How to determine the size of your target market for your business plan-Part II

How to determine the size of your target market for your business plan-Part II

How do you determine the size of your target market if such information is not directly available? Many aspiring business start-ups face this question as they develop their business plans. This article will show you how to determine size of your target market in the absence of direct market information using deductive reasoning and/or calculations.

In my previous post, I discussed the importance of establishing the size of your target for your business plan. Knowing the size of the target market helps you to:

1) Determine your potential revenues from that specific market;

2) Formulate your marketing strategy for that segment; and

3) Enable the potential investor(s) to gauge the size and scalability of the proposed venture.

In that post, I discussed a simple case where information needed to calculate the size of the market is directly provided. With the number of customers given and the amount they spend to purchase a given product/service is known then it is a straightforward matter to calculate the size of your target market as shown below:

Formula_Size of Target Market

Unfortunately, in many practical cases the numbers of customers and/or the amount they spent on your product/service may not be directly available.

Question – How then will you calculate the size of your target market through market research?

Answer – by deductive reasoning and/or deductive calculations.

This is best explained by using an example. Consider the following case study:


Jane lives in a country in East Africa and has a talent for making handcrafted items (especially hand-knit items such as woolen sweaters and blankets). Jane discovers that there are online market places where she can sell her items and she settles on Etsy. Jane wants to prepare a business plan to raise some money to develop her business. Among other specifics she must employ market research to determine the size of her target market. Some specific details concerning her chosen venture include:

Jane’s Business Model: The business will involve creating high quality hand-knit woolen items for children less than 5 years old and selling them through an online shop at Etsy. These will be shipped through a reliable post office service to the customer after an order is made.

Jane’s Target customer: female, aged 25-44 yrs, lives in North America, married or single, has at least 1 child who is not more than 5yrs old; has easy access to internet; earns at least $25,000/year


 

But during her market research, Jane quickly realizes that Etsy does not provide specific data on how many women buy hand-knit items or how much they spend on the same.

So the question is: How will Jane determine the size of her target market from market research with such little information?

Now to calculate the size of the target market, two things must be established:

1) The number of women who visit Etsy to buy hand-knit items for their children; and

2) How much they spend to buy these particular items

 

1. Calculation of the number of customers

Jane does some detailed arket research from various sources and summarizes her findings in Table 1:

Criteria of calculations

From this, the number of people who fit the target criteria is established as follows:

No of customers in target market

Thus, there are 63,360 women who fit the desired target customer profile who visit Etsy each month and make actual purchases. But this is just the general number of women who visit the site to make purchases. Jane must somehow find a way of getting the proportion of these women that specifically purchase hand-knit items.

So Jane does some research in the US Census Bureau and finds that households in the United States spend about 10% of their income on clothing. On this basis, Jane makes an assumption that out of the total number of women who visit Etsy to purchase an item, 10% of these will buy clothing items. She further assumes that out of these 10%, 10% will buy hand-knit items (i.e. 10% of 10%). So the actual number of women who can be expected to buy hand-knit items will be:

Total actual no. of target customers

2. Calculation of the total amount spent by customers in the target market

After further research at Etsy (using relevant search criteria), Jane finds that the average unit price of hand-knit items (relevant to her chosen category) is $50.

Therefore,

Final size of target market

3. Establishing the desired market share

With the above figure, Jane can now go ahead and make a statement like “I intend to capture 20% of this market by the 5th year of operations”.

Additionally, she can prepare a graph using excel to show how she intends to build her market share over a 5 year period as follows: (Remember the saying: A picture speaks a thousand words)

Jane_Market Share

Some important notes on calculating the size of the target market

1) Formulate justifiable assumptions. While it is not easy to predict what will happen in future this is definitely not an excuse to make wild guesses or assumptions in your business plan. It is a big mistake to assume that the investor/s will accept with blind faith whatever figures or assumptions that you throw at them. The investor expects that:

-you have done some rigorous market research to establish the size of your target market for your business plan; and that

-any assumptions made are rational and supported by plausible arguments.

