In the space of two years, with a mixture of debt, cash, and vendor financing, I bought three small businesses: a coffee shop, A hair salon, and a gym.

Each of these businesses presented new challenges and opportunities.

My starting goal for each business was to pay off debt and draw a wage.

My coffee shop, for instance, was tiny. $3k in revenue was a decent week. I thought because turnover was so low and the business model was simple, I’d be able to grow sales quickly, pay off debt, and draw a wage.

When I brought my hair salon. I had the same hypothesis; simple business with low turnover, so growing sales should be easy and then I can draw a wage.

Once more, I repeated this process when I purchased my Gym.

Each time I had the same theory buy, grow, pay off debt, and pay myself a wage.

Each time I found my hypothesis was just as challenging to execute.

I had owned different businesses with different business models in different locations and each was as challenging as the last.

When I owned the coffee shop, I thought hospitality was too competitive.

When I owned the salon, I thought I lacked required industry knowledge.

About a year into owning the gym and struggling there, I thought industry competition was my problem.

One afternoon while having a beer with my Mum’s partner and a few of his mates, I had the opportunity to talk to a guy I’ll call ‘Dave.’ Dave is a marketer and has been running his marketing and promotional products business for 30+ years.

At some stage, our conversation turned to business.

Dave asked “what my plan is”. I told him I was looking for businesses to buy, grow, and draw a wage from.

After explaining a little about the businesses I’d brought to date, Dave suggested I might be chasing the wrong opportunities.

“When you buy a small local business, you also have a small limited number of people to sell to”.

Every business I brought and attempted to scale was operating in a small limited market.

THE MARKET

A ‘market’ is simply a location. No different than your local farmers market. A market is a group of people buying and selling goods somewhere.

In a business context, the market generally has a value attached, representing the revenue opportunity offered to businesses operating in that market.

As such, to build a million-dollar business, would require a market value that exceeds $1mil.

There’s nothing worse than spending years trying to build a business to realise the market is too small for the business’s ambitions.

MARKET SIZE

Every ‘market’ has three segments.

 •  TAM = Total addressable market

It can represent the total revenue opportunity for a product or service or aggregate market demand for a product or service.

 •  SAM = Serviceable available market

The part of the total addressable market that can be reached/served. A business’s sales channel will generally only reach a particular segment of TAM.

 •  Target Market = people within a market that

A target market is a group of customers within a business’s serviceable available market that business targets.

The total addressable market for a new software company could be every computer user in the world.

If the software only worked in English, then SAM would be reduced to only English speaking people.

If the software were made specifically for Windows users, then the target market would be English speaking windows laptop users.

When Dave introduced me to the market, I’d quickly grasped why that is important. But I hadn’t yet made the distinction between different market segments.

Each small business I owned easily had a large enough total addressable market for my businesses to grow. However, I have since realised my target market for each business was restrictively small.

There are two different ways we can calculate a market’s value.

TOP-DOWN ESTIMATE

We can use a ‘top-down’ approach, which uses market data already available to us. Such as industry reports, google searches, press releases, market competitors, etc.

The top-down approach starts with the big picture, the Total Addressable Market. Once we know the total addressable market, we can use it to calculate our serviceable market and target market.

Like any model, the top-down approach has its flaws.

Top-down relies on past market data, which is useful but not always the best way to predict the future.

If there have been significant shifts in market behavior, perhaps new tech introduced, then estimating our target market size based on past data might produce wildly inaccurate results.

Additionally, often access to data is expensive and not easily accessible. The top-down approach seems more applicable to large companies assessing opportunities for new product lines.

Let’s look at how this could work for my hair salon, Arrowtown Hair.

The salon is located in Arrowtown and generally serves clients from Queenstown and Arrowtown. As the salon is a full-service salon, we can serve any person who needs a haircut.

First, we would contact the local council and request (likely pay) for a report that provides necessary demographic information on people living in the region.

Let’s say we receive a report back and learn 30,000 people are living in the area, and 75% of those people are over the age of 18. So the salon can potentially serve 22,500 people (we’re looking at decision-makers only here – to learn more about different customer types read here).

I would look for specific industry reports to find hair sales data. I can see IBIS International produces an annual report on the New Zealand hair industry from a quick google search.

Perhaps that report states that the average New Zealander spends $500 on haircuts per year.

With this information, we can calculate the hair salon’s TAM.

Twenty-two thousand five hundred people spending $500 per year on haircuts equates to $11,250,000 per annum.

Next, we would calculate our serviceable market size.

Arrowtown Hair’s price point is higher than average ~$45+ per haircut. This makes us affordable for only 50% of the population. We think the commute time for a trip to the salon is also a sales barrier.

Using some Google tools, we estimate the total number of people within commuting distance of the salon is only 23,000, and given our price range, we are only affordable for 50% of those 23,000.

To calculate our SAM, we need to account for these factors.

Of the 23,000 people within commuting distance, only 75% are over 18. So this reduces our available market size down to 17,250. Of these people, we think only 50% can afford the salon, which further reduces our serviceable market to 8,625 people.

We have learned from industry reports that the average person spends $500 on haircuts per annum, so our serviceable market value is $4,312,500 (8625 x $500).

Finally, we want to calculate the value of our target market.

Arrowtown Hair specifically targets female color clients. So we need to estimate the number of color clients in our serviceable market. We think our color clients are females between the age of 24 and 55.

After accounting for location, household income, gender, and age and using information from our council report, we estimate only 3,000 people fall within our target market.

So the value of our target market will be $1,500,000 (3,000 x $500 = $1,500,000).

Total Addressable Market (Population 18+ living in Queenstown) $11,250,000

Serviceable Market (Household Income medium/high, Lives within 20 minutes) $4,312,500

Target Market (Female Colour clients, Professionals) $1,500,000

BOTTOM-UP APPROACH

The opposite of the top-down approach is the bottom-up approach.

The bottom-up approach starts with some underlying assumptions about our business and estimates how far they can be scaled.

It doesn’t rely on big data.

The bottom-up approach is a time and cost-effective method for assessing market value.

Applying the bottom up market analysis to Arrowtown Hair would look something like this;

We need to know what we are selling, how much we are selling it for, and how many people we could sell to.

Arrowtown hair specialises in women’s color, so we would want to know the average price per color service. Digging into our CRM (Timely), we can find this information. Let us say this comes to $150 per color service.

Next, we would need to know how often our color clients visit the salon. Using Timely, I know that clients generally rebook every eight weeks, which equates to 6 salon visits per year.

That means a color client spends approximately $900 per year (6 x $150).

Finally, I would need to estimate how many color clients we could serve.

Using Facebook Ads manager, I discovered 14,000 people fit our color client demographic.

We can use that information to calculate our bottom up target market value $12,600,000 ($900 x 14,000)

Our top-down approach estimated our salon’s market size to be $1,500,000, whereas the bottom-up approach estimates our target market to be $12,600,000. Of course, I used fictional figures or estimated figures (based on facts). I suspect using real numbers would produce closer end figures.

A TAM or total addressable market size is just that. It only represents the salon’s market potential and is not a good indicator of how much value a business can capture.

The top-down approach doesn’t account for difficulties in reaching the target market. It assumes they are there and ready to buy.

The bottom-up approach doesn’t account for the limits of market size. The calculation assumes unlimited customer segments, and customers are available to be served with each new segment.