“The only function of economic forecasting is to make astrology look respectable.”

John Kenneth Galbraith

In this chapter

• Market size
• Market growth
  • The web of information
  • The four-stage process for demand forecasting
• Market demand for a start-up
• Market demand risks and opportunities

The analysis of market demand must come right up front in your business plan. It is the crux of the plan. If there aren’t enough buyers of the type of products or services you offer, at the right price, you won’t meet your plan.

Your backer wants to know, before all else, who these buyers are, how much they are buying, how much they are paying, why they are buying, what has been influencing them, how those influences may change and how much they are likely to buy in the future.

And they want to know all this in each of your main business segments.

If you can make this chapter of your plan convincing, you may have a backer. If not, you won’t.

I have seen so many business plans where analysis of market demand is hedged, sidelined or compressed into a couple of paragraphs in a chapter devoted to the company’s oh-so stellar positioning.

Most of those plans were written for the sale of a company. Potential backers either walked away or made an offer at a much lower price.

Your backer wants the market demand situation laid out as it is, clearly and concisely. If market demand prospects are not great, be they flat or even mildly declining, tell it like it is. Don’t try to obscure the reality.

If your backer has to find out for themselves that the reality differs from that presented in your business plan, you have no backer.

Of course, a backer would prefer to invest in a business that addresses a growing market. However, fortunes have also been made through backing winners in a declining but consolidating market.

Let’s be clear. This chapter considers demand not just for your product or service, but for all providers of products or services with whom you compete. It looks at overall demand in the marketplace.

Any market is made up of demand and supply. When demand and supply are in balance, that’s good news for all concerned. When demand outstrips supply, that’s good for the suppliers – though usually only for a while, until more supplies and/or suppliers arrive. When demand falls and supply exceeds demand, that’s bad news for suppliers. You’re one of those suppliers.

We are going to apply those fundamentals to the market for your product or service. We will look at market supply in the next chapter, but we’ll start with market demand in this one. We’ll try to forecast where market demand is headed over the next few years.

Your backer will also want to know what the risks are of things turning out worse than expected. And, conversely, what the opportunities are for things to turn out better than expected.

Market size

If your business is called Tesco, you will subscribe to a market research organisation. You will feed it data at the end of each period and receive results within a week or two on the overall size of the UK grocery market, its growth since the previous period and whether your market share has gone up or down from around 30%.

And so it is with most large organisations. Yet many medium-sized companies too will enjoy a similar relationship with a niche market research house or industry association. I have worked in some wholly obscure niches of the British economy over the years and it never ceases to amaze me how companies with a turnover of just £10 million still receive good, regular, informative market data from an external, independent research house serving that company and most of its competitors.

But for small companies this data may be punitively expensive to acquire, may not be directly relevant or may not exist.

Tough. You have to have a go; you have to make an estimate. Your backer will need to know whether you are a big fish in a small pond, or vice versa. Suppose you are a mega fish in a tiny pond, but one that can be protected from other waters. Your backer would like to hear that.

And they will want to know how that market size has changed over the last few years. So you’ll have to construct a market estimate not only for today, but also for, say, three years ago.

It is not that difficult. You know what your turnover is in a particular business segment. What about competitor A? Bigger or smaller than you in that segment, would you say? By how much bigger? Twice, three times? 50% bigger? And B? And C D, E, F? Perhaps G is too small to warrant inclusion in this segment, but let’s allow 10% for G and anyone else we haven’t thought of.

Add up all their highly approximate turnovers and, hey presto, you have an estimate of market size in that segment!

Now do the same again for three years ago. Start as before with your actual revenues three years ago (or less if your business is younger than that). Think carefully whether competitor A is doing more business in that segment now than before. By how much more? By proportionately as much as your revenues have grown in that time? How about B? Build up a market size estimate for three years ago.

Compare the two estimates and you have a rough and ready approximation of market growth over a three-year period. Evaluate the compound growth rate and you have an estimate, crude in the extreme, perhaps, but an indicator nevertheless, of average annual growth in that segment.

Believe me, this is better than nothing. Your backer will be impressed that you have tried to create some information out of nothing. And it gives them some sort of basis upon which to work, to do some checking.

One caveat. Make sure you identify the relevant market size. It has to be that of the particular segment you are examining. If you run a deli grocery in an off-high street location in Bristol, putting down the size of the UK grocery market as your addressable market will not be helpful. It’s fine for Tesco, not for you.