It goes without saying that references to your sources of your information should handy just in case you are asked for verification. For instance, the figures obtained in Table 1 are denoted by numbers in superscript (2 to 7). These refer to sources of information that have been used to obtain each figure and can be listed below the Table or somewhere in your Appendix.

2) Demonstrate that you have thought through the process. Your assumptions may not be 100% accurate and your calculation framework may have some minor flaws. But this is not the point – the point here is that the potential investor wants to see that you have thought through the process (as we have done) and taken time to think and work out the numbers – this is what is important. As long as this is evident, then you still stand a good chance of securing funds for your venture.

 

How to determine the size of your target market for your business plan-Part 1

How to determine the size of your target market for your business plan-Part 1

Establishing the size of your target market in your business plan is vital. Learn how to determine the size of your target market and present this information to investors. Further, the size of the target market is a precursor to establishing your anticipated revenues and/or market share. In this discussion, I assume that you have already identified why your particular target market is attractive to your venture, who your competitors are, and that you have carefully segmented this market (geographically, demographically, etc). If you are unsure about how to segment your market, read this insightful post on market segmentation. This is the first part of a two-part series of blog posts.

Where can you get information pertaining to your target market?

table-size-of-target-market

What information is important concerning your target market?

Ultimately, the investor primarily wants to determine the attractiveness of your target market. This includes, but is not limited to:

  1. The size of your target market.
  2. The rate of growth of the target market
  3. The market share that you seek to attain within your target market over time

An example of how to present information pertaining to your target market

The following is an example of how information listed above can be presented. This is taken from a business plan that I wrote some time back (no copyright issues infringed)

sample_target-market-size

As you can see from the snippet above, you will see notice the following:

Simplicity – information is presented in a simple, straightforward manner.

Source of Statistics/Data   – the source of data is mentioned.

Use of the Appendix section  – the description pertaining to the size of your target market should be very short. Extra information is given in the appendix. The appendix section is where you should place information that would otherwise clutter the business plan or obscure the main focus of a point. In fact, the above example only covers about half a page.

Use of diagrams  – ‘pictures speak a thousand words’. The figure shown (Figure 1) clearly shows the reader how ABC Inc projects its market share growth.

Conclusion: Tips and Pointers

  1.  Avoid lengthy prose – Remember that the investor ultimately wants to determine the attractiveness of your proposed target market. Do not make the mistake that many make – writing pages of prose which only serve to obscure the facts. While it is good to provide details, reserve most of the details for the appendix as the example has shown – present only the key facts in the main business plan.
  2. Is the market size readily available or is there a need to calculate? – The particular example given above is a case where, luckily, the size of the target market is given directly from a reliable source. However, in many cases, the size of the target market may not be directly available but must be calculated by deductive reasoning using available information from one or even several sources. I will provide an example of such a case later under this series.

Next from here?? ====> Look out for Part 2 of this series which explains exactly how to calculate the size of your target market together. I will also provide an example.

 

How to write a good executive summary for your business plan

Your Executive Summary will determine whether investors or financiers will take time to read the rest of your business plan or not. Many times clients ask ‘which is the most important part of a business plan’? I do not hesitate to answer that It is the business plan executive summary. In this post, I will argue why I think the executive summary is the most important chapter of any business plan and then provide a few pointers on how to write a good executive summary for your business plan.

Note: By investors/financiers, I am referring to venture capitalists, angel investors, bank managers, etc.

 

Create excitement and build interest

Your executive summary must create excitement and build interest – if it fails to do so, investors will stop reading your business plan and will not invest in your business. Take my word for it – a poorly written executive summary may easily cause your business plan to be ‘trashed’ – this may seem cruel considering the fact that you have probably taken considerable time, effort (and even money) to write your plan. Furthermore, your business plan may actually represent a viable business opportunity. There are two probable reasons why this may be so:

  1. Investors are busy people. Venture capitalists for instance, have to read tens of business plans every week. Thus, anything that does not present relevant information quickly and in a clear manner stands to be rejected.
  2. A good manager cannot write in a poor manner. A poorly written business plan including the executive summary is an indication that you are a poor manager – no one wants to invest in a poor manager.

