Estimating the size of the market, and then predicting how much revenue the startup can achieve and at what growth rate is indeed a tricky exercise. But going wrong on this could either kill your company, or if in a rare case you have underestimated your revenues, you may end up diluting more equity at a funding round than would have been necessary.
It is therefore very, very critical that entrepreneurs focus on working and reworking on the market size and revenue potential based on sound assumptions and with minute detailing.
Many startups make the mistake of taking broad brush reports from large consulting or research firms, and estimate the size of their market on the basis of those reports. Often we hear entrepreneurs mention “According to Gartner, healthcare is a 80 bn USD industry with a 23% growth rate”. Now, while this could be broadly true, for an investor, and even for the startups, these figures have little relevance. Here’s why…
In most market segments, the investors would be broadly aware of the scale potential. At a startup stage, investors will most likely invite a startup for a meeting only AFTER they have assessed that the concept does have a potential to address a large market. Hence, stating the obvious, especially in segments that are very obviously large does not add any value. E.g. For a education domain startup, highlighting in minute details the number of number of schools, number of students and growth rate in India is wasting precious time in the first meeting with investors. Assume that investors who are meeting a startup in the education space know the potential of the opportunities in the domain.
How then do you estimate the market potential? Simply, by being specific about your segment and making some assumptions on the specific segments and the revenues per customer/consumer. E.g. Instead of saying education in India is a USD 18 billion market, for a premium ‘home tuitions startups’ it will be prudent to state “With over 250,000 students in the top 10 cities in schools with fees above Rs.10,000 a month, at Rs.2500 per student, the market potential is roughly over Rs.500 – Rs.600 cr. P.a. At an all India level, the same translates to a market potential of well over Rs.1000 cr.
Some points to consider when estimating market potential
- Clearly define what problem you are solving… and for whom – this will give you a good idea of the number of customers with that problem in the geographies that you plan to be available in.
- Estimate the practical reach e.g. while there may be a 100,000 people in your target audience spread across 50 cities, you may want to take the top 5 or top 10 cities and see how many people you have within your target audience. This of course gives you the total market potential IF 100% of potential customers were to buy.
- Now, apply some filters i.e. ability to pay, ability to reach via media, etc. E.g. while there may be 60,000 potential customers in the top 10 cities you identified, and you may be panning to use a combination of media, if the total reach of these media vehicles is 50%, the total potential of the market is really 30,000 customers.
You could also apply some price filters to test the elasticity of the demand in comparison to price. I.e. work up alternate scenarios to reflect the increase / decrease in demand in case the price were to be moved up or down… and then evaluate which scenario makes a better business case. [Note: For different situations you may have very different parameters for a good business case. In some cases, rapidly acquiring customers, even if margins are lower, would be a key criteria… often relevant in new concept that make sense for the first mover to ‘land grab’ and lock in potential customers on whom profitability can be increased later.
- Now, if the product is of a repeat purchase nature, you would need to make some assumptions on the number of times the customers would buy the product / service in a year. In doing this, it is critical to map the reality or in case of new product categories, to do some qualitative and/or qualitative research to validate your assumptions on the number of repeat purchases within a year.
- All the above, and perhaps some more as relevant to your category/product/service, will need to be worked and reworked often to arrive at what seems like a practical market estimation.
How do you estimate your revenue and growth? This is a rather tough part, and the accuracy of these guestimates is largely dependent on how accurate your assumptions are.
Many entrepreneurs make the mistake of projecting revenues as a % of the market potential. Often we hear entrepreneurs state “Even if we were to capture just 2.5% of a Rs.1000 cr market, we are targeting a revenue of Rs.25cr in year 2”. This is obviously an oversimplification and without any basis for how the sales plan will be implemented.
To prudent way of arriving at a estimation of revenue is to build a business case ground up. I.e. how much revenue are you expecting per customer, how many customers can you get, how much does it cost to get each customer, etc. At the startup stage, it is important to do a month-by-month detailing of how you see the customer base increase based on what specifically you plan to do in your marketing & sales plan. Needless to say that this is not a one-time exercise, and you will keep reworking on this till the business case starts making sense.
While doing month-by-month revenue estimation, if you have multiple revenue streams, then make the revenue estimates for all the revenue streams, which then total up to make the overall revenue for the company. E.g. if you are starting a chain of restaurants, you may want to break up the revenue by breakfast, lunch, snacks and dinner as these would cover different dynamics of your restaurant business. Similarly, if you were doing an ad-supported Freemium product online, you would like to estimate separately your revenues from ads on the free downloads and the subscription from the paid downloads.
