The Power Duo: The Interplay Between Customer Segmentation and Market Sizing

Know Your Market, Grow Your Business.

Introduction

Determining the attractiveness and viability of a new venture opportunity requires founders to understand the target market's size and segmentation comprehensively. While developing a new venture, entrepreneurs will encounter multiple opportunities to assess the potential number of customers within their beachhead market segment. By continuously refining their understanding of target customers and estimating how many they can realistically reach, founders can gain valuable insights into the scalability and profitability of their business idea.

This post emphasizes the importance for entrepreneurs of clearly defining their ideal customer profile upfront and dividing the overall market into priority segments based on detailed demographic, behavioral, and need-based criteria. Furthermore, it explores methodologies founders can leverage to generate a rigorous top-down and bottom-up market sizing analysis. Conducting this level of due diligence across the pre-screen, segmentation, and go-to-market strategy phases enables founders to accurately quantify the revenue potential of their venture's beachhead market.

The ability to accurately size and segment the target market provides the foundation for founders to develop sound marketing strategies and financial projections. By investing significant effort into market sizing and segmentation, entrepreneurs equip themselves to make well-informed strategic and operational decisions as they work to prove and scale their venture over time.

The Pre-Screen Phase

Very early on in the process, as part of your pre-screening efforts, it is worth conducting what is sometimes called a top-down assessment of your market. This assessment derives from accessible secondary research into current customer behavior patterns related to the problem area you hope to solve with your venture. Staying focused on the market as directly associated with the customer's needs is essential. Consider your market as customers (consumers or organizations) who require solutions (products or services) to solve problems and satisfy needs. Keeping your focus on customer needs is critical to the future success of your venture. Start early and get into the habit of doing this.

During the pre-screening phase, keep your market definition open and flexible. If you focus too early on a market definition related to a specific product (solution), you limit your view of the market potential. I see this occurring time and time again. Founders view the market through their specific product idea instead of the customer's need. When this happens, you narrowly view the opportunity, limiting who you see as domain experts, influencers, competitors, and other market-industry stakeholders.

At this stage, you want to understand the market's overall size at the highest level. The current market size and associated trends will give you a 30-thousand-foot view of your potential market in the future. However, entrepreneurs should not see this as their future sales opportunity. You are just viewing current customer activity associated with the problem and any observable trends in the market direction.

There are a few additional questions to answer in this pre-screening effort beyond the question of size:

1. With a focus on customer needs, can you readily identify your market? This identification is not as easy as it sounds. Founders typically have many assumptions about customers. However, the beliefs are rarely detailed or actionable.

2. Is the market growing? How fast? It is time to understand where the market and associated products are regarding the life cycle. Are the solutions relatively new? Early-late growth phase? Or declining? For startups, there are always opportunities to enter a market. But most would agree that entering a fast-growing market is optimal.

3. Is the market segmenting? Associated with growth is the understanding of whether different customer behaviors or demographics segment the market. As will become apparent, understanding which segments already exist may open up opportunities for new market niches.

To conduct this high-level market analysis, founders can leverage secondary sources such as:

• Government data on population demographics and industry trends

• Market research reports from firms like Gartner, Forrester, IDC

• Industry associations and non-profit foundations

• Academic journals and conferences

• News articles and press releases related to the market

Your early estimates of your market's size will focus on the total number of potential customers needing a solution for the problem you hope to solve. The main reason to spend time on this estimate is to give you a sense of whether the opportunity is sufficient for your efforts and resources. This decision can be very personal for a founder, dependent on your passion for the problem and longer-term venture goals. However, if you plan to seek outside funding at some point, then you need to consider what the investors will see as an attractive size. Investor criteria depend on several factors and are beyond the scope of this post. In general, venture capitalists are looking for a minimum of 10X return on their investment, so potential markets valued at $500MM to $1Billion would be attractive. Smaller investors, such as angels, might see smaller markets as attractive depending on the percentage of the venture they think they would own after future funding rounds and associated dilutions. In this scenario, angels may be willing to invest in ventures that capture a good percentage of a $100MM to $500MM market.