Finally, here’s a simple example of constructing market size, adapted from one I did recently for a client, company A, which sold £30 million of equipment in a specific segment in 2010. The CEO figured that competitor B’s sales were significantly higher, say by one-third. Competitor C’s were smaller, but only just, say 10% below those of A. D’s were much smaller, less than half, say 40% of A’s. Then there were two or three much smaller players.

The market size in this segment in 2010 was therefore 30 (A) + 40 (B) + 27 (C) + 12 (D) + 10 (other) = £119 million, very roughly indeed. This gave A an estimated market share of 25% – a useful indicator for the next chapter.

The CEO thought that the relative shares of A and B had stayed more or less the same over the past three years, but C had gained share after its plant extension and D had stalled due to its poor reputation for product reliability. We knew A’s sales in 2007 were £24 million, so we estimated market size in 2007 at 24 (A) + 32 (B) + 18 (C) + 12 (D) + 8 (other) = £94 million.

On the basis of our informed guesstimates, the market in this segment seemed to have grown from around £94 million in 2007 to £119 million in 2010, an average annual growth rate of around 8%. Again, very rough, but nevertheless very useful in framing the subsequent business plan analysis.

Market growth

This is the big question. Is demand in each of your main business segments going to grow? Will it be bigger in a few years’ time, or smaller? Or more or less the same?

It’s not the only question, of course. Equally important, as we will see in the next two chapters, is the nature of the competition you’re going to face and how you’re placed to compete.

But it’s all a question of odds. You have a better chance of prospering in a market that’s growing than one that’s shrinking.

So how do you find out where market demand is headed? You need to weave your own web of information.

The web of information

I’ve been advising clients on market trends for 35 years. In the old days, you used to have to call up trade associations, write to companies active in the market asking for their annual reports, visit reference libraries to wade through reams of trade magazines and journals, and so forth. Or you might have to purchase an expensive market research report, often only of tangential relevance to the market you were researching.

Now it’s a breeze. All you have to do is switch on your laptop, click on to your internet connection, pop into Google or Yahoo!, and type in the name of your market alongside such words as ‘market,’ ‘growth,’ ‘forecasts’ and ‘trends.’

You’ll find that Google comes up with hundreds – maybe thousands – of websites to visit. Most of them will be irrelevant. One, two or more will be spot on. You’ll begrudge having to waste time trawling through dozens of useless sites – but think of the hours and hours of effort you’re saving compared to the old days.

You just need some patience and perseverance to systematically wade through the referred sites. Open up a Word file, and whenever you come across an article on a website that seems useful, copy it and drop it into your document.

You’re weaving your own web of information on your market.

You may find that your search directs you to reports produced by specialist market research companies. These should be used as a last resort. Some can be quite good, reflecting the direct access they may have had to market participants and observers, but too many turn out to be bland. And expensive. Better to do your own digging around on the web first.

There are some good news websites where you can search directly on market trends without having to subscribe. The BBC’s website (www.bbc.co.uk) is a hugely informative, internationally focused resource and doesn’t cost a penny. Similarly international in outlook, the website of The Economist (www.economist.com) offers a free search on articles less than a year old, but subscription is needed for older articles. The websites of the main broadsheet national and regional newspapers are also good sources, such as The Guardian (www.guardianunlimited.co.uk), which is free and requires no registration. There are also The Times (www.timesonline.co.uk), Daily Telegraph (www.telegraph.co.uk), Independent (www.independent.co.uk), Western Mail (www.icwales.icnetwork.co.uk), Scotsman (www.scotsman.com) and Irish Times (www.irishtimes.com), some of which require registration. The Financial Times website (www.ft.com) offers a wealth of financial, company and market information, but to search through back copies requires you to subscribe.

You can also find out much about the companies working in your market. Many will have their own websites that you can tap into. Smaller companies tend to use their websites just as product or service showcases, but some may provide snippets of information on where the market is heading, such as a press release summarising a recent speech by the CEO to a trade conference. Publicly quoted companies will attach their annual reports, in which you’ll be able to find the company’s views on market trends.

Another good source of market information on the web is online trade magazines. Typically they will have at least some sections open to the public without subscription, which can often be expensive. If you work in the automotive industry, for example, you could look up www.automotivenews.com. If you’re in the wine business – lucky you – how about www.wine-spirit.com? Whatever sector you work in, there is sure to be an online trade magazine.

