We believe that small business owners should make sure their business models can sustain an income from day one. We’re not suggesting you go out and buy a jet with your business profits, but we do believe that you should be able to live comfortably as a small business owner right out of the gate. However, that takes planning. And lots of it! So let’s look at one of the most important tasks of pre-venture planning — the sales forecast.
There are two methods for creating a sales forecast. This week, we’ll talk about the market share method.
Market Share Method
In the market share method, the sales forecast begins with an estimate of market size. This is the total number of consumers or businesses in your trading area that would be interested in purchasing your product or service. It’s your target market, but with a number attached to it — how many are there?
Once you have your market size, you need to estimate their consumption — how much are they currently buying? You can get information on past consumption through primary market research or secondary market research.
When you have an estimate of the number of buyers in your area and how much they buy each year, you can estimate total market demand by multiplying the two numbers together. For example, Jill and her sister Lauren want to open a flower shop. Their city has 100,000 households, but not everyone in the city would travel to their shop. So they assumed that only people who lived within five kilometres of their flower shop would want to do business with them.
Here’s market demand for Jill and Lauren’s flower shop:
City Size = 100,000 households
Market Size = 10,000 households live within five kilometres of their store
Annual Spending per household on floral arrangements = $140 (from local statistics)
Total Market Demand = 10,000 households × $140 spent per year = $1,400,000
Market demand vs market share
Market demand is not the same as market share. If Jill and Lauren open their shop, it will make theirs the seventh flower shop competing for the total market demand for flower arrangements. So, assuming all competitors are equal in size and competitive advantage, and that Jill and Lauren could jump right into business without any retaliation from competitors, they could potentially earn a one seventh share of the total market demand for flowers. So how does that translate into estimated sales for them?
Total Market Demand = 10,000 households × $140 spent per year = $1,400,000
Estimated Market Share = 14%
Estimated Sales for one shop = $1,400,000 × .14 = $196,000 in sales.
So, using the market share method of sales forecasting, Jill and Lauren (and hopefully you!) see the potential revenue for their shop. This estimate should be adjusted to account for seasonality, special events (like Valentine’s Day flower purchases), and general economic conditions of the region, weather, seasonal changes and holidays. It’s impossible to predict the factors that will most likely impact sales, but you should try to account for them in your sales forecasts.
Coming up next week: the daily capacity method! See you then.