So, where should you look for market size data at this pre-screen stage? For the most part, secondary sources should provide enough information to support a decision to continue to work on the venture or change directions. Founders rarely find a "report" that provides the exact market data required. And if such a report exists, it is rarely affordable. Start by focusing on available data in the public domain and some well-conceived assumptions to provide what you need at this point. From my experience, some of the most fruitful market data sources come from government publications and data sites, industry trade journals, press releases associated with the problem to be solved, and analyses of current solution providers—most likely your competitors.

This secondary research information will not go to waste as it will become an essential foundation as you analyze your market in more detail during the segmentation phase.

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The Segmentation Phase 

As you move deeper into the venture realization process, you will spend a lot of time defining your customer profile and thinking about how customer behaviors and demographics might segment the overall market. Understanding each customer segment's size is essential for selecting your first market to enter and future follow-on market segments.

The Customer Demographics Profile

Many of your early assumptions focus on identifiable characteristics of your potential target customers. List these first. Do you suspect that your early customers will be predominantly of a specific gender and age range? Education and income level? Do they have a particular lifestyle or manifest specific behaviors? With these characteristics, you are making assumptions about the demographics of your target customers. As with all assumptions, you will test these during early customer discovery. You will be looking to speak to customers with the specified demographics to learn about their experience with the problem and current solutions. You will begin to validate whether your assumptions about your target customer's demographics are correct from these interviews.

There are many ways to segment your customer base or market. Possible market segment methods include Geography, Demographics, lifestyle, behavioral, special characteristics, and Reasons for solution or purchase. These segments work well for Business-to-Customer (B2C) profiles. For Business-to-Business (B2B) profiles, segmentation focuses on business entities, the purchasing decision-maker, and the end user where applicable.

For example, a company selling gym equipment may segment its market demographically into age groups like 20-30-year-olds, 30-40-year-olds, etc. Or behaviorally into frequent gym-goers, at-home fitness enthusiasts, physical therapy patients, etc.

Prioritizing Segments 

Once you have identified potential segments, the next step is to prioritize which ones to target first. Criteria to consider when prioritizing segments include:

• Growth potential - Focus on segments that are growing quickly

• Competition - Target segments with lower competition

• Accessibility - Prioritize segments you can reach through your distribution channels

• The value proposition - Align with segments where you offer maximum value

• Strategic fit - Select segments that leverage your core competencies

By allocating resources to high-potential segments first, you can maximize the return on your customer acquisition investments.

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Applying Customer Segmentation to Market Size Analysis

A common approach provides entrepreneurs with a cascading model where you start at the broadest definition of the market and then peel back the layers. You hone in on your market picture until you have identified the customer base you will most likely reach in the early period of your venture. This model typically includes multiple layers and applies the following four: Total Potential Market (TPM), Total Addressable Market (TAM), Served Addressable Market (SAM), and Share of Market (SOM). If you google this approach, you will find many definitions, so you should define each level. Here is how I tend to determine each market level. 

Total Potential Market (TPM)

The total Potential Market (TPM) is the number of customers looking to solve the problem. How many customers would that total if they all (100%) purchased your solution? I think of this estimate as including customers across all segments. After defining all the customer segments and completing the rest of the market size analysis, you should calculate this number. You start by defining all potential customer segments. Then, prioritize the top 5-6 segments. These prioritized segments will meet the criteria mentioned above in the beachhead section. However, I think the keyword here is addressable, meaning a clear path exists to access and acquire the customers within each segment. There will be segments within the total potential market that you will not seek in the early stages. 

To understand "your" full market potential, determine the Total Addressable Market (TAM) for each segment you consider for early market entry. Like the TPM, the TAM represents how many customers you would acquire if you had a 100% market share in a specific segment. You will notice that I focus on the number of customers and not revenues. Many articles on market size discuss TAM in terms of expected market share in revenues. I tend to have founders focus on customer numbers, sometimes referred to as market volume, early on and revenue later. You can extrapolate some potential market revenue estimates through secondary research. For example, you should find any data about how much customers spend on products and solutions already in the market. You won't determine your potential revenues until you have decided on your revenue and pricing strategies. 