Do remember that this is just a guestimate… i.e. a well-thought-out estimate. This is just a reflection of how YOU expect the market and the world around it to behave. And because there are no guarantees that the world will behave as you predict it to, it is prudent to be very, very conservative with the revenue estimates. If you are too optimistic, you are likely to allocate a proportionate marketing investments behind the revenue growth… and if for whatever reason the revenues do not happen as you have predicted, you will have a sufficiently fierce problem on hand.
|Note:In many a startup scenarios, revenues may NOT be the key parameter of progress. E.g. in a startup which is establishing a new technology, proving the concept and the business model may be the main objectives in the startup stage.|
Do remember that your growth and revenue numbers should be mapped to the marketing plans and marketing investments, and should be rooted in reality. “We are smarter and we know social media marketing really well and hence our customer acquisition cost is much lower than others” is not a statement that investors would be keen to bet on [though if you state that they would be keen that you demonstrate your skills in lower cost customer acquisition 🙂 ].
As one of my mentors had said “See the film in your mind… for a startup, it is critical to be very clear on what specifically is going to happen on the marketing front, product front and sales front in which month and therefore what revenue and customer numbers that will likely translate into”.
- Try to achieve higher conversions than comparable others in the market, but estimate much lower conversion. This way, even if you do not do better than market average, your plans don’t go awry.
- Validate your assumptions – validate your assumptions – validate your assumptions…. Again and again and with multiple sources. Going wrong in assumptions can be disastrous, even if the rest of the components of your business do well. E.g. if you assume a 0.5% conversion, but it actually turns out to get 0.3% conversions, you may be off by a considerable margin in your profitability and may also run out of cash sooner.
- Identify the key ratios that you need to measure. E.g. Gross margins, cost of customer acquisition, headcount per ‘unit’ [i.e. could be a set of customers], etc.
Key points to remember
- Be conservative in revenue estimates
- Validate your assumptions
- Detail out the revenue plan on a month-by-month basis, and separately for each revenue stream
You would have often heard VCs and experienced entrepreneurs say “Ideas don’t mean anything. It is the execution of that plan which makes a good business case.”. Hence, often VCs will be willing to invest in a simple concept with high-quality teams with great implementation plan, rather than weak teams even if they have a great plan.
Good execution and operations management is a lot about making sure that the many moving parts of the business are in sync with each other.
Most entrepreneurs underestimate the competencies and skill sets required for a venture to be implemented. They detail out the product/concept/service but do not spend adequate time in detailing out the operations plan. It is critical for the entrepreneurs, or the people planning the operations for the startup, identify, discuss and debate every single aspect that will need to be planned for good implementation.
|For example: A startup planning a chain of coffee shops across the country does not need just great coffee and snacks making skills. In fact, that may be the least of the worries in creating a great coffee shops chain.Creating a coffee shops chain will require the following competencies.|
- Real estate management
- Brand identity
- Pricing strategy
- Supply chain
- HR, legal, finance
- Cash management
- ROI & capacity utilization
- Facilities management
- Org structure
Admittedly, startups are unlikely to have the full team to manage operations efficiently. However, planning does not require resources…. Investors invest, based on your PLANS for the future, whilst understanding that your current mode of operating is only due to resource constraints.
Especially for startups with a B2C concept, which could have rapid growth, it is important to plan for scale BEFORE the venture is ready for scale. It is almost always impossible to hack together the resources, processes, infrastructure and other elements to scale up quickly… these have to be built well in advance in most cases to be able to scale up smoothly.
At the pilot phase, or a concept test phase, it is critical to define very clear what is going to be tested and what the parameters of measurement would be. Many of the parameters could be qualitative as there may not be enough data to do a quantitative analysis. But identifying what and how it is going to be measured is critical.
Below are a few things that are tested in a concept test stage/pilot phase:
- The concept – the power of the idea itself: One of the key things to evaluate in the pilot phase is whether the idea or concept has appeal among the target audience. While research is one way of gauging customer/consumer acceptance of the concept, customers or consumers actually buying/using is a stronger demonstration of the appeal of the concept e.g. for an e-commerce venture selling real gold & diamonds jewellery online, the pilot phase may want to check if customers actually buy jewellery online
- The business model: Even if the concept rocks, how good and practical the business is will make or break the business case. In many cases, it may not be possible to check the business model in its entirety in the pilot phase. But at least it would give some indicators. E.g. for a company creating advertising platforms on college campuses, the pilot phase may check on whether the revenue split between the company and the colleges is being accepted as they had anticipated or are colleges asking for more or are they not allowing advertising on the campus. Also, things around the business model could be tested in this phase e.g. ‘How long does it take to close a sale? Who decides the pricing – the college, the advertiser or the company?’
