David Cummings on Startups

Startup Potential Revenue and Market Size

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David Cummings

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A reader of this blog sent me an email asking for advice about his startup. After hearing the pitch on the phone I told him that I didn’t think it was a large enough market to be worth his time. He then sent me an email with some stats about the market and a statement like:

2 million potential customers * $100/year * 1% = $2 million/year business

I quickly replied back saying that I don’t like doing the top down approach for how big a company can be but rather doing a bottom up approach is the way to go. What’s a bottom up approach look like? I’d recommend doing something simple like:

  • A typical customer will pay us $1,000/year
  • We’ll hire five sales reps
  • Each rep will sell 10 per month
  • We’ll lose a certain percentage of customers per year (churn)
  • We’ll up-sell a certain percentage of customers
  • With this math we’ll add approximately $600,000 in annual recurring revenue per year assuming churn and up-sell equal out

Here’s a good review of market sizing on DocStoc titled A Startup’s Guide to Market Sizing.

Comments

6 responses to “Startup Potential Revenue and Market Size”

  1. David Carroll Avatar
    David Carroll

    This should be taught, among other things, in any startup 101 class. Not as much fun learning from the school of hard knocks. That said, we’ve focused on market segmentation and building a bottom-up revenue forecast. This allows for a baseline of metrics and milestones to plan against allowing for adjustments when needed. Thanks for sharing the DocStoc link. Had not seen this slide before.

    Reply
  2. Lance Weatherby Avatar
    Lance Weatherby

    I am a fan of a combined top down/bottom up approach where you size the market from the top down and the company from the bottom up.

    Reply
  3. David Carroll Avatar
    David Carroll

    Lance – Good point. It’s the difference between being optimistic (top down) vs realistic (bottom up). I’m a bit guilty of the former more often than not. Optimism is the curse and driving force of being an entrepreneur. However, being insanely detailed and focused on metrics while creating a sales and marketing execution plan keeps me grounded and realistic. At least I hope so 😉

    Top Down makes it easy to evaluate an opportunity’s potential. Bottom Up is what will drive investments and/or profitability. Either way, both are required on both ends of the process.

    I talk to entrepreneurs all the time, in much earlier stages than where we are, who haven’t considered the bottom up approach. Consequently, many seeking investment capital don’t realize their idea isn’t venture scalable until they review the bottom up scenario. This evaluation would help many understand they need to continue bootstrapping their business, as well as, how to become profitable enough to build a great lifestyle company. That’s not a bad thing either.

    By the way, thanks for all you guys do for the Atlanta Startup Community. We’re lucky to have people like you guys who provide the guidance you do. Look out for me on Twitter @softRealtyDude.

    Reply
  4. Justin Ratner Avatar
    Justin Ratner

    Here’s the thing about market sizing:

    In science, we formulate laws based on testable hypotheses. Testing is done rigorously in controlled experiments. Once we have a full understanding of the assumptions involved, we begin to formulate a theory that predicts some sort of behavior. With luck, that theory will become a law of nature.

    In business, one shakes his voodoo rattle and writes a number down on a piece of paper. These numbers are riddled with assumptions and, often, not lived up to.

    I think a bottom-up market sizing is a good exercise i n planning, but most of the numbers are simply goals. Any smart person will set their goals higher than they believe they can achieve.

    On the other hand, I think a top-down market sizing is the only quick way to figure out if a market is worth your time. Most people want to know what the upside of the best-case scenario is before they go marching down a path.

    It seems logical to me that once you spot a market you like via a top-down approach. You should devote additional time coming up with a bottom-up approach in parallel with the initial stages of execution.

    One final thing: I believe any business is venture scalable. It just takes the right team of people who refuse to take “no” for an answer.

    Reply
  5. davidcummings Avatar
    davidcummings

    Thanks for the great comments David, Lance, and Justin. I think looking at the potential market size is an important part of determining the viability of a business, but IMHO, most entrepreneurs don’t do the bottom up exercise, and don’t realize how difficult it is to acquire profitable customers.

    Reply
  6. The $15 Million SaaS Revenue Plateau – David Cummings on Startups

    […] Market Size – While entrepreneurs talk about the amount of money spent in a market, the reality is that a much, much smaller percentage is spent on new software each year in that market. Most markets are smaller than what people think. […]

    Reply

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