This is a top-down technique for predicting (during your planning stage) how much revenue you think your company will make. This is a favorite among many so-called “marketing experts” because it falls naturally out of performance of market research, so it sounds scientific. However, its only value is to establish an upper bound on how much revenue your company could make theoretically. It has two major problems: (1) it completely ignores the most important aspect of revenue planning, i.e., how are you going to reach your potential customers, and (2) it lends itself well to suckering people into believing stupid revenue numbers by supporting claims like “look, all we have to do is capture ½ of 1% of the total available market, and we will all be rich!”
As long as you understand the limitation of this technique, and supplement it with a bottom-up revenue-forecasting technique, fell free to use it. To use it, you should estimate the percentage of the market you think you can reasonably capture each year for each product and each market in the figure below:
If you want to propagate a value from any cell to the right, click on the black and yellow arrow.
Note that the term “market” is not particularly specific. If you choose to use it with its broadest possible interpretation (e.g., the population of Gen-X-ers in the United States, or the number of small software companies in New York), then you should expect your predicted target penetrations to be quite small. On the other hand, if you use it in a very specific sense and limit it to a very narrow vertical (e.g., Gen-X-ers who are members of public golf courses in Colorado, or software project managers in Fortune 500 companies), then you should expect your predicted target penetrations to be much larger. Assumptions you want to record when using this sales modeling approach (for each product and each market) are:
Note that defining market size (as number of customers), average order size, annual rate of growth, and market penetration per year provides sufficient information to predict how many units will be sold by your company. Defining market size (as number of products), annual rate of growth, and market penetration per year provides sufficient information as well.
Should I use top-down revenue forecasting?
Absolutely! This is a perfectly acceptable sales modeling technique to demonstrate what percent of the total available market you expect to capture. But always supplement it with a bottom-up approach, which shows your real revenue forecast and demonstrates you know how you will be capturing your market. When the top-down and the bottom-up meet in the middle, people start to believe you.
What other ways exist to model sales?
How do I add a product to the sales model?
How do I add a market to the sales model?
How do I change the number of years (columns) in the sales model?