Foreword
By the nature of my work, I often launch products or make decisions about tossing them. The time to write a small blog about that has come. 😉
So let's start from the very beginning.
Before you even start to think about lean startup (target customer, underserved needs, etc.), you need to understand the market and build a value chain. Market and value chain understanding creates the right context, which can help you figure out financial projections, business model, and sales strategy.
It is time to create a pyramid:
I'm not too fond of pyramids when you try explaining the complex process. Okay, Maslow pyramid is the one that works well 😉. But to show the interconnection between components, we need to develop kind of the mutated Pythagoras tree:
Every theory should be reinforced by practice. I suggest we go through a concrete example and cover all steps from this framework at some level of details.
Turn on the imagination.
We are so excited about Mass Timber Market because the material is renewable, has low embodied energy, and stores carbon. Or we are so passionate about sustainable energy thus we would like to improve Solar Farms Energy design and construction.
Okay, let's throw the dice - Solar Farms - we want to devote our lives to solving problems around this exact market.
Red is about problem space
Here we need to do a few iterations of explorations: market -> value chain -> target customer -> market.
Each new cycle will refine the previous one's values.
For example:
n = 0
market_size = X revenue
value_chain = 0.2a + 0.7b + 0.1c
target_company = a
n = 1
market_size = 0.2X revenue
value_chain = 0.2a + 0.7b + 0.1c
where a = Y*m + Z*n
target_end_user = m
n = 2
market_size = 0.2X revenue
included N companies each included Y end users
As you see in the pseudocode above, at the first step (n=0), the market size was measured by revenue (how much money is channelling in it), and the value chain included three different companies that share this money. If we assume that our target company 'a', we can claim only 20% of the market. After that (n=1), we discovered that company 'a' contains different types of users ('m' and 'n'), and our target end-user is 'm'. Within step three (n = 2), we defined that our market includes N amount of companies within Y amount of users in each. Thus, we may conclude that our market size equals Y*N (measured by the number of end-users of our product/service).
How to define the market size?
There are a bunch of different subsets of the market: TAM (Total Available Market), SAM (Serviceable Available Market), SOM (Serviceable Obtainable Market). TAM is a total market demand for a product or service. SAM is a portion of TAM targeted by our product/service. SOM is a part of SAM that can be reached with our product/service.
So the main question for us is where to search these numbers and choose which of them we can rely on?
Let's go in order. Market size numbers always can be found in reports done by Market Research companies. There are many specific resources where you can download or buy such essays. Just Google 'solar energy market size' and you will get something like:
We need to check and validate these numbers as much as possible. The best validation is considering many different sources of information and comparing them with each other. It is a fun exercise, but we leave it behind the scenes to focus more on high-level things, so we have the numbers above as our TAM and we go further.
TAM size allows us or our investors to assess the upside potential. But we will not likely service our total addressable market because of geographical or economic limitations. So now we are looking into narrowing down TAM to SAM.
For example, we read about Solar ITC (Investment Tax Credit) - a federal policy mechanism that supports the growth of solar energy in the United States - so we decided to focus on the US market.
Thus we need to do the research as we did with TAM but inside chosen geographical region. Also, the closer we to SOM the more accurate we should be.
Ok, Google.
As you see screenshots above, we got different numbers from different sources. Although we found the exact number - the value of the US Solar Market is $24.5 billion in 2020, we still can do some calculations to prove it:
The Global Solar Market dollar size was $170.5 billion in 2020.
The Global Solar Market GW size was 125GW in 2020
Utility PV - 80GW
Non-residential PV - 20GW
Residential PV - 22GW
To check the value we need to find out how many GW was built in the US in 2020.
Ok, Google.
