Top-down versus Bottom-up Market Analysis

A Manufacturing Analogy

By: Kelly Lusson 

Even those who are familiar with the strategic side of sales and marketing get confused between top-down and bottom-up market research. Worse yet, the terms are sometimes used interchangeably when they really shouldn’t be. For market analysis as a whole, I’ve previously used the analogy of a puzzle to describe the process of gathering data from a variety of different sources in order to develop a clear picture of your relevant market (and related potential). To illustrate the differentiation between top-down and bottom-up market analysis, consider the difference between subtractive versus additive manufacturing as an analogy.

Subtractive Manufacturing

Subtractive manufacturing involves removing material from an object by manual or computer assisted methods, for example, turning, drilling, or milling. Alternatively, Additive manufacturing, as its name suggests, involves adding material together to create an object, for example, welding, layered fabrication, or 3D printing.  

By this analogy, top-down market analysis can be compared to subtractive manufacturing

Internally, we also refer to top-down analysis as taking a macro perspective on the market. We’re looking at the big picture, and trying to figure out how our little pieces or components fit in. We start with a big picture of the market, and we cut away the pieces of the pie which are not relevant to our product or service. Let’s use the US control valve market within power generation as an example.  If the global industrial valve market is $70 billion. and we know that control valves make up around 25% of the total market, we can estimate the global market for control valves to be about $17.5 billion From there, of that $17.5 billion, we know that power generation makes up about 10% of the total market, or $1.75 billion. If around 12% of global power plants are in the US, we can safely assume that our US market potential for control valves within power generation is around $210 million.

Additive Manufacturing

In contrast, bottom-up market analysis can be compared to additive manufacturing

We also refer internally to bottom-up analysis as taking a micro perspective on the market – we’re adding up the smallest pieces of the market to build up the big picture. The approach here begins with assumptions and adds specific relevant pieces of data to build a market potential estimate from scratch. From a market analysis perspective, this method requires much more effort, but the end result is typically more accurate. To continue with the control valve example, we could start by identifying our demand drivers, which we define as a structure, entity, event, or scenario which presents an opportunity for us to sell our product or service. The demand driver this case would be power plants. We’d find the total number of global power plants, and break them down into power source wherever possible (nuclear, natural gas, hydroelectric, wind, coal, etc.). Then we need to speak to our subject matter experts within each field to obtain an estimate of the average number of valves we could sell within each plant. Let’s say the number is around 5,000 individual power plants, and we can sell about 350 valves to each plant at a value of $1,000 each. If we run the math, we wind up with a market of $1.75 billion. The outcome is the same. The difference here is that we now have a global picture of the different types of opportunities, including geographically, where the highest market potential exists.

In my example, I’ve worked the numbers in these two scenarios to come out even, which doesn’t happen very often in real life. (When it does, I find myself double and triple checking my work to make sure I didn’t make a mistake!)

So which approach is better? In general, we find a combination of both approaches to be most useful, with a slightly heavier emphasis on bottom-up estimates.  Let’s take a competitive analysis as an example of our combined approach: 

From a bottom-up perspective, you can build up your market size by adding up the relevant product revenue of your competitors. This works best in highly concentrated markets. Obviously, the smaller the number of key players and the more similar the product offering, the easier it will be to figure out the size of the market. Combining this with a top-down approach can shed light on what we’re missing. Per our control valve example: if the revenue of the top 5 key players adds up to $1 billion, and our top-down research has resulted in a market size of $1.75 billion, we’re missing $750 million – we have to take the time to dig deeper. Are there alternative technologies which make up part of the potential? For example, is there a pneumatically-actuated globe valve which could take the place of our control valve? The market potential remains the same, the question is who we’re up against and how we plan to compete against a technology with similar or equal functionality. 

To make the data as useful as possible, we also build dynamic application-based models, which can be easily modified as we develop an increased understanding of the market environment or in the case of changing market conditions. The value of a bottom-up analysis is increased granularity and quality of usable data, and real-world potential is based on existing demand drivers. Once we know where the dollars exist, it’s a small jump to identify top potential customers, which ultimately bridges the gap between conducting market research and closing the deal.

Depending in the product, industry, and potential customers, an in-depth market analysis can be very tedious and time consuming – particularly if the researcher doesn’t know where to begin. I find that this is particularly true for companies who assign a sales or marketing resource to conduct market research on top of their everyday tasks and responsibilities. The result is that research takes months or years instead of weeks, and the key takeaways are inconclusive or fail to provide adequate direction for strategic development. This is where a professional firm can help to fill in some of the gaps.

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