Entrepreneurs are expected to do their homework and understand prospects who could become their customers. Learning about a new product’s market is as important as designing and prototyping your product.
Market research will answer many questions for a new venture. How much money is spent on the problem your product solves? Who are potential customers and how are they grouped? What competition exists in this market and what fraction of sales are captured by each competitor?
Measuring and Forecasting Demand
Marketing managers use extensive market research to determine the market opportunities that exist for their products and services. This includes forecasting sales and demand.
Market research is important to established firms in addition to new ventures. It is necessary to be able to have an accurate forecast because if the forecast is lower than the actual sales, the company may experience product shortage and logistical problems. On the other hand, if the forecast is above the actual demand, the company will have to deal with excess inventory, thereby blocking its capital cash flow.
Market potential critically depends on how the market is defined. As an example, consider how Coca-Cola CEO Roberto Goizuetto redefined the company’s view of its market. He led the company during a period when it dominated the cola market. If he had restricted his definition of the company’s market as only cola drinks, Coca-Cola would have reached almost maximum market penetration with almost no room left for growth. Instead, Goizuetto expanded Coca-Cola’s market definition to include all beverage consumption including milk, water, and tea. Coke products accounted for merely two out of 64 ounces of an average person’s daily beverage purchases. This new market definition inspired Coca-Cola to expand into other beverage product categories and as a result created an era of sales growth for the company.
Marketing managers are interested in determining demand in three ways:
Total Market Demand
Area Market Demand
Total Industry Sales and Market Shares
Total Market Demand
The total market demand is the total amount of sales possibly available to all the firms for a given product category, during a particular period under specific marketing and environmental conditions.
Market research that analyzes existing sales and forecasts sales growth can typically be bought or found for free. There are research firms which try to estimate the amount of money spent on a product category such as golf sports equipment or coffeemakers, and this information is made available to third parties for free or for a price.
If you cannot find this information, you may be able to estimate it by calculation. Consider the following example:
Total Market Demand (Q) = Potential number of buyers in the market (N) x Average quantity purchased by a buyer (q) x Price of one unit (P)
Example: A company is interested in finding out the total market demand for flavored milk among urban adults:
Total Market Demand for Flavored Milk among Urban adults = (Urban population above 18 years) x (Average disposable income [urban]) x (% of income spent on beverages) x (Average % of amount spent on dairy beverages) x (% expected to be spent on flavored milk)
Estimating Market Potential for Disruptive or New Products
. Fortunately, this can be accomplished by thinking about what the new and innovative product would substitute.
A product should satisfy a need or solve an existing problem. As a consequence, the market for your product can be measured because it probably already exists, even if nothing like your product has ever been sold. For example, the total market demand for smartphones could be estimated long before smartphones were introduced to the market. These devices compete against older cell phones to meet the communications needs of consumers. Since older phones met this need, the number of these phones being purchased is an estimate for potential smartphone customers.
Are smartphones disruptive and innovative? Yes. Are they fundamentally different from prior phones? Again, yes. Even though they are arguably new, the human problems they solve and their potential customers already exist. The money they spend to solve this problem serves as an estimate of the market size of total market demand for a new product, even one that is truly innovative.
Area Market Demand
Companies and marketing managers face the unending problem of choosing the best territory and allocating their budget optimally across the territories. They need to assess the market demand of different countries, cities and localities before framing their marketing plan.
The two main ways of doing this are the market buildup method and the market factor index method.
Market buildup method: This method is primarily used by business products marketers. It involves identifying all the potential buyers of the business products and estimating their potential purchases. Usually in the case of business products marketing, the list of potential customers is small and thus this identification and assessment process is easy. However, if the list is too vast or unavailable, then it is not possible to conduct this process.
Market factor index method: This method is generally used by consumer products marketers. It involves estimating the market demand by using market indexes and comparing it to existing sales figures.
For example, assume that an apparel manufacturer wishes to evaluate the sales of men’s shirts in a particular area. The total market demand has been estimated to be around $2 billion while the current nationwide sales of the company amount to $150 million. This is about 7.5 percent of the total market demand. The company’s sales in New York are $1.1 million. The buying power index (BPI) for a specific area is given by the following equation:
BPI = 0.2 x percentage of national population in the area x 0.5 x percentage of effective buying income in the area x 3 x percentage of national retail sales in the area.