 

Proposed structure of the business plan executive summary

Thus, it is extremely important to know how to write a good executive summary for your business plan. While there is no standard format for writing the business plan executive summary, there are several pieces of information that must be conveyed to the potential investor/financier.

In describing this information, I will provide a structure that I usually follow:

 

1st Paragraph ===> Company name, industry, and purpose of business plan

Industry of operation – This will quickly tell the reader what industry you are in. Investors usually prefer to invest in an industry in which they are familiar with or have expertise in. Stating your industry of operation will immediately inform the investor whether this is a venture that they should pursue or not relative to their interests.

Purpose of your business plan – this is a part many forget to mention. Are you seeking equity funding, debt financing? Is it seed capital (a new startup) or for expansion, etc?

2nd Paragraph ===> Establish the compelling benefits of your new product or service

Remember that the investor is a businessperson seeking an appropriate return on their investment. Why is your product superior than those in the market?

3rd Paragraph ===> Establish the size of the target market & strategy of entry

What is the size of the target market? This shows the investor that you have taken time to research your market. What is the strategy that you will employ to enter this market (business model)?

4th Paragraph ===> Details of the management team

Here, specify the talents of the people who will manage the exploitation of the opportunity. What are their qualifications and experience? Remember that the investor is keen to know the people with whom he/she is entrusting their money with.

5th Paragraph ===> Summary of financial forecasts/projections

This should be in summary form. Briefly mention expected sales revenue, cash flow, and profit and loss projections.

6th Paragraph ===> The ‘Ask and the offer’   

This is where you state what you require from the investor and what share of the business you are offering him/her.

 

Further tips and notes

  1. Continuous revising – considerable effort and time must be spent on the business plan executive summary. The summary is not a ‘static’ document and should be continually ‘tweaked’ in order to make it compelling, concise, and interesting or to present new ideas as they emerge.
  2. Not a ‘cut and paste’ job – the executive summary must not be ‘copy-pasted’ from sections of your business plan otherwise the feeling of déjà vu created when reading the document may lead to a negative assessment of the plan by the reader. Keep the executive summary fresh – avoid repetitive phrases or strings of words that are rather annoying and stale.
  3. Length – from a personal perspective, a 1 page business plan executive summary is ideal. But if it this is not possible, then it should not exceed 2 pages. Many business plan writers will agree with me that achieving a 1 page executive summary is not easy – but is not impossible. It means exercising parsimony and brevity must be. Parsimony in this sense refers to the willingness to avoid using unnecessary words that do not add value to the content of the summary. Brevity, in this context, refers to conciseness – sticking to the use of exact, relevant words only. In other words, your executive summary, just like the rest of your business plan, must be subjected to the painful scalpel of parsimony in order to keep it short and to the point.
How to make sales forecast for your business plan

How to make sales forecast for your business plan

It is good to know how to make sales forecasts for your business plan.  At some point, you will present your business plan to a potential investor/financier. Remember that the investor/financier (venture capitalist, angel investor, bank manager, etc) is probably an experienced investor and will quickly notice any inconsistencies pertaining to how you have come up with sales forecasts for your business plan.

In this post we look at 3 methods of making sales forecasts for your business plan and the merits and demerits of each method. The 3 methods of doing this are: 1) Manual sales forecasts; 2) Automated sales forecasts; and 3) Diffusion curve or sales growth curve.

Please note that these are names that I have chosen to use – these methods may be referred to by other names elsewhere. In this post, I will variously refer to a fictitious company name, ABC Inc.

1. Manual sales projection method

Here, you simply input the number of units that you anticipate to make manually, probably in a spreadsheet such as Microsoft Excel. See the example below:

table-1_manual-method-of-sales-forecast

Table 1_Manual Method of Sales Forecast

 

Table 1 shows that the units sold are added manually in the respective cells. Note: The cost per unit is assumed to be $200.