So, for the US, we have capacity installed in 2020:
The year ended with a total of 19.2GW installed
Utility PV - 14GW
Non-Residential PV - 2.1GW
Residential PV - 3.1GW
Now we can easily calculate that the US Solar market is part of the Global Market:
Utility PV: 14/80x100=17.5%
Non-Residential PV: 2.1/20x100=10.5%
Residential: 3.1/22x100=14.1%
We narrow down further our SAM focusing only on Utility PV:
The Global Solar Market for Utility PV: 80/125x170.5=$109.12 billion in 2020
The US Market for Utility PV: 109.12x17.5/100=$19.1 billion in 2020
$19.1 billion is our SAM (the US, utility PV) size measured by revenue in 2020.
What we have done previously is the so-called Top-down approach, where we took a bird-eye view using published reports and macro data. Also, we can use other methods to define SAM sizes, such as Supply-side or Demand-side. Within the Supply-side approach, we can estimate the market size based on the size of each competitor supplying the market. Within the Demand-side approach, we can combine end-user data with the number of operators in the market to create a formula that leads to the market size.
But we don't want to be stuck here, so let's go further. At the moment we have the following figures: TAM = $170.5 billion, SAM = $19.1 billion.
As it was mentioned before to define SOM we need to understand which part of SAM can be reached with our product/service. It is time to define what product/service we deliver and its place in the value chain.
How to build a value chain?
A value chain is a business model that describes the full range of activities needed to create a product or service.
To build it schematically, we need to understand the prominent roles there. It requires some deep industry knowledge. Let's not overcomplicate it. What are those companies that need to work together to deliver the final product - Utility Solar Farm?
Client / Developer
Design / Engineering Consultance
EPC Contractor
The genuine value chain will give us more insights into the needed product/service and its place in creating/delivering value. The following scheme can give you some ideas how a value chain could look like:
But for this blog, we will be using a very simplified value chain model: Developer, Engineering Consultancy and EPC Contractor.
And here is how it works:
Developer consider a few possible sites for potential Solar Farm
Investment negotiations
Federal and State Authorities grid requirements
The developer works with Engineering Consultancy to assess the environmental impact and to get permissions for building Solar Farm
The developer works with Engineering Consultancy to prepare a request for quote (RFQ)
Developer sends the invitation for bid to a few EPC Contractors
EPC Contractors returns to Developer with Proposals
Tender time
Winner EPC Contractor goes into Preconstruction design, planning and finally construction phase
It is good timing for some schematic explanations of the above:
As we considered before, to get the SOM numbers we need to understand which part of the value we deliver in the market. To answer this question, we need to describe which product/service we deliver, for whom and at what place.
Before we start speculating about target customer, I would like to mention that you cannot use value chain based market refinement when you build a product/service which presupposes disruption in the current chain.
Let me give a few examples. Many products help with process automation, collaboration or management with current value chains (email automation software, knowledge management software, etc.). But there are also a lot of products that disrupt the value chain (when covid happened educational companies needed to change the way how they teach, thus online education software disrupted the market). And it is very crucial to understand what you establish. I am not saying that we cannot change it every day. I am just saying that when we make our assumptions about the product market and value chain, we need to keep in mind whether the product is disruptive or not.
Back to the topic.
How to define a target customer?
Suppose, we want to build a product that will cover EPC Contractors' problem during the pretender phase - large expenditure of resources for projects that may not win the tender and positive decisions about loss-making projects.
We are going to build a tool, which will help them
to utilise resources carefully
to avoid substantial write-offs due to highly paid specialists
to avoid loss-making projects
It's time to speculate about the end-user. As we already agreed, we will solve problems during tender preparations; thus, our end user is an employee or a group of employees responsible for these preparations. Here we need to dive deeper into the EPC Contractor process flow and figure out who is this employee(s). There are many frameworks for customer discovery: Job To Be Done (JTBD), Customer Journey Map (CJM), etc.
Again, due to the high level of explanations of this blog post, I want to focus on critical steps and principles without diving too deep. If the topic is exciting people, I promise we will develop our 'molecular cuisine'.
