Bottom-Up Market Sizing

What is bottom-up market sizing?

Bottom-up market sizing (German Marktgrößenbestimmung von unten, also Bottom-up-Ansatz) refers to a method in which the size of a market is built up from individual, verifiable building blocks. These building blocks are the number of potential customers per segment, that is, per customer group with a similar need and price, and the annual revenue achievable per customer. In everyday terms, this corresponds to working out the coffee consumption of an office building from the number of employees and the cups per person per day.

The counterpart is top-down market sizing, which starts from a published overall figure and narrows it down through shares. Both routes serve to put figures on the levels total addressable market (TAM), serviceable addressable market (SAM, the market that can be served) and serviceable obtainable market (SOM, the market that can be won within a period). For the SOM, the bottom-up calculation adds sales capacity. Investors see this route as the load-bearing derivation. It rests on the same quantities as the sales and revenue planning in the financial model, the set of figures behind company planning: customers, segments, channels and prices.

The bottom-up formula and its building blocks

Formula: Market size = sum across all segments of (number of customers in the segment × average annual revenue per customer in the segment)

Number of customers

What is counted are the organisations or units that could buy the offer, separated by segments that differ in price or sales channel. The basis is provided by official business statistics by industry and size class, data from associations and chambers, commercial register and company databases, and the company's own sales data. The unit of count depends on the pricing model; with per-user billing, it is the number of users in the target organisations.

Price and quantity

Where available, annual revenue per customer is derived from the company's own contracts, as the value actually achieved after discounts. If prices differ between small and large customers, the calculation is made per segment. With usage-based pricing models, the product of expected quantity and unit price takes the place of the price, for example users, transactions or devices per customer. Stating it as average revenue per account (ARPA) makes it easier to reconcile with the sales key figures.

Calculation based on the substitute

For markets in which no comparable products are yet sold, for example when building a new market space (Blue Ocean Strategy), there is no market price. The calculation is then based on the substitute. It determines what the future customers spend today on the existing solution, including staff hours, external service providers and the cost of errors. It then estimates what part of this can be established as a price. This calculation is only as reliable as the evidence for willingness to pay, such as paid pilot projects.

Why investors ask for the bottom-up calculation

The bottom-up calculation forces statements that an investor can check one by one. It says who the customers are, how many there are, through which route they are reached and what they pay. The same quantities support the sales plan. A bottom-up market derivation can therefore be linked directly with the pipeline (the open sales opportunities), close rates and customer acquisition costs; a top-down calculation cannot. Already on the market slide of the pitch deck, investors see whether customer numbers and price per segment are given or only an overall figure.

Due diligence, that is, the review of the company before the investment, usually starts with the customer numbers, which investors reconcile with their own research. They then compare the prices with the contract data in the data room, the orderly collection of the review documents. If the prices achieved in the most recent deals deviate from the assumed average, the market size is adjusted accordingly. Finally, they reconcile the segments of the market calculation with the customer base. If the customers come predominantly from one segment, that segment gains weight in the valuation, and the others are regarded as not yet proven.

Reconciliation with the top-down calculation

The bottom-up calculation is easier to check but not free of error: segments defined too broadly or prices set too high affect the result directly. It is therefore reconciled with a top-down calculation. A prerequisite is the same delimitation by region, industry and size class. The two routes usually measure different things. Bottom-up gives the potential, that is, all suitable customers at the assumed price; a spending-based top-down calculation gives the market volume, that is, what is actually spent today.

The ratio of the two values is therefore a key figure in its own right, called the degree of saturation in marketing theory. If the market volume lies well below the potential, a large part of the customers does not yet use a comparable solution. If it lies above, either the prices in the bottom-up calculation are too low or the starting figure of the top-down calculation is defined too broadly.

Worked example: bottom-up market sizing in two segments

Hypothetical example market, the same as for TAM, SAM and SOM: maintenance planning software for manufacturing plants in Germany, Austria and Switzerland. All figures are freely chosen; they do not stand for any market segment that actually exists. Because prices differ by plant size, the calculation is made in two segments.

