Market sizing is a key component of a strategic due diligence. However, depending on how it is approached, its results can range from useless (or worse, misleading) to essential. How can this be?
The key lies in the granularity of the analysis and its ability to provide insight on the target’s competitive position. Indeed, under varying qualities of analysis , the same target company could potentially be perceived as either a small player with much upside potential or as a dominant player with little to no organic market growth potential. Let me illustrate with an example, that of a single target first examined through the lenses of the misleading analysis and then through the lenses of the useful analysis:
Misleading analysis: Airplane gear inc. is a player in the fast growing aerospace industry. It provides airplane manufacturers with landing system parts, a growing global market worth US$ 2,7 billion annually and expected to grow 2,4% annually over the next 3 to 5 years. With its US$ 40 million annual sales, the company has less than 2% of a fragmented market and can reasonably grow its share through acquisitions or organic growth.
Useful analysis: Airplane gear inc. is a player in the aerospace industry. It provides airplane manufacturers with landing system replacement parts. It is not an OEM to aircraft manufacturers and has a competitive edge in the aftermarket replacement part. It does not serve the military aviation industry. Its commercial strategy over the last 10 years has been to focus on landing system spare parts for midsized crafts. Through various research and triangulation techniques, we estimate its addressable market to range between US$ 125 and US$ 175 million. We also note that the replacement parts market is underperforming the overall market and is expected to grow at less than 1% annually for the next 5 years. With its US$ 40 million in sales, the company has between 31% and 43% of its target market.
As you can see, the same set of basic facts leads to a very different strategic conclusion!
The misleading analysis implies nearly unlimited growth potential and suggests that the target has a natural ability to grow by simply “rising with the market tide”
The useful analysis demonstrates that the target is possibly the dominant player and suggests that the target’s main source of growth will likely come from stealing market share from its main rivals, a strategy which might very well require aggressive pricing and hurt margins.
A key step in this matter lies in the proper definition of the market under study. This requires the investor to move from studying the TAM (total addressable market) to SAM (served available market), the latter being a more granular definition that takes into account the target’s specific product and segment choices (in our example, key segmentation factors were factors such as civil aviation only, spare parts only, specialized in midsize crafts, etc.). Once this is done, a variety of research (primary and secondary sources) and analysis techniques will allow you to come up with a reasonable “market size range” for the target.
The importance of properly sizing the market cannot be overstated, as it informs your entire investment thesis. It tells you whether the addressable market is fragmented or not. It gives you the possibility to compute your target’s approximate market share. This informed market share estimate in turn leads you to factually assess the company’s competitive position and its evolution through time, allowing you to determine whether the target’s performance is improving or deteriorating compared to its peers. While it necessarily includes estimates and assumptions, a properly-designed market sizing exercise is key in assessing a target’s strategic position and outlook.