Total Addressable Market (TAM)

To determine the TAM for a specific segment, you will apply a combination of top-down analysis through secondary research resources and a bottom-up analysis from select primary resources. You should conduct a deeper analysis of the potential number of customers in the segment in question, starting with details from your customer profiles, including demographics, behaviors, and reasons for purchasing. This step begins with demographic data for each customer segment bounded by the identified geographic area. Then, search for market data that provides a portion (percentages) of the population that manifests your target customer's lifestyle or behavior. This analysis will result in the Total Addressable Market for the segment in question. 

Once you thoroughly analyze your TAM for each segment, you add all segments together to have a reasonable estimate of your total potential market. This analysis will be a much better estimate than the one you started with during your pre-screening efforts.

Served Addressable Market (SAM)

The next level of market size analysis looks at customer purchasing behavior with a specific eye on the number of customers actively looking to solve the problem at stake. These customers are using current solutions to solve the problem, demonstrating how important it is for them to find a solution. Served Addressable Market (SAM) refers to the number of customers actively looking to solve the specific problem your solution addresses. You identify this market group by customers buying optional product solutions from your competitors or associated products typically purchased by those with a genuine interest in the product category. You accomplish this analysis by integrating market data on the purchasing behavior of similar products or optional solutions, including competitors' market share data. Then, extrapolate segment size by combining demographic and geographic data with percentages of the population that manifest appropriate behavior and purchasing patterns. 

The analysis you conduct to determine the TAM and SAM for a segment will give you a reasonable estimate of how many customers will be interested in your solution. You will focus on them during future marketing efforts. 

Share of Market (SOM)

The final market size analysis for a specific segment is your Share of the Market (SOM). SOM refers to how many actual customer sales you can achieve over a specified period. Once you understand customer acquisition strategies, costs, and other financial and operational considerations, you calculate SOM later in the venture realization process as you make strategic go-to-market decisions. Let's take a look at what I call the marketing strategy phase. 

Marketing Strategy Phase

Up to this point, you have focused on quantifying the number of potential customers across segments in your total potential market. As you determine your go-to-market strategy, your understanding of market size becomes all the more critical. A significant part of your marketing strategy concerns how you plan to acquire new customers and the promotional channels you will apply in customer acquisition. 

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Understanding your priority customer segment size becomes an important determinant of your marketing efforts and dollars. To estimate how many customers will purchase your solution over a specific time, you need to consider how many customers within the segment can gain access to and convert to an actual sale. The market size work conducted up to this point should give you an upper limit on how many customers are addressable within your target segment. This upper limit lets you decide on the most effective promotional channels. In turn, you have a more robust basis for estimating how many customers you can acquire and the expected revenues. So, you can see why such due diligence on market size supports your decisions regarding marketing efforts and subsequent revenue projections. 

By this point in the venture realization process, you can better predict your potential SOM, the number of customers, and the revenues you can realistically achieve once you enter the market. This estimate is typically for a time frame of 1-3 years. After your venture has been in operation for a while, you can refine your estimates of future market share. 

Market Sizing Data Collection Methods

Founders can use several primary research approaches to gather the data for rigorous top-down and bottom-up market sizing analysis. Each method has strengths and weaknesses, so market experts recommend blending multiple data sources to validate estimates. Leveraging existing market research provides top-down benchmarks, while building models from the ground up gives bottom-up forecasts. Analyzing competitors reveals the current served market size. Primary research through surveys and interviews offers direct customer feedback. And compiling industry data furnishes a broader market context. Using a mix of these data collection methods allows founders to overcome the limitations of any single technique. The time invested pays dividends by equipping founders with realistic TAM and SAM projections to inform strategy.

Top-down analysis: This leverages existing market research reports from firms like Gartner, IDC, and Forrester to benchmark the total global market size for the product category. Founders can then segment this overall market estimate based on geographic regions, customer demographics, use cases, and other relevant factors to derive the target addressable market (TAM). Valid for established product categories.

