Market potential is key to business valuation

Market potential key to valuation

Market potential is the indication of customer appetite and scalability in a business. Let’s go through the five elements of determining a market potential: (1) Industry. (2) Market size. (3) Market growth rate. (4) Margins. (5) Competition. (6) Market characteristics.

Investor value a business with market potential. A great product or team may be able to pull off a bad timing, but a poor market potential is hard for business. Sometimes that can be difficult to see from the inside, sitting on a grandiose ambition.

Industry as a market potential denominator

Different industries have different market potentials. Highly specialized industries has less potential for growth than broader services.

Timing is an important factor when to determine an industry market potential. There are plenty of cases when someone has been too early trying to scale a particular industry or sub-sector service. A late entry to an industry can also be a challenge. For exmaple if that industry is already well penetrated and oligopolized.

Entering a highly competitive industry can certainly be profitable if one has a much more attractive offer that current prevailing offers. However, the time, effort and investment needed mite make it less attractive than other less competitive ventures.

Market size

Market size is the total sales of all companies together in a market. Most markets are larger than viewed on the face of it.

A local market is limited by its reach. There is just so much to sell. Addressing a global market with services and distribution that has limited or no differences depending on the buyer will create a huge market size. That’s important if one is targeting a large market potential.

System as a Services, SaaS, is an example of a business model were market size can be huge if targeting a global audience.

Many tech industries address huge markets by offering software-based services online. Marketing and sales still needs to be adopted to local circumstances but the core product and distribution can be very much globalized.

Market growth rate

The next criteria to look at is the market growth rate. It’s much more attractive to address a fast-growing market than it is to target a declining market.

It can sometimes be difficult to determine a market growth rate. Demand can shift or broaden to similar products and services. Sub-sectors within fashion is an example where market growth rate can shift rapidly.

Product line extensions, complementary products and alternative products are other areas to factor when defining a market growth rate. Not least in technology and social media where changes evolve quickly.

Margins are key to market potential

Entrepreneurs and investors alike address a market to earn money. Margins are key when to determine a market potential.

Physical products with low prices have limited attraction from a margin point of view considering the low price, packaging and distribution costs. Online, software-based products are very attractive on the other hand considering its high margins from low operation and distribution costs.

Assessing a market potential means assessing its earning potentials and that’s way margins are important to examine, not only the overall demand or growth rate of a market.

Competition

Not everything has been invented. There are still new markets being build with first mover advantages and limited competition. The ride hailing company Uber is one example of a company creating a new market.

Not everything needs to be new either with differentiation being candidate to increase once market potential vis-a-vi the competition. One can also do it better than anyone else. Booking.com is an online traveler search engine for lodging reservations that made huge success despite entering a highly competitive travelling booking industry.

Entrepreneurs are often self-focused disregarding the competition. It’s important to make a thorough analysis of the competition or the market potential might be much less than anticipated.

Relevant market potential is another term to keep in mind. Customers often buy specialized services and products and one needs to narrow down on the market definition. This is a common early stage mistake by entrepreneurs when pitching to investors for growth capital.

Market characteristics

A transactional market is very different from a capital goods investment market. The market potential can be the same but the approach to the market could not be more different.

A transactional market characteristic requires strategic partnerships to scale. A business to business capital goods investment market like the machinery markets requires a strong marketing and sales spending. Margins therefore needs to be much higher then in a transactional market.

A strong market potential can make many businesses successful. Worth looking for.

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Jonas Florinus

Jonas Florinus

Jonas has 25 years operational experience growing businesses, 10 years with venture capital and private equity and more than $8 billion in personal transaction experience. For the last 5 years Jonas has been an entrepreneur himself.
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