mean that it makes a good business case, no
matter how sharply defined that niche is.
Often entrepreneurs make the mistake of getting excited about playing in a niche, and assuming that they can be
leaders in that niche simply because they are super-focused ONLY on that segment. The truth however is that
just because you focus on a niche does not mean that others who service broader segments are not at least as
good as you at servicing that niche as well.
Focusing on a niche makes sense only if that niche represents a fairly large market. Also, if servicing the niche
helps you build competencies which can be leveraged across a broader segment, there is really no merit in
building a business case around that niche, though you could have multiple brands targeting different niche
segments with the common competencies deployed across all the segments.

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