Bottom-up modeling: This builds TAM estimates from the ground up, starting with the target customer population size based on census and industry data. Surveys and interviews can help determine the percentage likely to adopt the product. Multiplying the addressable population by the adoption percentage and estimated average revenue per customer leads to the TAM projection. Helpful when products are highly innovative without precedents.

Competitor analysis: Researching pricing models, customer segments, market shares, and revenues of current competitor solutions helps reveal the existing served available market (SAM). A good comparison for analogous products. Public financial disclosures and third-party market research reports provide data.

Primary research: Surveys, interviews, focus groups, and beta testing with target customers and industry experts can provide insights into demand levels, feature needs, willingness to pay, purchase criteria, and reactions to the product concept. Invaluable for estimating serviceable obtainable market (SOM) potential.

Industry data aggregation: Compiling data points from government statistics, industry analyst projections, academic studies, and news articles can reveal trends in customer demographics, historic market growth, seasonal fluctuations, global vs. regional demand, and other functional patterns. Helps triangulate estimates.

Blending these approaches allows founders to cross-validate sizing estimates and minimize reliance on any single source. Robust market analysis requires synthesizing data from different vantage points to develop an accurate perspective.

Market Sizing Challenges and Common Mistakes

Obtaining reliable total addressable market (TAM) and serviceable available market (SAM) estimates is crucial, yet it can be challenging for founders. Without a realistic perspective on market size, founders risk building ventures on shifting sands. However, accurately quantifying the opportunity for an innovative new offering requires navigating complex analysis with limited data. It is easy to make missteps that severely skew projections. Being aware of potential pitfalls can help founders avoid them.

One major obstacle is the lack of robust data sources. Founders rarely have access to comprehensive third-party market research reports or extensive internal sales data to leverage like large corporates. This scarcity forces founders to make broad assumptions when extrapolating TAM and SAM. They may rely on snippets of secondary research, limited survey samples, and best guesses. Conducting extensive primary research through large-scale surveys, interviews, and focus groups requires significant time and financial resources - a luxury cash-strapped founders lack. These data limitations make it extremely difficult to corroborate estimates through triangulation.

Another critical challenge is the difficulty delineating the target market, especially for novel products. Without comparable offerings in the market, founders struggle to identify direct competitors and adjacent offerings to benchmark against. They also grapple with determining which customer segments, use cases, and niches to include when modeling the total addressable market. Founders tend to underestimate the intricacy of analyzing entirely new markets.

Additionally, first-time founders without experienced mentors often make flawed assumptions that skew TAM calculations. For example, they may double-count multiple segments or incorrectly estimate addressable customer populations and revenue per user. These faulty assumptions during bottom-up modeling lead to grossly exaggerated TAM projections. The optimism bias creeps in without oversight.

These challenges lead founders to common market sizing mistakes:

• Basing SAM on an inflated TAM figure without segmentation

• Overestimating TAM by assuming all possible customers purchase

• Using unreliable, outdated, or biased secondary sources

• Disregarding SAM and SOM, focusing solely on massive TAM estimates

• Misunderstanding TAM as customers versus total revenue opportunity

Careful market analysis requires synthesizing data from multiple approaches to pressure test assumptions. Experienced mentors provide invaluable devil's advocate perspectives. With eyes wide open to potential pitfalls, founders can mitigate risks and develop reasonably accurate projections.

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Sidebar: Cognitive Traps to Avoid in Market Analysis

Estimating a new business's market size requires careful consideration, especially considering the numerous heuristics that can lead to distorted or incomplete assessments. For example, entrepreneurs must be cautious of the availability heuristic, where one relies heavily on information that is immediately available or based on personal experiences. This condition can easily result in biased estimates. It's essential to counteract this bias by conducting comprehensive research and collecting diverse data to provide a more balanced market view. This approach will enable more accurate and reliable market size estimations.

Another common trap is the representativeness heuristic, which involves concluding by comparing a new business or market to existing, successful ones. Founders might assume their venture will succeed because a similar business or industry is thriving. However, this can lead to either overestimating or underestimating the market size. To prevent this, entrepreneurs should thoroughly analyze their target market to ensure it genuinely represents the opportunity they are pursuing. Making evidence-based comparisons rather than relying on superficial similarities is crucial for accurate market sizing.

