Demographics for Small Business: market segmentation and counting customers
The last couple of entries have focused on stories of entrepreneurs who have either not cared about customers or who believed that the entire world was a prospective client base.
While these strategies may work for some entrepreneurs, generally speaking, we need to have some understanding of the size of the market and what we can expect to sell. This understanding increases dramatically if you are a “product” based business, where you make or manufacture a product. Making too much can result in excess inventory and wasted operating funds, making too little and you forego potential profit.
I’ve created a 5 step process to help you segment your market and more accurately predict potential sales:
Go through this exercise – even in your head, and I guarantee you will have a better understanding of your potential customers and will be better able to quantify your market research to an investor, funder or partner.
1. Who will buy your product and why?
Most entrepreneurs create a product to fill a need or to improve. Who will buy your product and why they will buy is the first step in calculating your customer base.
2. How many of these individuals/group/needs exist?
For most people this is the hardest part of market research. Calculating the number of people in the “market” can be a daunting task. However it need not be that bad. If you determine that your product is aimed at young professionals who live with their parents, you would first need to consult the Census in your country to determine the number of professionals, then most censuses narrow these by age, so you can further segment professionals say in the 24-34 range.
3. Narrow, narrow, narrow that customer base
One of the core mistakes in research is that many people want as large a customer base as possible. This is a mistake. While some lenders will let this pass, to the trained business person, the more narrow a target market, the more I know that the individual has thought about his product and who will buy it. The trick here, is to tie the narrowed slice of the target group back to question 1 – who will use your product and why?
So in our example above, we decided that young professionals who live at home with their parents are your target market. You know that not all young professionals still live at home. However you saw a recent stat in a newspaper that said about 20% of these individuals lived at home until the age of 34. So if we determined that in our City, there are 200,000 young professionals, and we estimate that 20% of them live at home, then our market segment would be 40,000. (200K*20%)
4. Market penetration rates: The world is not your oyster.
The next biggest mistake people make is that they assume either naively or optimistically that they will sell to the entire market. Either this, or they assume a far too low market penetration rate. A general rule, the smaller and better defined your market, the larger your market penetration rate can be. The larger your prospective market size, the smaller your number.
Let’s clarify with an example.
So if I was going to sell business plans, and I know there are over 3,000,000 global searches a month in Google for business plans, I could say that I could sell to half of the market (50%) and I would have generous predictions indeed. Trust me, if I was selling 1,000,000 business plans a month I would not be here blogging!
Rather, I know that the 3,000,000 can represent less than the total market. Why? Because many individuals do a search more than once. Particularly for something like a business plan. Also, they may search on more than one device. Finally, this represents global searches and my market is the English speaking world of do-it yourselfers or those for whom English is not a first language.
So if I were to limit my search to Canada, there are over 12,000 searches in Canada. Assuming that half of these are repeat queries, and then taking the percentage of the general population that are do-it yourselfers, (perhaps in the 5-10% range) might provide me with a realistic size of the market that I am targeting.
(12,000*50% for repeat queries) = 6000*10% DIY market= 600 = the number of business plan writers that are DIYers
My target capture rate of 35% = 210 Plans per month – my sales at maturity.
Now compare this number with saying that I plan to capture 0.1% of the global business plan market – that would be 30,000 plans per month – still much to high, particularly since many of those searches are in a language other than English. Numbers below 1% make no sense to anyone, so segment, segment, segment I say.
5. What will your sales be in year one?
The third and final biggest mistake that people make, is that they assume they will sell their predicted sales at maturity in year 1. Remember, that your size of the market is once your sales reach maturity. For the majority of businesses, this can be a minimum of 3-5 years. How quickly you reach your sales will include how quickly the industry is growing, the number of competitors and the quality of your product. Anyone of these can change your sales forecast.
For myself, I know that I will most likely achieve 15-25% of sales at maturity in year 1 and then predict that sales will increase by 20-35% every year thereafter.
So, to all the prospective entrepreneurs out there, good luck and start selling!