What’s it: Market size is how big is total sales of all producers in the market. It is in terms of sales value, sales volume, or the number of customers. We also refer to it as market demand and can refer to current or potential sizes.
Measuring the market size is an integral part of market analysis besides analyzing market trends, market profitability, cost structure, competition level, distribution channels, and critical success factors.
Why market size matters
Market size matters for several reasons.
First, it has implications for revenue and economies of scale. A larger market size offers higher potential sales and revenue for the company. When firms can sell more products, they can produce higher economies of scale. It then contributes to lower average costs and increasing profits.
Second, to calculate market share. We calculate market share by comparing the company’s sales to the total market size. Say, consumer demand for a product in the market is 1,000 units, and 500 of them come from one company, so that company controls 50% of the market share.
We use market share to measure a company’s power and dominance in the market. It is also related to the effectiveness of the company’s strategy and the measure of consumer preference for the company’s products compared to competitors’ products. An effective strategy allows companies to generate more sales than their competitors, resulting in a higher market share.
High market share allows firms to influence the market and achieve higher economies of scale. And, specifically, the company with the highest market we call the market leader. By selling more products, the leader can produce more output, lower average costs, and generate higher profits.
Second, to measure the rate of return. When entering a new market, firms look at market size to determine the return rate. Market size affects potential sales and profits. When the cost of entering the market is higher than the potential profit, companies are reluctant to enter.
Apart from the current size of the market, a company usually also considers its growth and potential size to assess whether the market is fit to enter or not. Factors affecting market growth include increases in purchasing power and population, changes in consumer tastes and needs. A growing market with a large potential size is attractive. Companies can generate more sales and revenue without having to snatch customers away from competitors.
Fourth, it affects competition. The mass-market usually has more competition than a niche market. Mass markets offer more significant income potential and higher economies of scale. Therefore, many companies are interested in exploiting it.
In contrast, firms in niche markets typically face fewer competitors. Because it caters to consumers’ specific needs, sales volumes and economies of scale are low too. Large companies are usually reluctant to enter this market.
How to calculate the market size
You can calculate the market size based on the following three types:
- Sales volume – based on the number of goods sold, such as tonnes for commodities.
- Sales value – based on the monetary value of market demand. In other words, it represents the amount of money customers spend on products.
- Number of customers – based on how many individuals buy.
Sales volume or value
Calculating market size based on sales value is sensitive to pricing strategies, as well as sales volume. For the same product, firms may charge a high price, while others charge a low price.
Take, for example, high-end and low-end smartphones. To generate the same sales value (revenue), high-end smartphone manufacturers may only need to sell lower volumes than lower-end smartphone manufacturers.
The next consequence is, if you calculate market dominance based on sales value, the two producers have the same market share. Conversely, if you use sales volume, lower-end smartphones have a higher market share.
Therefore, you need to be careful in determining the market size and market share. The case tells you the value of selling is sensitive to its strategy for achieving a competitive advantage. Under the differentiation strategy, the company takes high-profit margins because it offers a premium product. Conversely, a cost leadership strategy should sell at high volumes because it takes on relatively low margins.
Types of market size
Market sizes vary widely between products, depending on their supply and demand. Some are very large in size, and others tend to be small and specific.
- Niche market. The market consists of a small number of potential customers. The company caters to a somewhat unique need or desire, for example, organic food. They can benefit from using a premium price because the opportunities to exploit economies of scale are relatively low.
- Mass market. The market consists of many potential customers. The company provides products for the majority of customers. Products fulfill a relatively general need or want, such as food. Companies usually sell standard products with a low profit per unit margin. To make a profit, companies must sell at high volumes and achieve higher economies of scale.
In calculating market size, companies will usually specify market definitions in the following categories:
- Potential market
- Available market
- Qualified available market
- Target market
- Penetrated market
First, the potential market. It consists of individuals in the total population who have a desire to use the product. Some of them have the ability to pay while others don’t.
Second, the available market. It consists of individuals who have the desire to use the product plus have the ability to pay. In other words, it is the potential market where consumers have effective demand. Individuals not only want a product but also have the money to buy it.
Third, a qualified available market. It consists of individuals who have effective demand and are legally permitted to buy and use the product. For example, the government requires companies to sell alcoholic beverages only to specific age individuals.
Fourth, the target market. This is the qualified available market segment that the company strives to serve.
Fifth, penetrated market. The market consists of individuals who have bought or used a product.
Example of calculating market size
Let’s take a simple example of calculating market size based on sales value.
First, to calculate the market size, you must look for data on the number of potential customers and estimate their penetration rate. As I have mentioned, not all individuals in the market have the ability to buy, even if they want the product.
Second, the number of potential customers you use must be specific to your target population, such as the 18-64-year-olds. Assume the number of potential customers is 100 people. Of this total, only about 70% are likely to buy. For the rest, about 30% are likely not to buy because they have low purchasing power.
Third, say, the average service life of the product on the market is 1 month. So, for each person, assume they will buy every month. We can find out the sales volume in one year from this data, 1,200 units (100 people x 12).
Fourth, assume, on average, firms set a selling price of $10 per unit. Thus, the market value for the product is $12,000 (1,200 units x 10).