How to calculate market potential

Market potential, together with market volume, market sales, and market share, is an important part of any market analysis. It describes the potential capacity of a market to absorb a particular good or service. It refers to the theoretically possible demand or the maximum achievable revenue volume within a defined period if all potential customers were to buy the product.

1. Why should you know the market potential?

There are two reasons you should know it:

• First for purely practical reasons: because it is an unavoidable part of the market analysis that belongs in every business plan.
• Second, to become familiar with the market you want to enter. The market potential tells you whether your business idea is worthwhile and capable of growth. It answers the question of how large a market could realistically be. As the name suggests, it identifies the potential of a market that has yet to be tapped. This information is particularly valuable to new founders before implementing their business idea and entering a new market. It is, however, equally important for established companies, especially when developing additional customer segments or launching a new product category or service.

Logically, market potentials are larger in a growth market (with rising demand, also called a future market) than in a saturated market (where customer needs are already met by the existing supply). In a shrinking market (with strong competition but declining demand), market potential is practically non-existent, and the question arises whether it is worth investing in such a market at all.

2. Difference between market potential and the other aspects of a market analysis

In order to calculate and understand market potential correctly, it must be distinguished from the other aspects of market analysis. These aspects are also known as market analysis key figures and enable informed marketing decisions.

• Market share is the percentage of the overall market that a company holds. It can be expressed as a quantitative share, as sales volume, or as a value-based share, as revenue. The larger a company's market share, the greater its power in the market.

  

  The formula and definition above apply to the so-called absolute market share. To gain a clearer picture of a company's market position, another key figure is used: relative market share.

  

• Market volume is often confused with market potential, but it is a much more concrete term. It refers to the actual/planned revenue or sales volume in a market within a specific period. Put simply, market volume describes the current market size and market potential describes the theoretically possible market size. From this we can conclude:

  

• Sales volume does not refer to the entire market but to the quantity of products or services sold by an individual company.

• Market saturation shows how much market potential has already been exhausted by the market volume. By relating market volume to market potential, you get the market saturation level, which can range from 0 to 100%. The closer it gets to 100%, the more likely the state of market saturation has been reached. A market is considered saturated when customer needs are already covered by the existing supply. Here, demand matches supply. Market potential therefore always corresponds to 100% saturation of a market.

  

3. What influences market potential?

Market potential is primarily influenced by the following factors:

3.1. Product life cycle

Just like living beings, products also go through different phases during their existence. The concept that describes this process, from a product's market launch to its withdrawal, is called the product life cycle. It depicts the sales of the product over time.

Ideally, the product life cycle comprises 5 phases

1. Market introduction – During this phase, a new product is released. Marketing measures play a major role here, because without them potential customers are not aware of the new product. Once awareness of the product has been raised, customers begin to buy it, provided there is interest in the product. This phase carries significant risk and, of course, the product may not be accepted.

   But back to the positive scenario: revenue is now slowly rising. However, profits are not yet generated. Reaching the break-even point (the threshold at which costs are covered by revenue or are equal) marks the end of the introduction phase here.

   
2. Growth – The next phase is the growth phase. Demand for the product increases and so does the sales volume. As a satisfactory level of awareness has already been reached, advertising spending also decreases. The product has established itself in the market, and profits are made for the first time. Rising sales figures and the potential the market offers attract the attention of competitors. They begin to bring their own products to market.
3. Maturity – When growth rates start to slowly decrease, the product reaches the maturity phase. This is usually the longest and most profitable phase. Along with high revenues, competition continues to grow. Here, marketing techniques come back into play. To stand out from the competition, companies take various measures. Proven practices include product variations, adjusting prices to the competition, opening up new market segments, and so on.
4. Saturation – In this phase, the market is already saturated. Companies often try to offer new, lower prices and win customers away from competitors. However, many customers already own the product and demand slowly declines. As a result, profits continually drop and the break-even point is fallen below again. This means that no more profits can be generated, ending the saturation phase.
5. Decline – The product has reached the fifth and final phase. In this case, marketing measures are ineffective and the market shrinks inexorably. As the name suggests, sales and revenue decline. Continuing to produce the product would only result in losses. At this point, companies have two options: either eliminate the product or try to revive it. This is achieved through significant product modifications combined with a new positioning. If successful, the product life cycle starts over again.

Overall, the old product is replaced by a successor product. The providers (specifically the product management team) are usually prepared for this and develop the new product in advance, unless they plan to exit the market.

In your business plan, you should state the phase of the product life cycle in which your offering is positioned. This has a major impact on market potential and also plays an important role for investors.

3.2. Trends in the target market

This refers above all to technological and sociocultural trends. By introducing new technologies, products offer additional functions, improved user-friendliness or appealing design. The consequence is the premature obsolescence of still-functional older products, which are replaced by new ones.

Sociocultural trends also have a significant impact on the potential of a market. These include, for example, new family structures, demographic developments, increasing environmental and health awareness, and so on.

3.3. Market drivers

Market drivers are influencing factors that trigger trends or determine their strength and direction. Examples include:

• Standardization and norming processes
• Subsidies for new political goals
• New laws and regulations
• Pressing inventions or innovations

Legal frameworks can also support some industries through various funding programs or benefits while making circumstances more difficult for others. We can see this in the example of gasoline cars. Due to environmental measures, they must be phased out.

You should also mention in your business plan the trends and market drivers currently relevant in your industry.

4. How do you calculate market potential?

We can calculate market potential using a simple formula. To do so, we only need the values of two variables. These are either estimated or determined using existing data sources. Such sources include:

• Industry magazines
• Association statistics
• Chamber of Industry and Commerce (IHK)
• the Federal Statistical Office (Destatis)
• Publications from market research institutes

For the first variable, we need to indicate the number of potential buyers. This depends on the target audience on the one hand and on the region in which the product is offered on the other. It does not matter here whether some of the potential customers already own the product; all potential customers are included.

Note: A buyer persona can help you define the target audience. It determines how many people in the selected region fit this profile.

The second variable represents the average demand per customer over a given period. This corresponds to the quantity of goods or the number of services that a typical customer consumes during the period under review (usually one year) — i.e. per-capita consumption.

Market potential = Number of potential buyers x Average demand in the period

If you want to determine market potential as a monetary figure (in euros, dollars, pounds, etc., depending on the currency), simply multiply the result by the price per unit.

5. Example: calculating market potential

To make this more tangible, here is an example:

You want to launch a new protein powder in Germany. Your target audience is health-conscious men between 25 and 39 years old. This is how you determine the market potential: