…the market size slide.
My sense is most entrepreneurs feel like they have to have a $1B+ market size for investors to get interested. And, then the more aggressive entrepreneurs, knowing that everyone else has at least a $1B+ market size, come in with the $5B-$10B+ market sizes. The means to arrive at these numbers is usually to take a generous number of possible customers and multiply that times a large spend per customer to equate to the multi-billion dollar “addressable market size“. Others might site 3rd party data sources which is intended to lend credibility to the analysis, but which are largely derived by the same methodology. It’s this approach to market size analysis which I don’t find particularly useful and can generate a false sense of comfort if you actually believe it.
When I’m looking at a prospective investment in a company, here’s how I think about market size:
The first question I ask is how much revenue do the companies that sell principally the same product or service generate today. This is the “current market size“. For example, when we invested in Ensighten in 2012, which started out as a tag management vendor, if you added up all of the revenue (from tag management software) of all of the tag management vendors, the total would have been less than $30M, but with hyper growth. That, in my mind, was the current market size for tag management. It was a small number because tag management was a new market rather than an existing market. Alternatively when we invested in Globaltranz in 2011, which is an Internet freight brokerage, the revenue of all of the companies that broker freight capacity in the US was $127B. It was a much larger current market, but with more moderate growth given the maturity of the industry.
It’s important to establish the current market size because it helps to establish whether the company is going after a new or an existing market. If the current market size is small, such as tag management was two years ago, that’s not a deal killer by definition. It just means you have to develop strong conviction that the market will grow and appreciate the inherent risk with that. Lots of investments fail because a new market doesn’t grow at the scale or pace anticipated. If the current market size is large, but not experiencing hyper growth, such as in the overall freight brokerage industry, that’s also not a deal killer by definition. It just means you have to have a crystal clear rationale on why market spend will shift towards a new upstart rather than stay with the incumbent. These are important and fundamentally different questions.
The next question I then ask on market size when evaluating a company is how much revenue, in aggregate, will all of the companies that sell principally the same product or service generate in the future (5-10 years from now). I think of this as the “attainable market size“. When you define a market size by the aggregate revenue of the competitors, it immediately juxtaposes market size against market leadership. For example, if an entrepreneur wants to say their company will have a large multi-billion dollar attainable market (e.g. $5B in 5 years), but their company “only” projects $50M in revenue in 5 years, then it begs the question why 99% of the spend in the market did not go their way. You can claim a large attainable market, but it becomes harder to claim market leadership with little market share. Alternatively, if an entrepreneur wants to call their company a market leader by generating $50M of revenue of a $200M attainable market, then it begs the question of whether the product or service has that much value if the eventual attainable market isn’t that large. It forces everyone to think through the realities of how their market will evolve and how their company’s competitive position will evolve alongside that.
Today, Ensighten is one of the fastest growing SaaS companies in the country and Globaltranz is one of the fastest growing freight brokerages in the country. Despite coming from diametrically different current market sizes when we invested, in both cases, the attainable market has turned out to be large and both have established strong leadership positions within those markets. We’ve been fortunate that the stars have aligned for both.
In summary, my biggest issue with the bloated addressable market slides we see day in and day out in company pitches, is we all know that when we fast forward 5-10 years, almost in all cases, the actual aggregate revenue generated by the companies in those markets will not come close to equaling the addressable market size. In other words, the attainable market almost always turns out to be a small fraction of the addressable market. This tells me that the addressable market size slide is too theoretical to actually be useful and should have little or no bearing on an investment decision. For this reason, in my opinion, it is generally the least useful slide in the pitch deck.