Dear Startup Investor,

Buck Jordan here to talk to you about all things markets, especially how to size them.

Picking your market is absolutely critical when deciding to build a company and equally so when deciding to invest in one. Andy Rachleff a partner at Benchmark Capital – one of Silicon Valley’s most iconic venture capital firms – once said:

“When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.”

This statement perfectly captures decades of investing wisdom condensed into a few short sentences. When building a startup it is almost impossible to change the dynamics of your market. The size of a market and how competitive it is are like forces of gravity. No matter how much money you throw at the problem, eventually these market realities assert themselves and help determine how large and successful your business can truly be.

So when it comes to investing in startups you want to pick markets just as much as picking specific products and teams you think have potential. So how do you pick a market? Well one of the most important factors in picking a market is the size of that market. Here’s a couple ways to think about sizing markets that investors around the world (us included!) use to size markets.

Top-Down Market Sizing

Top-down market sizing involves looking at a potential market as a whole and then narrowing down to the specific segment of the market a startup’s product is relevant to. You start at the very broadest level – the total market size – and slowly and steadily narrow down to the specific segment that a startup’s product is designed to target – the addressable market.

So what does this look like in practice? Let’s take Upright, a seller of instant oatmeal products that is currently crowdfunding as an example.

Starting at the very highest level the best place to start is to look at the total size of the milk market in the United States annually. Data from the United States Department of Agriculture shows that in 2020 roughly 46 billion pounds of fluid milk were sold in the United States. In dollar terms annually sales of dairy milk in the United States amounts to roughly $12 billion. However, we can go a layer deeper in our analysis and distinguish between dairy and non-dairy milk products. While Dairy milk products sales are about $12 billion a year the non-dairy segment is worth $2 billion a year.

While oat milk has been growing in popularity in the United States it accounts for a share of the total non-dairy milk sales annually. Once again we can go a layer deeper and look at the total annual sales of oat milk in the United States. Using data once again from CNBC/Nielsen we can see that back in 2019 oat milk sales were roughly $50 million annually. However, this data is a few years out of date and oat milk has been growing rapidly and since this data was published oat milk sales have rocketed to $350 million annually.

As investors we invest in companies with the belief that over time they will capture market share. This is why the size of a market is so important. Having 1% market share of a $50 million market is significantly different from having 1% of a 50 billion dollar market. When it comes to analyzing Upright’s market size the most optimistic way to look at it is to use figures for the total dairy and non-dairy sales combined annually, roughly $14 billion. However, a more realistic way to analyze their opportunity is to look at the annual sales of oat milk and underwrite what kind of market share we think they can capture 1, 5, 20% etc. This is in a nutshell how top-down market sizing works.

Bottoms-Up Market Sizing

Another common approach to market sizing is the bottoms-up approach. This approach involves looking at the basic unit of a product and the price of each of those units and multiplying it by the number of customers you believe are part of a company’s addressable market. Let’s look at the example of Miso Robotics to see how bottoms-up market sizing works. Let’s say we’re trying to size the market for our Flippy 2 product which we sell to restaurants starting at $3,000 a month or $36,000 annually.

The next step is to figure out how many potential customers there are out there for Flippy 2. Given that Flippy two prepares fries and wings it’s logical customer base are quick-service restaurants (QSR) like Wingstop, McDonalds, Chipotle and others. As of the end of last year there are about 197,000 QSR restaurants in the USA. Given this, we can multiply the average revenue per customer for Flipply 2 ($36,000) by the number of addressable customers out there (197,000) and come up with a bottoms-up market sizing of $7 billion.

Now $7 billion is a healthy sized market to go after for any startup, especially a startup like Miso that has the clear technological lead and leading brand in the food automation space. When sizing a market as an investor it always pays to be conservative. We haven’t included in the sizing of Miso’s market some other potential customers such as sports stadiums, non-QSR restaurants or restaurants outside the US. So as an investor we know that the $7 billion addressable market in the US is large and worth going after and we also know that there is potentially even more upside with new markets outside of this core addressable market.

It’s Not a Zero Sum World

The last thing I want to leave you with this week is that the world of startups and business is rarely a zero-sum world. Time and time again in my investing career I’ve seen that when startups are launched in markets with plenty of legacy customers it is rare that they steal a large part of the market share of these legacy players. Instead what I’ve seen is that startups that offer better, faster, cheaper versions of existing products expand the market for those products. They grow the pie.

Think about the example of electric cars. For a long time everyone – especially Tesla fanboys – thought Tesla was going to displace so many traditional automakers and capture huge chunks of their market share. Instead, Tesla opensourced all their patents with the aim of accelerating the whole industry’s shift towards electric vehicles.

Now your first reaction to Tesla doing this is probably to conclude that the traditional automakers with their massive design teams and huge, sophisticated manufacturing operations would soon release electric cars of their own that would be better and cheaper than what Tesla produces – stealing market share back from them. Instead, as the graphic above from shows, all these automakers are selling more electric cars today than in 2015 and will sell many more cars in 2025 than today.

Tesla releasing its patents and accelerating the shift to electric vehicles has grown the pie for all automakers. Everyone is selling more electric cars and the pie is growing every year. Markets are rarely zero-sum games. As long as a market is growing it is likely to be a positive-sum game and less likely to be a zero-sum game.

Next time you’re looking at angel investing in an opportunity I hope you use these tools to size the market and keep in mind that markets are rarely every zero-sum. Happy investing!