Posts Tagged ‘Demand’

8 Steps to Determining Market Size

May 1, 2009

Whether you’re an entrepreneur writing a business plan or an established firm looking to introduce a new product or service, you will encounter the need to estimate the size of the market/s that you plan to serve.  Market-sizing is an interesting and exciting branch of marketing research, but it can be almost as much an art as it is a science.  Today, I will walk you through the process of estimating market size, using the example of a financial planner looking to develop a practice in his community.

Step 1: Define your target market

This can never be stressed enough.  If you don’t know the type of customer you want to serve, you will waste a lot of time and money trying to get any customers.  Market-sizing is easier when you know the exact group you’re searching for.  Our financial planner has decided that his target market will be married couples with young children.

Step 2: Determine the needs of your target market and how they create demand for your product/service

Here you formulate a hypothesis.  Ask yourself the benefits your product or service offers your target customers.  What problem does your product help them solve?  Begin with a statement about why your target customers need your product.  Our financial planner’s statement might be: “Married couples with young children need my services because they must be prepared for college, as well as for unexpected emergencies such as disability and early death.”  This statement assumes, of course, that the financial planner sells financial products that address these needs; if the planner sells only financial plans, his statement will be different.  

Step 3: Identify the information you need to estimate the size of your market

Now that you have identified your target market and hypothesized about its demand for your product, what information do you need to develop your estimates?  Among other things, our financial planner would need to know:

  • The age distribution within the geographic area he serves;
  • The number of households with children in that area;
  • The distribution of family income in that area;
  • Home market values in the area;
  • Educational attainment and college enrollment rates for graduating high school students;
  • How many competitors, direct (other financial planners and insurance agents) and indirect (stock brokers, banks with financial planning services, etc.) are serving the market; and
  • What financial planning services people buy and how much they pay.

There are others, but this list is pretty comprehensive.

Step 4: Identify the sources you need to obtain that information

So where do you find information about your market?  These days, there is such a wealth of published statistics about almost every industry and market segment, that a combination of library and online research can fulfill most of your information needs.  In some cases, if you are looking for very specialized information, you may need to conduct your own primary research (surveys, focus groups, etc.) to get what you need. 

The U.S. Bureau of the Census provides comprehensive demographic statistics by metropolitan area, county, ZIP code, census tract, and state.  Information about population, age, income, educational attainment, presence of children, and home market value can easily be obtained at any of these levels, so the financial planner would be able to answer many of his questions.  In addition, the Census Bureau also produces County Business Patterns, which provides information about the activity of each industry by each of the same geographic levels listed earlier.  Hence, our financial planner can also obtain the number of financial planning establishments,  insurance agencies, and brokerage firms serving the area in which he hopes to establish his practice.

In addition, our financial planner may consult online data sources such as Dun & Bradstreet’s Million Dollar Database and ABI’s ReferenceUSA to identify specific financial planning firms and insurance agencies in his area and get estimates of their employment size and revenues.

The financial planner can also get lots of relevant information from trade associations, local chambers of commerce, Web sites of his existing competitors, and through primary research, such as surveys and interviews with experts.

Step 5: Collect the data

Now that you have identified your data sources, you need to extract the data.  The financial planner will scour all the sources he identified to pull out data that meets his information needs.  He will determine whether his data sources provide sufficient and useful data, or whether they provide insufficient or suspect data, at which point he may seek out additional sources to answer his questions.

Step 6: Analyze the data

Now that you have all the data, what does it mean?  What is it telling you?  Let’s say that the area our financial planner wants to serve has 200,000 households, of which 15% – or 30,000 – are two-parent households, with a median family income of $60,000 per year, a median age of 32, and an average household size of 4.  Immediately, the financial planner knows he is serving a young upscale market, and it’s very likely – without looking at the number of competition – that there will already be an above average number of financial planners trying to serve them.

The financial planner may also find from financial planning industry statistics that 60% of families in that age group carry life insurance, and that the average policy face value is $100,000.  Given the affluence of this area, the planner may reason that households in his target market have much greater assets and income to protect, so he may adjust his estimates of life insurance coverage for that area upward – to policies of maybe $250,000 or $500,000.  He’ll make similar estimates for any other financial products and services he offers.