The anchoring and adjustment heuristic presents another challenge, as it involves basing estimations on a specific number or reference point, which can then influence subsequent adjustments. Entrepreneurs might inadvertently anchor their market size estimates to initial numbers, limiting their ability to adjust based on new information. To minimize this bias, entrepreneurs should critically evaluate their assumptions and use multiple data points to make more informed adjustments. Continuously revising estimates in light of new information is crucial for accurate market sizing.

Confirmation bias, the tendency to selectively acquire or interpret information that supports preexisting beliefs, can also distort market size estimations. Entrepreneurs might unconsciously seek data confirming their initial assumptions and ignore evidence that challenges them. It's essential to seek diverse perspectives and challenge one's assumptions actively. Entrepreneurs should consider alternative viewpoints and data sources that provide a more comprehensive market understanding.

Finally, overconfidence bias, which involves overestimating one's abilities or the accuracy of judgments, can lead to inflated market size estimations. Entrepreneurs might be overly optimistic about their business idea and potential, which can result in unrealistic expectations.

It's essential to approach market sizing with a realistic and critical mindset, carefully considering the potential risks and challenges. This mindset helps entrepreneurs make more balanced and evidence-based estimations.

By recognizing and actively managing these heuristics and biases, entrepreneurs can adopt a more objective approach to market size estimation. Gathering comprehensive data, critically evaluating assumptions, seeking diverse perspectives, and revising estimates based on a thorough analysis of market dynamics are all essential steps in achieving accurate market sizing. With a clear understanding of the market, entrepreneurs can make informed decisions and position their businesses for success.

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Making Realistic Market Sizing Estimates

Developing reliable total addressable market (TAM) and serviceable available market (SAM) projections is critical for founders yet fraught with potential pitfalls. Without realistic market sizing, all subsequent startup strategy risks may rely on faulty assumptions. However, obtaining accurate estimates requires navigating complex analysis with limited data. Diligence and an unbiased perspective are indispensable.

The first essential step is sourcing high-quality data. Founders should gather market information from reputable providers like government agencies, academic institutions, market research firms, and industry associations. Relying on accurate, unbiased, and current data ensures estimates are grounded in market realities.

Next, founders must employ top-down and bottom-up modeling approaches and compare the outputs. The top-down analysis leverages existing market research benchmarks, while bottom-up projections build estimates from granular customer and revenue modeling. Using both allows mutual validation.

Founders must also carefully define the TAM's geographic, demographic, behavioral, and need-based target market segments. Scoping the boundaries avoids inflating estimates by overextending into peripheral segments unlikely to purchase.

Additionally, factoring in market dynamics like competitive forces, industry lifecycles, technological shifts, regulations, and customer preference trends is crucial. Incorporating these expected changes over the projection period results in estimates reflecting real-world conditions.

Connecting with experienced mentors and advisors also provides an invaluable outside perspective. They can scrutinize assumptions, call out cognitive biases, and surface potential flaws obscured by founders' narrow vantage points.

Finally, founders need to stress test their key assumptions through sensitivity analysis. Varying assumptions around conversion percentages, revenue per customer, and market growth reveal how projections shift. This method filters out unrealistic estimates derived from flawed assumptions.

With eyes open to potential pitfalls, founders can develop pragmatic market sizing to inform strategy. Though imperfect, realistic TAM and SAM models provide an indispensable compass for new venture direction.

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Unlocking Market Expansion Analysis with the Power Duo 

Evaluating new market entry opportunities requires deeply understanding potential customer groups and quantifying total addressable demand. The power duo of rigorous customer segmentation and market sizing unravels these critical puzzles.  

Breaking down markets into customer segments and sizing the potential demand provides a critical starting point for assessing new market opportunities. This analysis answers vital questions on who the target groups are and how sizable the opportunity is with each.

Who precisely are the target customer groups?

• Divide markets into segments based on everyday needs and behaviors 

• Create detailed buyer personas representing high-potential niches

• Prioritize segments to focus on based on attractiveness criteria  

How significant is the opportunity with each priority group?