- The assumptions: How good your business case is and how close to reality it is will be entirely dependent on the quality of your assumptions. One of the critical things to test at pilot phase are the assumptions. e.g. For an e-commerce company, the assumptions around conversions from clicks, cost of customer acquisition, average ticket size, repeat purchase rates, etc. are critical factors to be tested.
- Understanding operational challenges: Actually implementing on the ground highlights some challenges that you would not have anticipated in your planning. These learnings are critical as they help plan resources, processes and infrastructure that would be required to manage the operations.
- Testing processes and operational capabilities: As the startup scales up, the dependence on processes will increase. Else scaling up will either not be possible, or will be inefficient. A pilot phase is a good time to draw some basic processes and observe the operations to understand what these basic processes should evolve to.
Processes are important even in a startup. However, many entrepreneurs tend to begin operations without even the basic processes, with the assumption that as they learn the dynamics of the business, processes can be formed. In fact, many entrepreneurs feel that processes are too restrictive and are meant only for larger, complex organizations.
However, process need not be complex. Processes are nothing but a standardized way of doing a particular activity or handling a particular situation. In fact, rather than slowing down an organization, processes actually help the startup become more efficient as the basis of decision making is pre-decided as a process. Once some effort has been put into creating and defining processes, founders or leadership team then does not have to get involved in the day-to-day operational level decision making as these can be easily be delegated to the team and monitored through clear measurable goals, milestones and reviews.
In fact, it is at the beginning of the journey that entrepreneurs are likely to find some time to think through the processes. If the startup starts picking up speed and growing, it is always almost impossible to ‘make’ time to invest in processes as at a growth stage there are too many other tempting aspects of managing growth that seem more important.
When you company is growing is almost always the wrong time to plan for growth. You have to plan for growth to the next level when you are at a level below. Else, you will always be in the operational challenge of managing operations instead of driving growth.
In my view, having a decent office does play a very important role in the early stages of a company.
Here are some of my observations on this subject: Working out of home in the initial phases does not help No matter how serious and committed you are to your venture, working out of a ‘non-office environment’ [i.e. home or Cafe Coffee Day type outlet] just cuts down on your productivity. It is not just about inadequate infrastructure and support system, an office environment and the people around you just add to the feeling of being a real company.
It is very difficult to recruit talent without a good office Perhaps rightly so, people create perceptions and first opinions about a company by looking at the office. In our case, we have been particularly lucky to have received the generous support of our ex-bosses who kindly accommodated us in their offices and thus allowed us to attract high-quality talent which perhaps otherwise would have been difficult to do.
Without an office, business plans tend to get restricted by space available Inadequate or no office space and working out of coffee shops does leave you vulnerable to taking decisions based on restrictions of space.
Revenue projections for a Facebook app should be done like you would for any product, say a refrigerator, or service. Here are a few steps you could consider:
- You need to first define your target audience, then estimate how many people from your target audience are already active on the platform [e.g. Facebook] and in the geography you are targeting [i.e. the markets you are addressing].
- Once you have the number, you need to calculate the number of people you CAN reach through your media spends and the activities that are within your control ( e.g – ads in the press or online) and your distribution channels (e.g. if the product/app is bundled with another existing brand or sold through app stores, etc). Remember, just because your app is on Facebook does not mean that your marketing & advertising channel should also be Facebook. E.g. you could put efforts on PR – get a few TV interviews, press articles, etc. – and you could probably reach a much larger audience with your limited budgets.
- Then you make some assumptions on how many additional people in your target audience can be reached through means like PR, viral effect, etc.
- Once you have these numbers, you make assumptions on the percentage of people who are likely to buy/download your app.
- If your revenue is based on buying/subscriptions, you estimate how many people X how much per download. If your revenue is advertising, you estimate how many impressions, and use existing media rates to estimate your revenues.
Now, to extrapolate this to the future, you make various assumptions on the base target audience size. You can use various media reports on where the target audience numbers are likely to go on the platforms you choose to be on.