Step 7: Derive your market estimate

Now that you’ve compiled and analyzed your data, you need to come up with an estimate of market size.  Our financial planner may – through all his data sources – come up with an average and standard deviation of the policy amounts of life, disability, and other policies aimed at his target market in that area.  He will then project that amount out by the number of households within that market to come up with an aggregate size of the financial planning market in that area.  From there, he will build in a margin of error, perhaps using a 95% confidence interval, to come up with a low estimate, a middle estimate (which would be the aggregate size he determined earlier), and a high estimate.

Step 8: Apply your estimate

Your market size estimate is useless if you do not apply it.  Once our financial planner derives his aggregate estimate, he will estimate how much of that market he can reasonably get based on his competition and the amount of money he can earn based on his commission structure.  This will feed his business plan projections.

In addition, the size and characteristics of this market will help our financial planner determine how best to market his services, whether by direct mail, giving presentations, networking, or other means.

Market-sizing can be a daunting, tedious task, but the value it adds to your planning and marketing efforts can make the time, money and effort invested in it more than worthwhile.

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Pricing Demystified, Part II: The Van Westendorp Price Sensitivity Meter

March 12, 2009

Several different analytical approaches are available to help marketers determine the optimal price to charge for their product or service.  Here, I will discuss the Van Westendorp Price Sensitivity Meter, which is simple to employ, yet gives some very useful information.

Start with Four Questions

Van Westendorp starts with a survey asking respondents just four simple questions about price:

  1. At what price would you consider this product so expensive that you would not consider buying it? (Too expensive)
  2. At what price would you consider the price of this product so low that you’d question its quality? (Too cheap)
  3. At what price would you consider the product starting to get expensive – not out of the question, but you’d need to give some thought to buying it? (Expensive)
  4. At what price would you consider the product to be a bargain – a great buy for the money? (Inexpensive).

Graph the Responses

Once you have compiled this information, group the answers to each question into frequency distributions and plot the cumulative frequencies on a graph.  Each question above will have its own line on the graph.  The percentage of respondents should comprise the vertical axis; the price points, the horizontal axis.  Since the lines need to intersect, invert the cumulative frequencies for the “Inexpensive” and “Too cheap” on the graph.

Determining the Acceptable Price Range

The price at which the “Too cheap” and “Expensive” lines intersect is described as the “Point of Marginal Cheapness,” or PMC.  PMC represents the lower limit of the acceptable price range.  Similarly, where the “Too expensive” and “Inexpensive” lines cross is the “Point of Marginal Expensiveness,” or PME.  This is the upper limit of the acceptable price range.

Determining the Indifference and Optimal Price Ranges

Next, the point where the “Inexpensive” line and the “Expensive” line cross marks the “Indifference Price Point,” or IPP, the point at which the same percentage of respondents think the product is either cheap or expensive. 

Finally, the point at which the “Too cheap” and “Too expensive” lines intersect is known as the “Optimal Price Point,” or OPP.  It is at this point where the percentage of respondents who say the price is too cheap equals that who say it is too expensive.  OPP is optimal in the sense that the price senstivity to the product for being cheap is equal to that of being too expensive, and is often the recommended price.

Using the Results

  1. The OPP is the recommended price for your product or service.
  2. Competitive products will rarely be priced outside the acceptable range (between PMC and PME).
  3. If your goal is a healthy balance of revenue and market share, price as closely to OPP as possible.
  4. If your goal is to maximize market share or penetration, price somewhere between PMC and OPP.
  5. If your goal is to maximize revenue, or “skim the cream,” price somewhere between OPP and PME.

Warnings

Finally, be aware of four limitations or dangers of Van Westendorp:

  1. Your data is derived from surveys, so questions must be worded properly to avoid biased responses, and sample size must be large enough for statistical accuracy;
  2. Different customer segments have different price sensitivities.  Hence, if you serve multiple customer segments, the OPP and acceptable range may be different for each;
  3. Even if you price within the acceptable range, you can still price too low such that you lose money and/or get regarded as low quality; and
  4. Even with a skim the cream strategy – pricing within the acceptable range –  you can price your product too high that your competition wins your customers.

All this said, continue to know your customers intimately and, using Van Westendorp’s points for a guide, experiment with different price points until you find the one that brings you the closest to achieving your marketing objective.