Startups Should Do “Value Pool Sizing”, Not Market Sizing

Value pool sizing, as a mathematical exercise, can be simple. What’s the $ size of a pain that a buyer has? How much can we alleviate it? That’s it.

Your revenue is the percent of the value pool you can capture in price, while the rest goes back to the buyer as the value they get for using your product.

Note that a value pool is focused on a specific customer pain point and area of need. The need may not yet be served by any solution.

Market sizing is an exercise to size up … well, a market. A market by definition already has one or more major incumbents that define it. A market is then defined by a type of product and not a specific need.

How to do Value Pool Sizing

For example, let’s look at customer turnover for commuter rails. From our interviews, imagine we heard 30% turnover in rider base over the course of a year is normal. They measure the cost of customer turnover as equal to the cost to acquire a replacement—about $500.

Thus, the size of the pain = a ridership base of 100k people * $500 * 30% = $15M / year.

Our targeted impact is a percentage of that size of pain. If we can help them reduce their turnover rate by a tenth (i.e. 30% -> 27%) it would be worth $1M (2% * 100k * $500). That’s the value pool for this one customer.

Would the $1M savings per year get the commuter rail’s attention? You need to ask the buyers. And only through interviews will you learn, for example, that a Director of Operations role is solely accountable for managing all rider turnover.

Customers often look for a 5:1—10:1 ROI on their investments. Thus, the price point you’d target for this value pool would be about $150k/year. They spend that, and with a 7x ROI, they will see $1M/year in savings on an overall problem that costs them $15M/year. Maybe over time we can improve our product to take on a bigger chunk of the $15M.

Why I prefer value pools over market sizes

The exercise above is focused on a buyer, a buyer’s need, and how we can address that need. Market sizing, by contrast, is more about how much money customer are spending today on a product category. That’s just less relevant for a startup looking to introduce something new.

Value pools and market sizing can both be useful; they measure different things for different reasons.

If you choose to go the market sizing route, some thoughts follow.

TAM = Total Addressable Market

Let’s start with definitions:

TAM for Product X = the Total Addressable Market.

TAM is the total amount of revenue your product could make every year if you served all possible customers and they all bought a complete solution from you (Product X) including only product components you expect to have over the next one to three years if you made no major unforeseen investments or changes in product direction.

For example, if you’re selling sandals over the internet, you might size “Internet-based sandals”. But you might also size “Internet-based shoe sales” or “Internet-based beach wear”. This is based on an understanding that internet-based sales are core to your business model and it would take major unforeseen investments to change that (e.g. to open a brick and mortar store). But you could well expand into broader product category areas without unusual new investment. Which direction—all shoes sales or beach wear—should you size? Possibly both. The TAMs can then help you decide where to anchor your strategy.

When you calculate a TAM, questions may come up:

  • If I’m inventing a new market, how do I size it? (Answer: use a value pool approach; see above.)
  • What’s the right level of detail when calculating TAM for a product? E.g. do you calculate for food, candy, candy bars, coconut candy bars, or Mounds?
  • What’s the right level of detail when calculating TAM for a customer segment? E.g. do you calculate for direct customer sales, grocery store sales, direct business sales, or mix them all?
  • What’s the difference in size between TAM and SAM (the reachable, or Serviceable Addressable Market)? In other words, what part of the total market is serviceable by you (i.e. SAM) versus not (i.e. in SAM but not TAM) and why?
  • What if our product will grow over the next few years with new value-creating and price-increasing features—should we size based on today’s available market or the future’s?
  • What if we have customers who pay for an enhanced product—should we size assuming everyone might buy it, or size based on some mix of enhanced versus basic product options?
  • If we have an established product and an established price, should we use our price for the market size, our competitors’, or some mix?

There is no official answer to many of these questions. If you’re doing market sizing, as long as you align on an approach and use it consistently, that’s what’s most important. I guess I could offer more answers to these questions … but my point is, why bother so much with TAM anyway?

The nice thing about value pool sizing is that it sidesteps these and focuses instead on what really matters: how much are you able to help a customer.

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All books and other resources referenced in this article