Pitfalls in Market Sizing (part 6 continued)

In my last post
I outlined a way to think about market sizing for your VC pitch and
emphasized what I think you should do.  In this much shorter post and
with no title alliterations (and some emoticons 😉 I will highlight 3 common mistakes that I often see and that I suggest you avoid.

1. 1% of China 

The first problem I call metaphorically the 1% of China problem
because it uses a large number and small market share to make it sound
like a “no brainer” that you’re business will be successful.  We are
only charging $3 / month so if we capture just 1% of China that’s a
$430 million market opportunity for us.

In reality I see people pitch it this way, “we’re going after the
$2o0 billion US market for local contractor services annually.  We
think that third-party websites that help broker these relationships
can capture 5% of the value, making it a $10 billion opportunity.  If
we capture just 2% of this market (not a tough ask, right?) we will be
doing $200 million in sales.  Your market sizing (and frankly your
income statement) needs to reflect realism about how the market is
disaggregated and therefore the real value you can capture.

You probably need to start by figuring out that of the $200 billion
40% is the value of the products they install, 40% is their labor and
20% is their margin.  Therefore a more realistic market size might be
$40 billion to start with.  It is even more useful to know how much
local construction firms pay per year in marketing their services
because is probably a much better market analogy for what you’ll be
trying to replace.  If they spend $2 billion on local advertising then
you need to know who they spend that with.  You can make a case that
you capture part of this TAM and now your presentation is distinctive
because you’ll be talking about the differences in your solution to the
Yellow Pages, ReachLocal, radio, ValuePak, etc.  Even better if you can
then show that in the top 10 DMAs
that you’ll be targeting in the first 3 years they spend $300 million.
 I learned from doing this the wrong way.  In 1999 I used lots of 1% of
China examples.  It was so 1999.

2. Conservative Estimates

One of my biggest pet peeves is the dreaded “conservative estimate”
as in, “we’ve modelled out the market for the next 5 years and we’ve
used very conservative estimates to show how we’ll capture 15% of the
market and be doing $120 million in sales by year 4.”  First, 90+% of
businesses never achieve the targets that they show in their Series A
investor presentations and 70+% seem to announce that they’ve used
conservative estimates leading to a healthy dose of estimation cynicism
by many investors.  So the first thought I have when people give me
“conservative estimates” is “yeah, right”.  The second thought I have
is, “if these are conservative estimates then WTF don’t you just give
me the real estimates?”.  Simple advice – don’t ever tell a VC you’re
giving them conservative estimates.

3. Loosely defined industry

The last obvious pitfall I see is the loosely defined industry.  
“I’m addressing the $300 billion US energy market.  We want to have
people 10% on energy.  Therefore our market size is $30 billion” or
“I’m addressing the $2.3 trillion US services market.  It is a huge
market.”  You’ve already lost credibility so whatever you say next
almost doesn’t matter.  Define your market sizing as tightly as you
can.  Nobody will fault you for coming up reasonable estimates.  They
will fault you for no thought about your market size or too loosely
defined a market.

Next post: How to talk about the competition.

(Cross-posted @ Both Sides of the Table)