Sorry Guys — It’s the Size of the Wave, Not the Motion of the Ocean

Part 6 in my VC pitch series:

If you haven’t read any previous posts in this series consider starting here at the start but it isn’t really required to get the gist of the post. If you want to go to the post immediately prior to this one it is here.

So by now I know your bio and why you eat nails for breakfast. I understand the problem you’re trying to solve and why your solution is just the fix. You’ve shown me your killer demo and I’m excited. MAN! Who could have thought you could do THAT with Ajax ;-)

But now comes the time for one of the biggest VC roadblocks that many VCs will tell you they aren’t obsessed with and I guarantee you that 98% are (and the other 2% are liars). “How big can this get?” It is one of those vague objections that is used to kill off many deals. The reason that many companies fail on this question is that they don’t put enough effort into this analysis (and frankly, if more people did do this analysis some businesses might actually not get started).

My own hypothesis on why more market sizing doesn’t happen is that many entrepreneurs are in love with product features rather than thinking through how much they could charge for their product, how many people would actually buy it, how many competitors they will have and therefore how big the market might be. It leads to what a friend of mine at First Round Capital termed FNAC (Feature, Not a Company). But even if you are a “company” how big is your market? If you’ve never done market sizing before try to find a friend through LinkedIn that knows someone at McKinsey, Bain or BCG. They churn this stuff out for breakfast.

Market Sizing

1. TAM — The starting point in market sizing is something we call TAM or Total Addressable Market. It usually starts by your defining the industry you’re in. For example: The US apparel industry is worth $280 billion per year. You might even have a stacked bar showing the breakdown by shoes, athletic wear, formal wear, casual, etc. … if that sort of breakdown were relevant. But PLEASE don’t for a second imply that you’re going after a $280 billion opportunity. Many people make the mistake of alluding to this massive market size, which sets off the VC wondering about your sense of realism.

Next you need state that the online market for retail is between $18–22 Billion and you might have a stacked bar to the right of the apparel bar (you don’t have to format it this way, but I do recommend some sort of graph / visual to walk through this exercise is possible). If you have the breakdown by either category or major vendors (or both) that would be helpful. I recommend that you have a very small footnote in the bottom left of the slide in a really small font that denotes your data source. If your VC is an ex consultant or banker he/she will be feeling really good right now.

But wait, are you really going after the entire online apparel industry? Or just a sub-segment? I’m guessing the latter. Better define it. You might be going after the high-end, fashion forward segment and that might be $1 billion of the online market and $20 billion of the total market. Now we’re talking. You’re going after the $20 billion, high-end online apparel market of which only $1 billion is sold online today. [while you estimate that 8% of all apparel in the US is currently bought online — only 5% of high-end is bought online … hopefully that was part of your problem statement]

2. Bottom Up — For some industries it may by easy to do a bottom up slide also, but even if you don’t please give it some thought in case you’re asked. If presented with the information above and I know a small amount about online retail I might say, OK, let’s see … BlueFly does about $100 million in sales, Nordstrom must do at least that much, then there’s ShopBop, RedEnvelope and all of the “private sale” sites like HauteLook, Gilt and Ruelala. OK, $1 billion sounds reasonable. Maybe even light? You’d be surprised how many market sizing discussions blow up here. A partner asks, “so how big is the largest player in this segment today” in order to try and do the back-of-the-envelop calculation to see whether your market sizing is right. “I don’t know” isn’t going to earn you kudos. Credibility starts to wane. If you don’t know how big (or at least a guestimate) the largest player in your segment is that’s not a good sign. Maybe you haven’t really thought through this whole go-to-market thing as clearly as I had thought when I saw that sexy demo?

3. Market Growth — OK, so it’s only a $1 billion market today but it IS the fastest growing segment of the eCommerce market today. Show me the 5-year projections how this will grow to $9 billion in just 5 years and make sure you do all your math because you know that we will. VC’s are really good on the fly at these kinds of calculations. We watch these presentations day-in and day-out. You do them once / year TOPS (hopefully). So … $9 billion in 5 years and it’s a $20 billion market segment growing to $22 billion. That’s about 40% of all high-end fashion being bought online in 5 years. Is that reasonable? I don’t know. But you better. And you better be prepared with the reasons why. You don’t have to lead with the percentages and explanations — but be ready to answer it if asked.

4. Market Share — So, the market is $1 billion growing the $9 billion. What is a reasonable share for your NewCo to grab given entrenched competitors? Maybe year one you think you can do $500k in sales growing to $100 million in year 5. This still represents just 1.1% of the market share. You will address later on a different slide how you can get to $100 million but in a category like this I’ve seen it happen in even a shorter period of time. (in face, showing examples of similar company growth projections adds to your credibility). In any case, beware of the large market share problem. Doesn’t apply in this example, but there are times where people assume too big a share — like 50% in year 5. Even 35% share in many instances will seem high. On the other hand if you’re only 1% after 5 years perhaps you need to define your market more granularly.

5. Market Value (Gross/Net) — Don’t be tripped up by gross / net. If you think that you’ll be doing $100 million of “gross” sales through your website in year 5, how much of those sales are attributable to you? If you’re Land’s End selling your own product the answer is 100%. If you’re PrivateSaleCo selling OPP (Other People’s Product, that is) then you’re true value might be just 30–50% of the value of the goods if you, in fact, don’t take inventory. If this is the case you’re probably better off reporting your “net” revenue. Same applies for categories like hotel rooms, flights, etc.

6. International Expansion / Segment Expansion — Many people add in growth plan comments at the end of their market sizing exercise and I recommend it. In our example you could say, US high-end apparel is $9 billion in 5 years. But don’t forget that Europe will be $11 billion and Asia will be $5 billion. We won’t be going after these markets in the near term but as we increase our success we will obviously look to other markets. Also, while we’re starting in high-end fashion we will likely extend down into the next product category down in fashion terms, which is a $25 billion segment. We haven’t modelled that into our numbers yet but we believe that this market can be addressable once we’ve built the brand.

Your goal here is just to stretch my imagination and get me excited by the future potential. You need to get over that all important VC hurdle … this is a BIG market.

OK, so I’ve droned on for too long in this post. My next post will tell you the biggest 3 pitfalls that I often see in market sizing.

Do you have some feedback on this post? Questions? Are you an ex McKinsey guy who can give me some tips to make this advice better? Please leave some comments. Love to get all input and get the discussion going.