• Estimate the total addressable market (TAM) for each target segment

• Determine the served addressable market (SAM), the current spending, and the market share for your product category

• Project realistic first-year sales goals (SOM) 

Armed with this information, companies can determine if a new market looks promising enough to enter. The market analysis guides critical strategic decisions:

• What tailored messaging will align with segment values?  

• How should we adapt our minimum viable offer?

• What level of resources should we invest early on?

• How can we sequence targeted tests by segment?

With clarity from these market analyses, companies gain several strategic advantages to determine if new expansion makes sense. Once business leaders construct new customer profiles, tailored messaging can align with priority segment values. Minimum viable product and promotion strategies also become apparent by mapping offerings to segment needs. The market sizing quantification also guides appropriate investment levels relative to the opportunity presented across target groups. Essentially, the Power Duo analysis spotlights which new markets merit entering by revealing customer demand trends, customization requirements, and revenue potential.

Continuously refining buyer personas and demand forecasting models based on in-market evidence strengthens global growth strategies. Anchoring expansion efforts to real-world segmentation and sizing clarity creates ventures with lasting viability.

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Maximizing Venture Success

There are a few actions to follow throughout the venture development process to leverage the power duo of customer segmentation and market sizing effectively. These activities include a continuous review of segments and market dynamics. These actions lead to potential refinements to your customer segmentation efforts and associated sizing calculations.

Prioritize Segments

Allocate resources based on the potential value of each customer segment, focusing on segments with higher growth potential or untapped opportunities. Not all customer segments are equal regarding revenue potential or long-term growth prospects. Businesses should prioritize segments that align with their core competencies and offer the most significant growth opportunities. This prioritization ensures the proper allocation of resources such as time, budget, and personnel where they can have the most significant impact. By focusing efforts on segments with higher potential, businesses can optimize resource allocation and maximize returns on investment.

Monitor Market Dynamics

Stay updated on market trends, customer behaviors, and changes in customer segmentation to adapt strategies and seize emerging opportunities. Markets and customer preferences are dynamic and continually evolving. Businesses must stay attuned to market trends, shifts in customer behaviors, and emerging opportunities. Companies can continuously monitor market dynamics to identify new segments, emerging needs, or changing customer preferences. This proactive monitoring allows them to adapt their strategies proactively and stay ahead of the competition. Regular market research, customer surveys, and competitor analysis can provide valuable insights for ongoing investigation and adaptation.

Refine Segmentation Efforts

Continuously review and refine customer segments based on market feedback and evolving customer needs, ensuring the segmentation remains accurate and relevant. Customer segmentation is not a one-time exercise. As markets evolve, customer needs change, and new data becomes available, businesses must refine their segmentation efforts. This process involves reviewing and updating customer profiles, reassessing segment characteristics, and incorporating new insights into segmentation strategies. By maintaining accurate and relevant customer segments, businesses can tailor their offerings, improve customer targeting, and adapt their marketing efforts to meet evolving customer need

Conclusion

In the early stages of evaluating a new venture opportunity, thorough market sizing and customer segmentation analysis provide the indispensable analytical foundation. By continuously refining their understanding of the total addressable market, priority segments, and realistic market share, founders gain valuable insights into the scalability and profitability potential of their business idea.

While market analysis involves complexity, synthesizing data from multiple approaches allows founders to develop reasonably accurate projections despite limitations. Combining top-down and bottom-up modeling, primary research, competitor analysis, and expert guidance minimizes the risk of biased or skewed estimates.

Diligently following key steps to size the market and profile target segments equips founders with a compass to guide strategy. Their market projections and customer insights directly inform positioning, messaging, sales modeling, fundraising targets, and operations planning. With a realistic perspective on TAM, SAM, and SOM, founders can make well-informed decisions aligned with market forces and customer needs.

Though imperfect, pragmatic market sizing and customer segmentation provide the foundation for founders to develop sound business strategies and financial projections. The time invested upfront generates clarity for direction and decision-making as founders progress on their venture realization journey.