Advantages – it is possible to make sales forecasts that match the actual expected situation (the reality on the ground). For instance, ABC Inc feels that due to the nature of their business or due to seasonality, the number of units sold will reduce towards December.  ABC anticipates that sales will start off slow at the start of the year and increase progressively as the year proceeds – this pattern is repeated over the years. Thus, the advantage of manual input of sales forecast is that it allows one to capture seasonality or anticipated changes within the year.

Disadvantages – this method can be tedious. If in future you have to make some changes to your sales forecasts, you have to go back and change figures manually. While this can be done, you will soon realize that making a few changes in one part of the spreadsheet may cause you to make changes to other sales projection figures. In fact, it is not unlikely that you may have to change all your figures across the period of projection. Indeed, this can be quite cumbersome.

2. Automated sales forecasts method

Here, you can use some simple formulas in Excel to make sales forecasts. Table 2 shows how this can be done.

table-2-automated-sales-forecast-method

Table 2 – Automated Sales Forecast Method

As Table 2 shows, growth rate can be set in percentage terms from year to year using Excel formula. For this case, I have set it at 100% so that you can see how the sales figures have changed over time.

Please note that this may not represent the actual situation. The reality is that more realistic year-on-year change look like Table 3. Between the 1st and 2nd year, growth may be pronounced as the business grows. The same case may apply between the 2nd and 3rd years. But while overall sales may rise, percentage sales increases may start to decrease between the 3rd and 4th years and 4th and 5th years as competitors increase or as the market saturates.

table-3-more-realistic-growth-sales-growth-rates

Table 3-More realistic growth sales growth rates

Advantages – this method allows for fast and easy change to figures. Also, it allows for changes to be made in line with other metrics in the spreadsheet. For instance, you can play around with the year to year percentage increase while looking at how other metrics are changing for instance, the balance sheet, breakeven, etc.

Disadvantages – this method does not capture seasonality within the year (it only captures growth across the years). It assumes that growth is constant, which is not always the case for seasonal businesses.

Diffusion curve or sales growth curve method

Assume ABC Inc wants to enter a market that is growing at 3% per year and the market is worth $6 million. Assume also that ABC intends to capture 20% of this market by the 5th year. In this case ABC has set initial sale amount for the first month to be $20,000. Excel can be used to establish the sales curve – data used to do this is summarized in Table 4. The technicalities of doing this are beyond the scope of this post.

table-4-figures-used-to-make-the-sales-curve

Table 4-Figures used to make the Sales Curve

The result of this is Figure 1, which is the resultant sales curve.

figure-1-sales-growth-curvediffusion-curve

Figure 1-Figures used to make the Sales Curve

Advantages – In my personal opinion, I believe that this is the best method of making sales forecasts. As Figure 1 shows, the sales curve starts from a very low figure, which is very realistic because new businesses usually have low initial sales. I believe that the S-curve nature of the graph is actually what happens. Low sales initially slowly but progressively increase, at some point, sales increase can be quite high (shown by the steep nature of the curve). Unlike what some people may project, any business, no matter how good, cannot continue with steep sales growth indefinitely. At some point, due to market saturation due to competitor activities, amongst other reasons shows that sales will start to plateau off at some point.

Disadvantages – the sales curve method does not still cater for inter year seasonality but this is countered by the realistic nature of the s-curve discussed above.

 

Conclusion

In this post, we have discussed how to make sales forecasts for your business plan. Trying to suggest that sales will continue to rise in a straight line indefinitely will simply show an investor that you are over zealous. The sales growth curve is discussed above is closer to reality and adopting this method of making sales forecasts shows the investor that you know what you are doing. Making realistic, prudent, and well thought out sales forecasts will take you one step closer to realizing your dream of securing funds for your venture.

I welcome further discussions, insights, and comments regarding the content discussed in this post.