Market and customer analysis: from market definition to a realistic market size

"The market for commercial vehicles is huge" appears in many business plans and helps nobody decide anything. A market and customer analysis replaces it with something you can work with: a clearly bounded market, the customer groups within it that need different things, the criteria they buy on and a realistic estimate of what you can win.

A van fit-out workshop runs through this page as the example. It equips service vans with racking and storage for installers, works from one site and wants to know whether a second site would pay off.

Five questions a market and customer analysis answers

• Definition: where does your market end, in products and in geography?
• Segments: which customer groups differ in what they need and how they buy?
• Buying criteria: what do those customers weigh, and what must you do well to win?
• Size: how large are the total, the serviceable and the obtainable market?
• Movement: is the market growing, shrinking or shifting between segments and channels?

How to define your market: product and geography

Start from what the customer buys, not from your product name. The installer does not buy "racking"; it buys a van in which technicians find parts quickly and drive safely. That job can also be done by a plain van with crates or a van bought ready-fitted from the dealer. Those are the substitutes.

Porter's advice for industry analysis applies here too: draw the boundary in product scope and in geographic scope. Two questions settle it. Who would a customer turn to if you disappeared? Those are your direct competitors, and they belong in your market. What would the customer do instead of buying from anyone like you? That is the substitute, and it caps your price. For the workshop, the market becomes "fitting out service vans for trade businesses within about two hours' drive".

Market segmentation: which customer groups make the difference

Wendell Smith described product differentiation and market segmentation as alternative marketing strategies in the Journal of Marketing (July 1956). Differentiation tries to win the whole market over to one offer; segmentation adapts the offer to groups whose needs differ. Segment on what predicts behaviour, not on what happens to be easy to measure.

The last row comes from Clayton Christensen and colleagues in Harvard Business Review (September 2016): customers in effect hire a product to get a job done, and fire it when it does that job badly. More on this in value proposition and jobs to be done.

A segment is useful when its needs or buying criteria differ, it is large enough to matter, you can reach it and you would actually do something different for it. If you would treat a group exactly like the rest, it is a label, not a segment. For the workshop three segments emerge: small installers with one or two vans, firms with a fleet that want one layout for every van, and lease companies that order fit-outs for many clients.

Buying criteria and key success factors

Buying criteria are what the customer weighs when choosing: price, delivery time, quality, advice, total cost of ownership, reputation. Key success factors are what you must do well to score on those criteria. The first belongs to the customer, the second to you.

"Customers only look at price" is usually an effect, not a cause: customers fall back on price when they see no other difference. Some criteria only qualify you to be considered, such as safety approval of the racking; others decide who wins. Find out which is which.

Customer interviews and lost quotes as a source

Desk research tells you how big a market is; customers tell you why they buy. Ask about what they did, not what they would do.

• Trigger: when did you last buy this, and what made you act?
• Before: what did you use before, and why did you change?
• Doubt: what nearly stopped you from buying?
• Switching: what would make you move to someone else?

Keep a simple log of lost quotes: date, customer, segment, the reason given and who won. A few dozen entries say more about your real buying criteria than a long survey. Ask permission before recording a conversation, and store notes without names where you can. More on customer conversations in test your idea.

Market size: TAM, SAM and SOM explained

Market size is usually expressed in three layers. The terms are common in start-up and investor practice, no single author owns them and definitions vary slightly, so state yours.

Work bottom-up where you can: start from a counted population, multiply by how often they buy and what they spend, then narrow step by step. A top-down estimate, a percentage of a published market total, is quick but rarely tells you where the customers are. Counted populations come from official business statistics, such as the US Census Bureau's County Business Patterns, Eurostat's structural business statistics or the Australian Bureau of Statistics' counts of Australian businesses. Check what is counted: County Business Patterns covers establishments with paid employees, so firms without staff are missing, and one company can run several establishments.

Worked example: a van fit-out workshop

The workshop now does 120 fit-outs a year and has room for about 250. Winning its full SOM would fill most of that capacity, so a second site only pays off with customers in a new region. The weakest assumption is the 60% that outsource: at 40%, the SAM falls to 1,000 fit-outs (€4.0 million) and the SOM to 150. That is the assumption to test first, with calls to installers and fleet managers.

Fictitious Firmfocus example: all figures, including the number of businesses, are invented. Replace them with a counted figure for your country and sector. The logic works in any currency.

Market growth and shifts

A market can grow in value while shrinking in volume, through price increases alone, so separate the two. Look at business demography statistics for the number of firms entering and leaving your customers' industry, at shifts between segments and channels, and at the developments from your PESTLE analysis that change demand. If more installers lease their vans, buying power moves from installers to lease companies. For strategy, such a shift between segments often matters more than overall growth.

Market analysis pitfalls

• Defining the market by your product name: start from the job the customer wants done.
• Segmenting on what is easy to measure: age or company size only helps if it predicts what people buy.
• Segments you treat the same: if nothing in your offer differs, merge them.
• Asking only loyal customers: lost customers and lost quotes teach you more.
• Mixing counting units: enterprises, establishments and vehicles are different populations.
• Treating the SOM as a forecast: it is a ceiling for planning, not a target you have already won.

Market and customer analysis in a small business and in a larger organisation

Market and customer analysis tells you where you can play; competitor analysis and Porter's five forces tell you who you play against and how much the game is worth. All models are in strategic analysis, and every other topic in Strategy.