The four-stage process for demand forecasting

There is a four-step process you need to follow in any assessment of market demand trends. Get this process right and all falls logically into place. Get it out of step and you may end up with a misleading answer. You need to apply these steps for each of your main business segments. The four steps are as follows:

1. Assess past growth – check how market demand has grown in the past.
2. Assess past drivers of growth – identify what has been driving that growth in the past.
3. Assess changes in drivers – assess whether there will be any change in influence of these and other drivers in the future.
4. Forecast future growth – forecast market demand growth, based on the influence of future drivers.

Let’s look at each of these briefly, then at some examples.

1 Assess past growth

This is where it would be good to get some facts and figures. It’s surprising how the most straightforward of searches can reveal recent growth rates in the markets you’re looking for.

Be careful not to fall into the trap of relying on one recent number. Just because demand for a service jumped by, say, 8% last year doesn’t mean that trend growth in that market has been 8% each year. The latest year may have been an aberration. The previous year might have seen a dip in the market, followed by the 8% recovery.

You should try to get an average annual growth rate over a number of recent years, preferably the last three or four. As long as there haven’t been serious annual ups and downs you can usually get a usable approximation of average annual growth by calculating the overall percentage change in, say, the last four years and then annualising it. If there have been ups and downs, you should smooth them out with three-year moving averages before calculating the percentage change.

If yours is such a niche market that there is little or no data to be found, that can’t be helped. Useful information can still be uncovered. You just need to find out whether the market has been growing quickly, growing slowly, holding flat, declining slowly or declining quickly. We can define growing slowly as moving along at the same pace as the economy as a whole (gross domestic product or GDP in economics-speak), which is roughly 2–2.5% a year in the long run in Britain and most other large Western economies. That’s in ‘real’ terms – in other words, in terms of tangible, wealth-creating growth. On top of that sits inflation, typically around the same 2–2.5% a year these days, although it has been much higher in the past. Slow growth in terms of ‘money of the day,’ or in ‘nominal’ terms, can therefore be taken as roughly 5% a year in the long run. Actual data on GDP growth can be extracted from government statistics if that is helpful. Interestingly, real GDP growth in 2010–11 has been low, but inflation has been higher, so nominal GDP growth has again been around the 5% a year mark.

2 Assess past drivers of growth

Once you have uncovered some information on recent market demand growth, you need to find out what has been influencing that trend. Typical factors that influence demand in many markets are as follows:

• Per capita income growth.
• Population growth in general.
• Population growth specific to a market (for example, of pensioners or baby boomers, or general population growth in a particular area).
• Some aspect of government policy.
• Changing awareness, perhaps from high levels of promotion by competing providers.
• Business structural shifts (such as towards outsourcing).
• Price change.
• Fashion, even a craze.
• Weather – seasonal variations, but maybe even the longer-term effects of climate change.

Not all of these drivers will be relevant for all your business segments. You need to pick those that are the most important. There may also be factors that are purely specific to your market. Fashion, fads in particular, can have a huge effect on some markets.

3 Assess changes in drivers

Now you need to assess how each of these drivers is going to develop over the next few years. Are things going to carry on more or less as before for a particular driver? Or are things going to change significantly for that driver?

Will, for instance, immigration continue to drive local population growth? Is the government likely to hike up a local tax? Could this market become less fashionable?

The most important driver is, of course, the economic cycle. If it seems that the economy is poised for a nosedive, that could have a serious impact on demand in your business over the next year or two – assuming your business is relatively sensitive (or ‘elastic’, in economics-speak) to the economic cycle. Or maybe your business is relatively inelastic, like, for example, the food industry. You need to think carefully about the timing of the economic cycle and the elasticity of your business in your business plan.

4 Forecast future growth

This is the fun bit. You’ve assembled all the information on past trends and drivers. Now you can weave it all together, sprinkle it with a large dose of judgement, and you have a forecast of market demand – not without risk, not without uncertainty, but a systematically derived forecast nevertheless.

Let’s take a simple example. Your business offers a relatively new service to the elderly. Step 1: you find that the market has been growing at 5–10% per year over the last few years. Step 2: you identify the main drivers as (a) per capita income growth, (b) growth in the elderly population and (c) growing awareness of the service by elderly people. Step 3: you believe income growth will continue as before, the elderly population will grow even faster in the future and that awareness can only get more widespread. Step 4: you conclude that growth in your market will accelerate and could reach over 10% per year over the next few years.

