Forecasting is the process of estimating future demand and revenue for a product. Forecasting is used to assist with investment decisions in new products, to drive manufacturing, to set budgets, as part of the strategic planning process, and to guide Sales and Marketing efforts. This article outlines how to build a forecast by taking both a top-down and bottom-up view of the market.
Estimate the total market size (TAM).
TAM, or Total Available Market, is an estimate of the size of the overall market for the product. Calculate TAM by multiplying the total number of units expected to sell in the market during the forecast period by an estimated average selling price (ASP) to arrive at a revenue estimate for the total market.
Segment and estimate the size of the target segment (SAM), if applicable.
If the product is not a mass market product and is instead focused on a subset of the overall market, segment the market and similarly estimate the size of the target market segment. This is the Serviceable Available Market (SAM). SAM and TAM are identical if the product is targeting the whole market.
Estimate the Share of Market (SOM).
Finally, estimate the part of the Serviceable Market the product will capture for the forecast period, the Share of Market (SOM). Usually, SOM is a fraction of SAM, which is, in turn, a fraction of TAM. The Total, Serviceable, and Share of Market can be represented in a few ways:
- TAM, SAM, and SOM can be represented in absolute terms as units and revenue.
- SAM is also often represented as a percentage of TAM.
- SOM is often represented as both a percentage of TAM and as a percentage of SAM, depending on the context.
Compare the “top-down” forecast to a “bottom-up” forecast.
Some products lend themselves better to top-down forecasting, where you begin with an overall estimate for TAM and drill down to SOM. Other products, especially products with a highly concentrated customer base, can be more accurately forecasted by estimating the demand on a per-customer basis. It’s useful to create both a top-down and bottom-up perspective to cross-check the forecast for accuracy.
Create worst-case, expected, and best-case estimates.
Define the expected forecast and then calculate a best-case and worst-case forecast to show how the forecast could vary depending on a stated set of assumptions. This is useful to show that the forecast is just an estimate and that the actual results could vary, for better or worse. A common mistake is to focus on the potential upside, the best-case, while ignoring the downside potential of the forecast.
Read more about forecasting and other key product management topics in my book, Mastering Product Management: A Step-By-Step Guide, available now in paperback and eBook.