As we understood in Part 1 of this series (https://www.finnacleshahclasses.com/forum/business-analysis-series/blog-108-masterclass-series-on-forecasting-industry-size-part-1) that
a) Low Penetration ratio
b) Low per capita consumption (from here on referred as PCC)
c) Low Organized Market Share and
d) Low Industry Size to GDP %
communicates a potential for the industry/company to grow in the future.
Let's look at some of the current penetration levels, Organized Vs Unorganized Market, Industry as a % of GDP etc. of some product categories in India
These data point were presented in a brilliant presentation by Oaklane Capital's Fund Manager Mr. Kuntal Shah.
A catch here is just seeing low penetration level or low PCC or low organized share should not excite you. You need to answer a lot of questions before you can come to any conclusion about the future. (Please read our part 3 of this series for the same)
For now let's understand the math step by step on how to forecast future industry size (5/7/10) years down the line using above parameters:
This is how the basic template looks
Let's understand step by step how these calculations are performed:
Step 1: You start with collecting all the historical data relevant to your industry like what we have done here: Population, Target Market %, Possible qty per person, Price/Unit, Qty sold this year, Organized market (Rs) & Unorganized market (Rs)
Step 2: Few Historical numbers needs to be calculated like
a) Target Market (in person/ in Quantity) = Population * (1 -% of population not in target market)
b) Target Quantity = Target Market * Possible qty per quantity
c) Target market (Rs) = Target Quantity * Price per unit
d) Current Industry Size = Qty sold this year * Price Per Unit
e) Penetration Levels = Industry Size / target Market (Rs) or Qty sold/target Market (qty)
f) Per capita consumption = Qty sold/target Market (in person/in quantity)
g) Organized Market = Organized Industry/Current Industry Size
h) Unorganized Market = 1 - Organized Market
Step 3: You need to build estimates for few parameters (for a few years into future like we have done for 5 years in above example) like in our example above of various parameters like for Target Quantity -> population growth rates, Trend of Diabetic population, Consumer Behavior Evolution and for Expected Industry Size -> Future penetration levels, Price per unit, organized market.
Step 4: Now calculation till Target Market (in Rs) are straightforward
a) Expected Population = Current Population * (1+population growth rate)^5
b) Expected Target Market (in person/in quantity) = Expected Population * ( 1 - Expected % of population not in target market)
c) Expected Target Quantity = Expected target Market * Expected possible quantity per person
d) Expected Price = Current Price per Unit * (1 + growth in price)^5
e) Expected Target Market (in Rs) = Expected Target quantity * Expected price per unit
f) Now here's the first change in expected Vs historical method. In order to get
Expected Qty sold = Expected Penetration level (an assumption) * Target Quantity
g) Expected Industry Size = Expected Qty sold * Expected Price level
h) Now you get the expected Industry growth rate = ((Expected Industry Size/Current Industry Size) ^(1/5) - 1) * 100
I) Now to get organized Industry Size = Expected Organized Market Share * Expected Industry Size
and finally
J) Organized Industry CAGR = ((Expected Organized Market Size/Current organized market Size) ^(1/5) - 1 ) * 100
Note: Please find our excel sheet attached where you can see the actual calculations and applied formulas
In above calculations very casually we assumed two very important variables - The future penetration level and The future share of organized market.
In reality a lot of thought process around presence of some catalyst or understanding of megatrends is required to come to such conclusions. PLEASE read part 3 of this series to understand factors that helps in framing such conclusions of the same here - https://www.finnacleshahclasses.com/forum/business-analysis-series/blog-110-masterclass-on-forecasting-industry-size-part-3-final-part
Some Mandatory Reading: