#2 Understanding Estimation or Guestimates Questions
Estimation or Guesstimate Questions
Estimation questions are a common part of PM interviews. They test your analytical thinking, problem-solving skills, and ability to work with numbers. In this first email, we’ll cover how to approach these questions with a structured framework and provide a practical example to illustrate the process. If you missed the first one please click here
Framework for Estimation Questions
Here's a step-by-step framework to tackle estimation questions:
Clarify the Problem: Understand the question thoroughly. Ask clarifying questions to ensure you grasp all aspects of the problem.
Choose an Approach: Decide between a top-down or bottom-up approach based on the context.
Break Down the Problem: Divide the problem into smaller, manageable parts to make the estimation process more systematic.
Make Assumptions: Clearly state your assumptions. These should be reasonable and based on common knowledge or simple logic.
Perform Calculations: Use basic arithmetic to combine your assumptions and breakdowns to reach an estimate.
Validate and Reflect: Check if your answer makes sense. Validate your assumptions and calculations, and reflect on any potential improvements.
There are primarily 2 types of approaches for this: top-down and bottom-up. The top-down approach solves most of the cases.
Top-Down Approach: Start with a broad estimate and break it down into smaller components. Use this approach when you have a good sense of the overall size but need to refine details.
Bottom-Up Approach: Start with detailed components and build up to the total estimate. Use this approach when you have detailed information on specific elements but not on the overall size.
You will also need to understand the current outlook for population, gender split, percentage split of the population of tier 1, 2, and 3 cities, internet adoption, etc.
Example: Estimating the Number of Demat Accounts in India
Let’s go through a detailed example using our framework. We’ll estimate the number of Demat accounts (a type of account that holds securities and shares in electronic form) in India.
Step 1: Clarify the Problem
Start by understanding the scope of the question. Here are some clarifying questions you might ask:
Are we considering only active demat accounts or the total no of accounts created?
Are we including both retail and institutional accounts?
For our purposes, let’s assume we’re looking for an estimate of the number of active Demat accounts currently in use by retail investors.
Step 2: Choose an Approach
In this case, we’ll use a top-down approach, starting from the total population and narrowing it down based on relevant factors.
Step 3: Break Down the Problem
We need to break the problem into smaller parts:
Total population of India
Percentage of the population that is financially active
Age group that typically holds Demat accounts
Percentage of the financially active population that has a Demat account
Step 4: Make Assumptions
Based on available data and common knowledge, we can make the following assumptions:
The population of India is approximately 1.4 billion (1,400 million).
About 60% of the population is between the ages of 15 and 64, which is typically the financially active age group.
Around 70% of this age group is financially literate or active.
Of the financially active population, about 25% of individuals hold Demat accounts.
Average Number of Demat Accounts per Investor: Assume 1.2 accounts per investor (some investors may have more than one account).
Step 5: Perform Calculations
Let’s perform the calculations step-by-step:
Total population of India: 1.4 billion
Financially active age group: 60% of 1.4 billion = 0.60 * 1,400 million ~ 800 million
Financially active individuals: 70% of 800 million = 0.70 * 800 million ~ 550 million
Individuals with Demat accounts: 25% of 550 million = 0.25 * 550 million = 125 million
No of Demat account per individual: 1.2 x 125 million = 150 million
So, our estimate is that there are approximately 150 million Demat accounts in India.
Step 6: Validate and Reflect
Are the assumptions reasonable? Adjust if necessary (e.g., different percentage of investing age population, different average number of accounts).
Does the final estimate make sense? Compare with any known figures if available.
Now, let’s validate our estimate. Does 150 million demat accounts make sense? Considering recent growth in stock market participation and looking at some of the numbers of stock brokerage platforms, it does make sense.
Mastering estimation questions is all about being systematic, making logical assumptions, and validating your answers. By using the framework we’ve discussed, you can approach any estimation question with confidence.
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