2006, OVP Venture Partners, 8/23/06

A Startup’s Guide to Market Sizing

Pen Goodale, Director of ResearchOVP Venture Partners

8/23/06

2006, OVP Venture Partners, 8/23/06 2

The Need for Accurate Market

Sizing Never Goes Away All firms, start-ups to Global 2000, need to do market sizing before they invest time, money & resources in new ventures – companies, business divisions or products.

Market segmentation is critical before you tackle market sizing. The sharper your focus, the better. Key variables to consider: Which product segments in the solution stack -- initial focus & 3-5 year plan? Which regions – initial focus & 3-5 year plan? Type of customer:

― Residential/consumer (Do you also need to segment by age group, or tech. adoption rates?);― Enterprise (Global 2000, small- to medium-size firms, or small office/home office [SOHO]); or― Service providers.

For enterprise markets -- horizontal or vertical solution? Are there 1 or 2 “best fit” verticals?― Which vertical industries have the greatest need? ― Which verticals are early adopters or early majority customers?― Market size and timing for each vertical. How big & when will revenues ramp up?― How easy will it be to sell to each vertical? It may be a big vertical, but if it is going to be costly & hard to sell to, it probably is not

worth targeting. Which distribution channel(s) will be most effective for reaching your target customers?

― Direct sales vs. indirect channels , e.g., value added resellers (VARs), distributors/resellers, …― OEM agreements also have become a key avenue for startups to gain traction.

Before you lock in your market segmentation/targeting strategy, you need to develop rough market sizing estimates to determine which segments have the most potential.

Again, it’s an iterative process.

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Market Sizing Tips

Gather as many data “factoids” as possible while researching your industry & competitors. Look for industry-specific & vertical-specific data that can be used to estimate your market size. Don’t assume all of these “factoids” are right, but the more reference points the better. Find out who are the best analysts/forecasters for your market -- important long-term contacts.

Even if your firm can afford detailed industry research reports, you need to take a closer look at the market & the forecast assumptions that apply to your firm. Don’t just use analysts’ #s.

Your firm’s Total Available Market (TAM) is a subset of an overall market, based on your targeting strategy -- near-term & long-term.

Few Global 2000 firms sell to all market segments (all layers in stack, customer types, regions …). It is best to have a small team develop market sizing models. Leverage each other's skills & insights to build, refine

and proofread the model. Developing Total Available Market (TAM) models for emerging markets takes a combination of: research skills; luck in finding

free "factoids;" creativity; basic algebra, financial analysis & Excel skills; and being comfortable with taking "educated" guesses. Make sure you document your sources & assumptions as much as possible. Don't worry about getting it right on the first try. The team can refine your approach & assumptions. Especially if your model has to be built on only a few reliable "factoids," err on the conservative side. The team approach helps

ensure that the guesses aren't too optimistic or too conservative. Review your models with seasoned executives and industry experts.

Market sizing forecasts don't need to be precise. Rough "ballpark" estimates -- short-term & long-term – are usually fine.

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Top-down forecasts: Usually industry analysts’ worldwide estimates for a large market, which are then split into segments by major product group, region or vertical industry.

Bottoms-up forecasts: Build up revenue forecasts by defining the key underlying variables and estimating how they will change over the next 3-5 years. An illustrative example:

Top-Down vs. Bottoms-Up Forecasts:

Complementary, Reality Checks

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An Open Source example:The rSmart Group

2004 2005 2006 2007 20083-Yr. CAGR(2005-2008)

rSmart's Total Worldwide Higher Education TAM (in $Millions)Sakai Project -- Community Source Course Management System (CMS) 2 13 56 140 300 185%Kuali Project -- Community Source Financial Information System 0 0 4 33 105 n/m OSPI (Open Source Portfolio Initiative) -- ePortfolio Solutions 2 4 14 27 43 121%uPortal -- Community Source Portal Solutions 13 11 20 28 40 54%Kuali II -- Community Source HR Information Management System 0 0 0 4 33 n/m Kuali III -- Community Source Student Information Management System 0 0 0 0 4 n/m

rSmart's Total Worldwide TAM (in $Millions) $17 $28 $94 $232 $525 166%

rSmart's Worldwide TAM in the Higher Education Community Source Market

$0

$100

$200

$300

$400

$500

$600

2004 2005 2006 2007 2008

in $

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s

Kuali III

Kuali II

uPortal

OSPI

Kuali I

Sakai Project

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A Closer Look at 1 of rSmart's Product Segments:

Sakai in N.A.Key Assumptions for N.A. TAM:% Change

Yr.-to-Yr. 2003 2004 2005 2006 2007 20083-Yr. CAGR(2005-2008)

Total # of Higher Education Institutions in North America (1) 0%Universities with doctoral, master's & baccalaureate programs (DR) 330 330 330 330 330 330 7%4-Year Institutions with master's & baccalaureate programs (MA) 650 650 650 650 650 650 15%4-Year Institutions with baccalaureate & associate programs (BA) 674 674 674 674 674 674 15%Community Colleges (AA) & Other Specialized Institutions 2,778 2,778 2,778 2,778 2,778 2,778 63%

Total # of Higher Education Institutions in North America 4,432 4,432 4,432 4,432 4,432 4,432 100% 0%

rSmart's N.A. TAM for Sakai -- Community Source Course Mgmt. System (CMS)Sakai Adoption Rates by Market Segment