Plugging in the figures for New York into the above equation, it is observed that New York should optimally account for 0.5935 percent of the nation’s total potential demand for men’s shirts, which equals $11.87 million. The current company sales in New York ($1.1 million) amount to 9.3 percent of this total area market demand, which is significantly higher than the national average of 7.5 percent. Thus, the company should keep in mind that much of its revenue is coming from the New York area and maybe allocate a greater budget for this area.
Total Industry Sales and Market Shares
Apart from determining the total market demand and area market demand, a company also needs to know the actual industry sales and forecast its own sales. Industry sales can be obtained from data published by trade associations such as AC Nielson.
Below are some of the common methods to forecast sales:
Survey of buyer's intentions
It is important for every company to know how a buyer is likely to behave under a given set of conditions. The ability to understand this behavior and forecast it correctly is what sets excellent companies apart from average ones. To understand their consumers better, companies hire research firms to conduct consumer surveys.
For example, a shoe retailer may want to ask its customers, “How often do you shop for shoes?”
The customers can choose among the following selections:
Twice a month
Once a month
Once every 3 to 4 months
Twice a year
Other (Please elaborate)
Such a question will help the retailer better understand the buying habits of its customers.
Composite of sales force opinions
Sometimes it is not possible to conduct consumer surveys. In such cases, the companies may ask their sales representatives to estimate future sales based upon past sales. This is useful because the sales representatives know the actual reality and market demand, since they are in constant touch with the customers. However, some of them may make highly optimistic estimations and some may be pessimistic; thus, the estimations have to be adjusted to get a realistic figure.
Another useful method of obtaining estimates and analysis is to interview experts, dealers, distributors and marketing consultants. Often, they are able to provide companies with useful insight on the topic since they are specialists in their fields. It may be useful at times to have a group discussion among them to generate ideas.
However, experts are commonly asked to supply their estimates individually, with the company analyst further refining this and combining them into a single estimate. This process is known as the Delphi Method.
Analysis of past sales
A very useful and often used method for forecasting future sales is analyzing past sales. This can be done using time series analysis and analyzing the various components such as seasonal, cyclical and trends. Statistical analysis and econometric analysis, which consist of studying the impact of different variables on sales, are also useful.
Market Segmentation and Customer Acquisition
Top-down market research is required for investors and other stakeholders to take a business plan or venture seriously. However, a bottom-up approach is more useful for a new venture. This process starts by figuring out how to find individual customer groups, which is how businesses really build a customer base.
It may seem like fun to think about total market demand, but it is not really relevant to the first years of a new venture. Regardless of the size of the market, a new venture will be unknown and will start with very few customers. The venture will have to work to find new clients, regardless of market potential. Questions and challenges facing a new venture will be the same if it is entering an industry with $1 billion in annual sales or an industry with $50 billion in annual sales.
New ventures will have to think small and try to figure out which customers they will approach first. This requires that they break the broad market into subsets, or segments of customers. These segments are divided by common needs, location, common viewpoints or common behaviors. For example, if you are launching a new non-alcoholic beverage you should think about what segments you would like to target. The same advertising and positioning of your brand will not appeal to everyone.
Once the target market segments have been identified, new ventures should brainstorm exactly how they will find and sell to new customers. They should think about how they could estimate the cost of acquisition of a new customer based on typical success rates of different promotional activities. This is research that involves finding the costs of different marketing campaigns and gauging the fraction of those marketing impressions that are converted into customers. An estimate for the average cost of customer acquisition from a marketing campaign can be calculated by dividing the marketing costs of the campaign by the estimated number of new customers generated. The customer acquisition cost can also be calculated by dividing the cost of each impression made on a consumer by the conversion rate.
Hypothetically, let's assume that a company is considering advertising using internet banner ads. Each banner ad costs $0.05 and the conversion rate is 0.5%. Thus, the customer acquisition cost is calculated as $0.05/0.5%, or $10 per customer.