The market size for a particular market is the dollar volume of sales that actually occurred in a given year. The market potential is the volume of sales that would occur if every company that could buy a particular solution, did buy it. A market potential study is also called a “served market” or “market penetration” study.
My goal in this article is to explain the difference between traditional market studies and market potential studies, and then explain some of the complexities associated with getting good data on how penetrated a particular market is. I will explain these concepts by focusing on how a market potential study would be done in the warehouse management system market (WMS).
Market size studies, which often include market share and average selling price data, are used by companies to help them determine how they are doing compared to their competitors, and what segments of the market are growing faster and slower. This analysis allows companies to better allocate their sales and marketing budgets, and figure out what kind of functionality they should invest in.
Market potential studies show how large a particular market could be if the market was completely penetrated. In general, market potential data is used when software companies are looking for investors, or when they are considering entering a new software market.
All market research has a margin of error associated with it. But the margin of error associated with market potential studies is significantly larger than market size studies, partially because a series of assumptions will need to be made to size the potential market. Further, market potential data is much more costly than market size data – on the order of 5 to 10 times more costly.
Why is this?
Let’s assume your company wanted market potential data for the warehouse management system (WMS) market. You would start by looking for market research firms that had already sized the WMS market.
How would a market research firm utilize their market size data to generate the size of the potential market? It differs somewhat in different supply chain software segments, but I’ll describe how it would be done surrounding the warehouse management system software market.
The market research firm already know the size of the WMS market. What they don’t know is how many companies that could have bought WMS, did not do so. So what the researchers need to determine first is how many warehouses exist.
In the case of the U.S., the government has data on this. For other nations around the world, this just does not exist. So this is where the first set of assumptions are needed. Let’s say you wanted to size the potential market in North America, with North America being defined as Canada and the U.S. A researcher might say, these two countries have roughly similar GDPs and economies, and the Canadian economy is X% smaller than the US, so let’s take the number of warehouses in the US and multiply by .X to get the number of Canadian warehouses. Then by dividing by the North American average selling price into the total North American WMS revenues, you understand the penetration of WMS in this region.*
In other regions of the world, this won’t work so well. The number of warehouses differs by industry. There are many more warehouses associated with the wholesale/distribution sector, for example, than with industrial manufacturing industries. And the percentage of GDP generated by a particular industry can be very different in different countries. For example, a much higher percentage of GDP is generated by the oil and gas industry in Saudi Arabia than in India.
I work at ARC. What we often do in this instance is use a model we have developed that understands GDP by industry by country; this allows us to divide the average selling price for WMS software in that region and industry. Then we know the penetration at the industry/country level and can roll it up to the regional and then global penetration.
Believe it or not, I’ve actually simplified this a great deal. For one thing, the analysis has to be adjusted to account for the fact that one company has bought a WMS and implemented it at five warehouse sites, a smaller company only has one warehouse.
Further, the number of warehouses reported by the government is not really the total number of sites where a WMS can be installed. With omni-channel initiatives, for example, some retailers are developing store formats that have big back rooms where they store goods that will be shipped to internet customers. Those stores are not counted as warehouses.
There are a number of other complexities as well. In short, a researcher will almost always have to do a series of interviews with WMS software companies, system integrators, and warehouse real estate companies to intelligently account for the complexities. And to get information from these sources, the researcher needs to be prepared to give something in return.
So in conclusion, market potential studies contain more assumptions, and are therefore less precise than many other types of market research. Market potential studies can be devilishly difficult to execute, and thus they are much more costly. But for software or consulting companies looking for outside investors, this data can be a critical part of their sales pitch to investors.
* Market size/divided by average selling price = Number of warehouses where WMS is installed.
Number of warehouses where WMS is installed/total number of warehouses = Site penetration
(% of unpenetrated sites * ASP) + Size of Existing Market = Potential Market