• Plants with 50 to 249 employees: 12,000, of which two thirds have a supported ERP system, that is, 8,000
• Plants with 250 to 1,000 employees: 6,000, of which two thirds have a supported ERP system, that is, 4,000
• Annual value achieved after discount: EUR 8,000 in the smaller segment, EUR 20,000 in the larger segment
• Smaller segment: 8,000 × EUR 8,000 = EUR 64 million
• Larger segment: 4,000 × EUR 20,000 = EUR 80 million
• Serviceable market: EUR 64 million + EUR 80 million = EUR 144 million; average annual value EUR 144 million / 12,000 plants = EUR 12,000
• Potential without the ERP system filter: 12,000 × EUR 8,000 + 6,000 × EUR 20,000 = EUR 96 million + EUR 120 million = EUR 216 million
• Top-down calculation for the same region and size class: EUR 108 million of current spending
• Degree of saturation, that is, market volume in relation to potential: EUR 108 million / EUR 216 million = 50%

If the company had applied the smaller segment's price of EUR 8,000 to all plants, the serviceable market would be 12,000 × EUR 8,000 = EUR 96 million. That is one third less than the value determined segment by segment. Conversely, the larger segment's price for all plants would give 12,000 × EUR 20,000 = EUR 240 million. The example shows why investors check segmentation and the origin of prices particularly closely. The degree of saturation of 50%, in turn, is coherent only if roughly every second suitable plant already has spending of this amount. This can be verified in customer conversations and from the sales data.

Distinction: bottom-up, top-down, unit economics and ICP

• Top-down market sizing: derives the market size from an overall figure through shares. It is faster but harder to check and serves as a cross-check.
• TAM, SAM and SOM: the levels calculated with both methods. The serviceable obtainable market does not follow bottom-up from the number of customers alone but only from sales capacity.
• Unit economics: the profitability per customer from contribution margin, acquisition costs and customer value. Unit economics use the same price per customer as the bottom-up market calculation; the two calculations must match here.
• Ideal customer profile: describes the characteristics of the best-fitting customers. The ICP supplies the criteria by which the bottom-up calculation delimits and counts its segments.

Common mistakes

• One uniform price for all customer sizes. Large customers often pay a multiple of what small ones pay; a single price distorts the result in one direction or the other.
• Confusing existence with reachability. Counting all plants in a country, although only some are reachable through the company's own channels and with today's product, mixes up TAM and SAM.
• Pilot prices extrapolated. Prices from first pilot projects are often shaped by discounts or special services and do not support extrapolation to the whole market.
• Customers counted twice. Groups that buy centrally are counted with every site, or plants appear in two segments at once, for example by industry and by size.
• Customer number without a source. An estimated number without origin and reference year is replaced in the review by the investor's own research.
• No link to the financial model. If the revenue plan uses different prices or segments from the market calculation, the derivation loses its most important advantage.

Frequently asked questions

How many segments make sense?

As many as prices or sales channels differ noticeably; as a rule of thumb, two to four. Additional segments increase accuracy only if reliable figures exist for each of them.

How is the calculation made if there are no official customer numbers?

Through verifiable proxies, such as member directories of associations, register evaluations, job advertisements for particular functions or samples from company databases. The proxy and its limits are named openly.

Is bottom-up market sizing better than top-down?

As the load-bearing derivation, yes, because the number of customers and the price can each be evidenced and linked with the sales plan. The top-down calculation nevertheless remains useful as a cross-check: two independent routes whose deviation can be explained convince more in the review than a single figure.

Which price is used when there are hardly any customers yet?

A price supported by paid pilot projects, signed offers or published prices of comparable solutions. A price without such evidence is usually replaced in the review by a more cautious value.

How is a template for the bottom-up calculation structured?

As a table with one row per segment. The columns contain the number of customers with source and reference year, the shares of the individual filters, the remaining number of customers, the annual value per customer and the result; the total row gives the market size. On the market slide of the pitch deck, the condensed version with segments, customer numbers and prices is sufficient; the full table belongs in the data room.

The Roemer Capital view

In mandates, we build the market size bottom-up as a matter of principle, on a separate sheet of the financial model that uses the same segments and prices as the revenue planning. Every customer number carries a source and a reference year, every price a reference to the contract data from which it comes.

The market calculation thus becomes part of the data room that can be reviewed in due diligence without rework. If an investor changes an assumption, for example the price in the larger segment, he sees the consequences for market size, revenue planning and capital requirement in the same file.