By now, it’s evident that early-stage founders often use market-size research prepared by consultants as a proxy for the market-size slide. This is more evident when founders use the top-down approach. There isn’t anything fundamentally wrong with this, but what happens when there’s a lack of secondary data to estimate the market, or when the market being sought after doesn’t neatly fit into an existing category? Above al, market size doesn’t inform us whether customers actually want what the startup is selling. The thing is markets evolve, definitions change, and the projections used can be disputed. Recall the debate between Bill Gurley and Aswath Damodaran over Uber’s potential market? The question wasn’t how large the existing taxi market was, rather if Uber can expand beyond it.
Surely then, there has to be a better way? Oh, what about the bottom-up approach? That’s fair, but it’s also built on assumptions. How many customer can a startup acquire, how much will they spend, or how quickly can they capture the market? These are valid questions, but projecting the answers without speaking to potential customers leaves a rather crucial gap. So, I’d argue that founders should be conducting customer interviews, run surveys, and if possible get early customers to pay for their product or service. The findings can then be used in adjacent to the bottom-up market-size calculation, replacing some of the assumptions with evidence from the people the startup intends to serve. I have a strong preference towards this approach.
Here’s a case in point.
Based on a 2019 study published in Social Science & Medicines, a peer-reviewed academic journal that analysed 50 papers comparing hypothetical and actual willingness found that the hypothetical willingness to pay was, on average, 3.2 times higher than actual willingness to pay across 84 comparisons reporting mean values. Of course, there were limitations in the study whereby the authors also found a considerable variation across studies thus it should be taken with a pinch of salt. For founders though, the gist of it is quite straightforward - customers saying they would pay for a product or service is different as opposed to them actually paying for it.
This also goes to show that customers feedback helps establish the fact that a problem exists, while paid pilots, pre-orders and actual transactions provide a much stronger evidence that customers value the proposed solutions enough to spend their money. The more concrete the evidence, the better the conviction that investors will have on a startup. Conviction is simply easier to build when founders can show the proof. A market-size figure might tell an investor how much money could theoretically be made, but customer evidence starts to explain why this startup might capture some it.
So, show the investors who has the problem, what have they told you, how many of them are willing to pay for it or have started to. Then use those findings to build your market-size assumptions, and explain how the business can scale beyond its initial customers. Of course, showing traction alone will not guarantee an investment because the team, product, business model, economics, and competitive landscape still has to add up. But if founders have evidence that customers want what they are building why downplay it in favour of a large market-size figure?
Reference
Kanya, L., Sanghera, S., Lewin, A. and Fox-Rushby, J. (2019). The criterion validity of willingness to pay methods: A systematic review and meta-analysis of the evidence. Social Science & Medicine, 232, 238–261
