McKinsey Quarterly
Beating the odds in market entry
November 1, 2005 | Article
Potential market size has to be estimated.
How big is the market?
Estimating a market's potential size typically involves categorizing customers into a number of segments and then using pricing and elasticity assumptions to estimate the percentage of buyers in each category the company might capture.
The biase of “anchoring and adjustment”: the failure to adjust estimates sufficiently from an initial value, regardless of its origin. An optimistic anchor that often infects market estimates is an industry's current growth rate, which rarely endures for long. Another anchor is the initial “gut” forecast number an analyst plugs into a spreadsheet with the intention of making adjustments as more information arrives.
How influential are such anchors? In one recent study, experienced real-estate brokers, who had contended that the listing price of a house wouldn't affect their evaluation of its “true” value, were asked to assess a property. Each broker received a ten-page booklet on the house and on the prices and characteristics of houses in the area. Each then visited it, plus others in the neighborhood. The agents didn't know that the listing prices they had been given for the house in question were all different and had been randomly manipulated within a range of plus or minus 11 percent of the actual listing price. Those spurious listing prices significantly affected the evaluations of the agents. Yet even when they were told about the results, they maintained that the listing-price anchor had had no effect on them.
Life cycle stage of the industry - Important to estimate
To avoid anchoring estimates on a target market's current growth rate, companies should always try to determine the life cycle stage of the business they wish to enter. At some point, most industries experience shakeouts, which can be particularly severe in fast-growing sectors. Although it is difficult to predict the exact timing, efforts to think through the possibility of a shakeout—and how many companies are likely to survive it—often highlight the unsustainability of current growth rates.
A second useful way of improving estimates of market size is to use the reference class of other entrants as a benchmark. Consider the fate of the Segway, a new type of two-wheeled vehicle unveiled in December 2001. Dean Kamen, thought 10,000 a week could be sold after a year: A typical approach for arriving at such a figure would have involved combining an analysis of the number of consumers who could both afford the Segway and realistically use it for commuting or recreation . Use of penetration rates in this demographic for similar products, such as scooters and bicycles, is also an input.
But the Segway's usefulness depended on changes to infrastructure. How many cities would allow people to drive the vehicle on sidewalks? If roads were the only alternative, how many potential purchasers would be willing to use it? Since the answer to both questions was “not many,” just 6,000 Segways were sold in the first 21 months. A broader reference class that included conventional automobiles, fuel cell cars, hydrogen cars, and infrastructure-dependent technologies such as high-definition television and telephones might have shown that securing the right to ride the Segway in cities was of paramount importance. After all, it took years to create the roads, power grids, standards, and networks necessary for cars, electric lighting, HDTV, and telephone service to become ubiquitous.
https://www.hackingthecaseinterview.com/pages/market-sizing
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