But still, let me write a little about building one of the frameworks above:
As we develop our own understanding of problem space, we create a lot of hypotheses about the pains of our end users
After that, we need to test these hypotheses and confirm/deny them
The best way to do this is to interview customers. The interview is a complex process although it seems like an easy one
The answers to three main questions should be found: What problems is the user trying to solve now? How does the user solve them? What are the obstacles to the solution?
The empathy map should be taken into account
It is good to have interviews with the end-users and decision-making representatives at the company level simultaneously because the problems the product solves for the company and problems the product solves for the end-user can be different
It is essential to confirm that the problems our product is going to solve are real and the company have the willingness to pay for the solution
For now, let's just assume that we know enough to say that our end-user is a solar preconstruction engineer/designer.
The problems we solve for EPC Contractor at the company level:
Large expenditure of resources for projects that may not win the tender
Due to time constraints, there is a risk to make a decision and start the loss-making project
The problems we solve for EPC Contractor at the end-user level:
Responding to RFP takes a lot of time and efforts
Every new design iteration require cost/energy recalculations which make the number of calculations very limited due to time constraints
The end-user story:
As Solar Preconstruction Engineer / Designer I want a tool that allows me quickly respond to owner site/layout changes with feedback on energy and cost so that I can find the best cost-energy trade-off and communicate to owners the impact of the changes they request.
Now we have enough data about our target customer and the product/service we strive to deliver.
Back to market size (SAM -> SOM)
As you remember, here are our market numbers: TAM = $170.5 billion, SAM = $19.1 billion.
And here is our place in the value chain:
Our product/service will cover pretender phase 'Proposal' entirely and preconstruction phase 'Design' and 'Planning' partially.
The main question now, how to define how much money is channelling precisely in this space?
We can always assume that our product will change how the process goes and bla-bla-bla, but we need to be careful with our assumptions, and we intend to define actual serviceable obtainable market size.
Let's speculate...
The SAM = A, SOM = XA, where is X is the percentage SOM concerning SAM.
The main performance indicator of the market is Utility PV MW installed
We can assume that percentage of MW installation cost we cover with our product/service can be used proportionally to define SOM concerning SAM
Ok, Google, lead me through the most accurate, relevant and recent Market Research reports:
As you see from the chart above, the design, engineering and permitting proportion is one of the most stable MW costs during 2019/2020. I bet this is a rigid approximation, and no one really could calculate it correctly 😉. However, design, engineering and permitting takes 0.04/0.91x100=4.4% from the whole MW cost. We know that a well-thought-out preconstruction planning and design can solve many problems with Logistics and Installations. Still, we leave it behind the scenes as we want to get the most pessimistic market estimations.
And still, we don't fully cover design, engineering and permitting (so we cannot use 4.4%). Coffee ground predictions can help us here (it is better to get insights about actual percentages during the interview process or to find the way to define them as accurate as possible):
Thus we have 80%, which is applicable for the whole preconstruction phase. Since we cannot cover the full preconstruction phase we need to make another assumption about what part of it we cover with our product/service. I will not torture you anymore with endless assumptions - British intelligence reported that our product will cover 80% of preconstruction phase.
Finaly, we will define the percentage of SAM as 4.4x0.8x0.8=2.82%. Thus our SOM is 2.82% of SAM in 2020:
SOM=19.1x2.82/100=$540 million.
What is much more important than actual market size numbers from the last year is:
How the market grows, which can be defined from the same reports (CAGR) or extrapolated from the previous years
What percentage of the market we will penetrate with our product/service
But that is another story.
Conclusion
Using Google and school mathematics we defined market size for our imaginary product/service: TAM = $170.5 billion, SAM = $19.1 billion, SOM = $540 million.
We saw how value chain and target customer profile can help us refine the numbers above.
I hope it was a fun exercise for you.
In the next blogs, we will go into the Green branch of the mutated Pythagoras tree. As you already understood, Green is about solution space. So we will develop solution space for considered above problems in the market. And after that, we will go into the Blue branch of the mutated Pythagoras tree. Blue is about how you apply Green for Red.
Thanks for reading to the end. 😉
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