How to Estimate Market Potential

Everyone wants to know the potential of their market. Here are some ways to think about the problem.

Market potential calculations are often used in sizing new market opportunities, but they also can be helpful in allocating resources across existing opportunities, establishing benchmarks, and as an input to sales forecasts.

All definitions of market potential share the notion that there is some maximum number of units a group of customers might consume in a given time period under a given set of conditions. If all customers who could benefit from a solution purchased and fully used that solution, what would that number be?

To be clear, this is about estimating potential demand for the market as a whole, not industry sales. Industry sales represent the portion of market potential the industry has realized, composed of the number of current customers and their current usage rate. Your sales represent the portion of industry sales that your organization has realized.

In all cases, market potential is an imaginary number. Exact market potential is ultimately unknowable (how would you know if you had reached 100% of potential?) and may change over time.

Estimation Techniques

Broadly, there are two ways to build an estimate of market potential: top-down and bottom up.

Top-down Estimation

The top-down approach starts with a global estimate of the target population and its likely purchase rate.  Some high-level hypothetical examples:

• As of 2018 the World Health Organization estimates that some 15 million Americans suffered disabling hearing loss.  If all these people would benefit from hearing aids and people replace their hearing aids once every five years, that suggests 3 million pairs per year for this cohort.  
• As of 2017 the American Pet Products association indicates Americans own 94.2 million cats as pets. If you’re selling a cat toy that lasts six months, that’s a maximum potential of 188.4 million units per year.

In reality, of course, no one would come close to those numbers, but it’s a place to start. Better top-down analyses winnow down the (typically large) initial number to a more realistic estimate by either eliminating obvious non-customer populations or emphasizing populations that will find your product attractive. If your hearing aids are expensive, you might look at how many of those 15 million Americans can afford them. You might look at secondary research that suggests how many Americans are dissatisfied with their current hearing situation. This often gets summarized in a multiplicative or “chain ratio” model:

• 15 million people X 20% replacement rate X 40% can afford X 60% are dissatisfied = 720,000 potential pairs in a year

For ideas on how to winnow down your big number, consider the gap between industry sales and market potential (see Figure 1).

The gap between industry sales and full market potential can be summarized by five sub-gaps:

• Awareness Gap. Existing or potential customers may lack awareness of industry offerings, meaning they won’t consider the industry’s solution to their problem.
• Availability Gap. The industry’s solution may be in too few (or the wrong) distribution outlets, and within those outlets the offering may not be featured appropriately.
• Affordability Gap. Industry prices may simply be out of range for a segment of customers.
• Value Gap. Even if the industry price is within the range of affordability, it may not be perceived as good value relative to the benefits the customers receive. This can result from either inadequate benefits for a reasonable price or adequate benefits for an unreasonable price.
• Usage Gap. Even if customers purchase the industry solution, they may not use the product to its maximum potential.

Figure 1. The Gap Between Sales and Market Potential

Adapted from Best (2009), Weber (1977)

Consider how each of these gaps might affect your big market potential number. Which is likely to be a big problem? What segments are more or less affected by a particular gap? Eliminating groups with big gaps and/or focusing on groups for whom these gaps are smaller can lead to an intermediate number that is sometimes called the “serviceable” or “accessible” market. This is usually a more realistic number than the initial top-down estimate, and can also identify important strategic and tactical issues for the solution in question.

Bottom-up Estimation

No matter how good your top-down estimate, a good bottom-up approach is a very useful complement.

A bottom-up approach takes segments of a market and then builds up to a total market potential estimate. It has two virtues. First, different segments have different characteristics, and accounting for them often produces more realistic segment estimates that in turn lead to better total estimates. Second, sometimes we have very good data on a particular segment that we can then project to the market as a whole.

The best way to build a bottom-up analysis is based on some level of actual segment sales that you can then project to the larger market. If you have been selling a product to segment A, what have you learned that you can apply to the broader market? This segment could be as small as your town or as large as your country. You may also know different things about different segments and be able to aggregate that knowledge to a broader market.

For example, Schaller (2018) discovers that San Francisco has the highest ride-sharing use per capita of any city in America at 86 rides per person in a year (totaling 75 million rides in 2017). Suppose San Francisco is close to market potential. It was the first city market for both Uber and Lyft, and thus has the longest history. It is also a city where ride-sharing is starting to generate significant resistance as of this writing.

If we believe the San Francisco market can’t get much bigger—say 100 rides per person as potential—we can then look at unrealized potential in other cities based on this hypothetical potential number. If a city has one million inhabitants, maximum potential might be 100 million rides a year. We could also use this to compare potentials of cities in which ride-sharing already exists. In the same report, Schaller estimates Manhattan has 42 rides per person in a year as of 2017, suggesting that the Manhattan market for ride-sharing could ultimately double in size. 

More broadly, you can think of creating indices of potential in particular markets, using either a current market or the market as a whole to represent a baseline. For example, suppose you’ve been selling a new craft beer in Chicago.  As of 2017, the Community Expenditure Survey from the Bureau of Labor Statistics indicates that the average Chicagoan spends $509 per year on alcoholic beverages.  If we call Chicago the baseline (= 100) we can then array other cities in their spending relative to that baseline. The same survey indicates average spending in Minneapolis-St. Paul is $754. $754/$509 = 1.48, or 148 as an index number. Index numbers can be useful in projecting the market potential in particular segments; as Minneapolis indexes high for alcoholic beverage consumption, it may be a good market for your Chicago beer.

If you don’t have segment-level sales to work with, you will need to rely on market research to generate estimates. These might arise from concept testing or surveys—recall the “satisfaction with existing solutions” survey I hypothetically quoted in the hearing aid example earlier. Depending on the sample, you can use market research data to identify winnowing factors in top-down estimates or segment-level factors in bottom-up estimates.  

Questions addressing the sales vs potential gaps in Figure 1 can be particularly helpful. What portion of the market is aware? What portion of the market sees the product as good value for its price? Willingness to pay and purchase intention are also useful.  

In Summary

Use market potential estimates not only to size new opportunities but to understand existing opportunities. Compare and/or combine top-down and bottom-up estimates to get a more realistic view of the market, and use these insights to identify strategic and tactical actions that will close the gap between market potential and sales.

References and Further Reading

Best, Roger J. (2009), Market-Based Management, 5th ed. Upper Saddle River, NJ: Person Prentice Hall.

Schaller, Bruce (2018), “The New Automobility: Lyft, Uber and the Future of American Cities,” Schaller Consulting, June 25, http://www.schallerconsult.com/rideservices/automobility.pdf

Weber, John A. (1977), “Market Structure Profile Analysis and Strategic Growth Opportunities,” California Management Review, Fall, 34-46.