And now an example of how not to do it. Many years ago I was doing some work with a crane manufacturer in the North of England and came across a draft business plan. In the section on market demand, its young author had stated that there was no data to be found anywhere on UK demand for cranes. So, for the purposes of the financial forecasts, he assessed real growth in the crane market to be the same as for UK engineering output, forecast by the OECD at 2.4% per year.

Oops! The mistake is one of exclusion. Yes, macro-economic demand was an important driver of demand in the crane market. But there were three or four other drivers of equal importance, on which there was, admittedly, no hard and fast data but plenty of anecdotal evidence. They included evidence of destocking, a thriving second-hand market and, above all, an imminent downturn in high-rise construction activity.

None of these drivers bore any relation to engineering output as a whole and their combined impact served to translate a 2.4% per year crane market growth forecast into one of steep decline, possibly at 10% per year for two or three years.

The moral of this tale is to make sure that all drivers are taken into account, irrespective of whether hard data can be found on them. Use your judgement.

Market demand for a start-up

This chapter of your plan may well be the most difficult of all to write in a start-up. Yours may be a new product or service designed to convey a customer benefit not previously realisable. In which case, how do you define the market? What is market demand for a product that has not previously existed? What is its size? What are its growth prospects?

On the other hand, your start-up may be in a market that’s already well defined – like the Dart Valley Guest House and Oriental Spa, which will be unique and distinctive, but fits snugly into an already buoyant market for three- and four-star tourism in the West Country.

Or you may be opening a boutique selling designer childrenswear on the high street. Again that is a definable, existing market, to be researched in the same way as set out above.

But what if your product or service is indeed something that has not existed before? How can you convince your backer that there will be buyers for your offering, and at that price? You need evidence.

You’ll have to do some test marketing. If yours is a business-to-business proposition, get on the phone and set up meetings with prospective corporate buyers. Explain the benefits of your product and why at that price they have a bargain.

Keep a record of these meetings and analyse the findings. Write a report drawing out key conclusions from the discussions, with each supported by bulleted evidence – whether comments from named customers, comments from third parties quoted in the press or data dug up off the web. Collate them into a short and sharp market research report, which will be Appendix A of your business plan. It will be the first appendix, because it will be the single most important item of evidence your backer will look for.

If yours is a business-to-consumer product or service, test it on the high street. Get out your clipboard, stand outside an Asda or a Waitrose, depending on your target customer, and talk to people. If you’re offering a product, show them. If it’s a service, explain lucidly but swiftly its benefits.

Again, collate the responses, analyse them, draw firm conclusions, support them with quotes and data, and stick the market research report in your Appendix A.

Now, based on those responses, make an estimate of your potential market size. Imagine there are many suppliers of your product or service and that the whole country is aware of its existence, then what would the market size be? How does that compare with the market size for products or services not that different from the ones you’ll be offering? Does your estimate make sense?

And how about market demand growth? If your start-up is serving an existing market, you can use the same four-stage process for demand forecasting that an established business would use.

If your start-up is for a new market, you may try the same four-stage process, but in reality this will not be the prime consideration of your backer. They will be concerned with the existence of such a market in the first place. Any growth on top of discovering and serving a new market will be icing on the cake.

Market demand risks and opportunities

You have now come to a reasonable forecast of what’s likely to happen to market demand in your key business segments over the next few years. However, your backer needs to know a little more than that. You’ve assessed what’s most likely to happen. But what are the risks of something happening to market demand that could make things worse than that? What could happen to make things much worse? How likely are these risks to happen?

On the other hand, what could make things better than you have forecast? What could make things much better? How likely are these opportunities to happen?

Your backer is going to be very interested in these risks and opportunities. They are going to use your market demand forecasts to help assess whether your financial forecasts in Chapter 7 of your plan are reasonable. Then they will look at all the risks and opportunities around those forecasts in Chapter 8. And market demand issues will be the first set to be factored in.

Identify the main half a dozen risks that might affect your market demand forecasts, then assess them from two perspectives:

• How likely are they to take place – a low, medium or high likelihood?
• If they do occur, how big an impact will they have – a low, medium or large impact?

Now do the same for the opportunities you have identified.

Are any of these risks or opportunities ‘big’ issues? We’ll define a ‘big’ risk (or opportunity) as one where:

• the likelihood of occurrence is medium (or high) and impact is high
• the likelihood of occurrence is high and impact is medium(or high).

Any big issues of market demand need to be set out clearly in your business plan. If it is a big risk, you must set out how you are going to address it and mitigate its impact. If it is a big opportunity, you must elucidate on how you plan to exploit it.