Universities with doctoral, master's & baccalaureate programs (DR) 0.0% 9.0% 10.0% 15.0% 20.0% 30.0%4-Year Institutions with master's & baccalaureate programs (MA) 0.0% 0.3% 3.0% 10.0% 15.0% 25.0%4-Year Institutions with baccalaureate & associate programs (BA) 0.0% 0.0% 1.0% 5.0% 10.0% 15.0%Community Colleges (AA) & Other Specialized Institutions 0.0% 0.0% 5.0% 20.0% 30.0% 45.0%

Sakai Adoption Rate for N.A. Higher Educ. Institutions (2) 0.0% 0.7% 4.5% 15.9% 24.0% 36.4%Commercial CMS Adoption Rate for Blackboard & WebCT (3) 78.5% 78.3% 77.0% 68.6% 65.0% 55.0%Institutions with "Home Grown" (& Other) CMS Solutions (3) 15.2% 15.0% 13.0% 10.5% 7.0% 5.6%Institutions with No CMS Solutions (3) 6.3% 6.0% 5.5% 5.0% 4.0% 3.0% Total Higher Education Institutions in the N.A. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

# of N.A. Institutions Using Sakai -- Cumulative Installed Base #sUniversities with doctoral, master's & baccalaureate programs (DR) 0 30 33 50 66 99 44%4-Year Institutions with master's & baccalaureate programs (MA) 0 2 20 65 98 163 101%4-Year Institutions with baccalaureate & associate programs (BA) 0 0 7 34 67 101 143%Community Colleges (AA) & Other Specialized Institutions 0 0 139 556 833 1,250 108%

Total # of N.A. Institutions Using Sakai 0 32 199 705 1,064 1,613 101%Avg. Rev. per Year for Maintenance Subscriptions (in 000s) year-to-year increase ------->> 0% 20% 80% 20%

Universities with doctoral, master's & baccalaureate programs (DR) $39K $40K $50K $90K $110K 40%4-Year Institutions with master's & baccalaureate programs (MA) $28K $30K $40K $70K $80K 39%4-Year Institutions with baccalaureate & associate programs (BA) $19K $20K $25K $50K $60K 44%Community Colleges (AA) & Other Specialized Institutions $18K $20K $25K $50K $60K 44%

Avg. Rev. for Installation/Integration Services -- 1st year only for new customersUniversities with doctoral, master's & baccalaureate programs (DR) $40K $40K $50K $55K $65K 18%4-Year Institutions with master's & baccalaureate programs (MA) $40K $40K $50K $55K $65K 18%4-Year Institutions with baccalaureate & associate programs (BA) $40K $40K $50K $55K $65K 18%Community Colleges (AA) & Other Specialized Institutions $40K $40K $50K $55K $65K 18%

Avg. Rev. per Year for On-going Professional Services -- Beginning the 2nd YearUniversities with doctoral, master's & baccalaureate programs (DR) $25K $25K $25K $25K $30K 6%4-Year Institutions with master's & baccalaureate programs (MA) $25K $25K $25K $25K $25K 1%4-Year Institutions with baccalaureate & associate programs (BA) $25K $25K $25K $25K $25K 1%Community Colleges (AA) & Other Specialized Institutions $25K $25K $25K $25K $30K 6%

N.A. TAM Details for the Sakai Project (in $Millions)Sakai Maintenance Subscriptions $1 $5 $21 $58 $105 176%

Sakai Installation/Integration Services 1 7 25 20 35 71%

Sakai On-going Professional Services 0 1 5 18 30 211%

rSmart's Total N.A. TAM for the Sakai Project (in $Millions) $2 $13 $51 $96 $170Sakai N.A. TAM Summarized by Market Segment

Universities with doctoral, master's & baccalaureate programs (DR) $2 $2 $5 $8 $15 96%4-Year Institutions with master's & baccalaureate programs (MA) 0 2 6 11 19 112%4-Year Institutions with baccalaureate & associate programs (BA) 0 0 2 6 10 n/mCommunity Colleges (AA) & Other Specialized Institutions 0 9 38 71 126 141%

rSmart's Total N.A. TAM for the Sakai Project (in $Millions) $2 $13 $51 $96 $170

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What Do VCs Look for in a Startup’s Market Forecast?

Have you done a bottoms-up TAM forecast for your targeted market segments, as well as a top-down view at your market size? Does the methodology reflect deep understanding of the target market segments?

Are the numbers and assumptions realistic & believable? Market timing & adoption rate assumptions are critical.

― For an emerging market, have you studied historical adoption rates of related technologies to develop conservative estimates? e.g., for predicting penetration rates of wireless LAN usage in the residential market, try applying DSL & cable Internet access adoption rates.

Do the assumptions accurately reflect pricing pressures & other key market variables? From a VC’s perspective, it’s better to be a smaller fish in a big pond, than a big fish in a small pond, as long as

you are a “big enough” fish. Being the #3 player in a big market is better than 50% share in a niche, $100-$200M market. The market needs to be large enough support a few $100M firms in 5-7 years. General rule of thumb: minimum market size of ~$500M in 3-4 years.

― For markets with primarily indirect sales channels the hurdle is even higher. If there is no demonstrable market yet, the bar is higher now than a few years ago.

If your market will be <$500M in 4 years, you still have a shot at building a successful, profitable firm, but you may need to seek funding from angel investors vs. VCs. VCs are obligated to invest their time & their Limited Partners’ capital on startups that have strong potential to grow to

$100M companies.