Understanding Market Share Calculations
The concept of market share is pretty simple – just divide your company sales by the total sales within the market. The problem is getting accurate information for the denominator in this ratio. Three common approaches and their relative strengths and weaknesses are:
Bottom-up Approach – this method relies on information gathered directly from the users of the product. It is theoretically the most accurate since these users can provide unfiltered input on their current suppliers, product usage and forecasted requirements. The supplier collecting this data, however, has a potential bias toward overestimating market share by gathering data from customers who are known to the company and overlooking applications or firms that are not currently served.
Top-Down Approach – this method uses high level econometric data and projections to derive demand for the product and thereby estimate market share. This method is less subject to consistent bias but is prone to the compounding of errors in the underlying assumptions used to derive demand. Moving from a high level forecast (such as GDP) to sales of a specific product requires either:
- A series of fractions which model how overall demand is broken down by region, industry and segment or
- A rule of thumb that implicitly captures these assumptions based on historic ratios.
Both methods are subject to random error depending upon the validity of the assumptions and the potential for these assumptions to deviate from historic norms.
Purchased Industry Analysis – this method relies on a third party to capture product sales data within a specific industry. Using such a service should provide better information since they can collect data without representing any particular supplier, are likely to take a comprehensive view of the available market and, since this is their core business, will invest more to refine their methodology over time. On the other hand, these services tend to simplify their data collection by relying on industry suppliers to provide accurate sales figures rather than going directly to a large customer base. Each supplier has a natural desire to maximize their reported sales / share and may include spares, service and upgrade revenue in their reported figures. This tends to overstate total demand and underestimate market share for those companies who accurately report sales.
As you can see, each method has limitations. The best approach is to understand and compensate for those limitations. Utilizing more than one technique is a very useful practice since it forces you to compare results achieved by different methods and understand the underlying assumptions and limitations of each method – ultimately resulting in both more accurate share numbers and a better understanding of market dynamics.
