Are you curious about how big your market is? Look no further than the Total Addressable Market, or TAM.
Understanding your TAM is crucial for any business looking to expand or launch new products and services - it defines your playground size.
So let's dive into what TAM is, how to calculate it, and how you can use it to inform strategic decisions and have a better understanding of your market.
Total Addressable Market (TAM) is the total revenue available for a product or service if you were to capture 100% of the market.
One way to think of TAM is as a guardrail. It gives you a reasonable estimate of the size of a revenue opportunity while keeping you from venturing anywhere no reasonable opportunity exists.
In other terms, it can help you assess the potential of your market. Without any sense of what your TAM is, you might be at risk of investing too many resources in pursuing a market too small.
TAM can be employed by both startups and established businesses. Whether launching an entire new product or just a feature, it helps companies and investors create a viable value proposition by estimating the size of the market, the level of competition, and any untapped market segment.
But TAM isn’t the only way to measure the market. You can get even more specific by subdividing it further.
While TAM represents the entire growth potential for your company, the Serviceable Available Market (SAM) is a more realistic measure of what revenue level you can reach.
SAM refers to the segment of the total market you are serving. This serviceable area can be defined by your particular geography, your business model, or your specialization.
For example, say you sell bicycles. Your TAM would be the worldwide bicycle market. But since you are unlikely to have bicycle shops in every country, your SAM would be limited to just the United States market. Or, if you are a one-person shop, your SAM might be even further limited to the city or town you’re located in.
SAM is useful since it gives you an objective estimate of the market share you can potentially acquire. This, in turn, can help you determine your targets.
Unless you have high demand and no competition, even the most robust businesses are unlikely to capture all of their SAM.
This is where the Serviceable Obtainable Market (SOM) comes in.
By taking into account your competition, SOM measures the portion of the SAM that you can realistically capture.
Using the bicycle example again, if your SAM is the entire U.S. market, then your SOM will be whatever portion is leftover after considering the market share of your competition. Or, if your SAM is limited to just your city, then your SOM might be the neighborhood you service.
Figuring out your TAM can be difficult since it depends on many different variables, such as the size of your industry, how much information you can get from competitors, market research, or even how your market can be defined. Because of this, there are several ways of calculating it. Let’s look at the two most widely used methods.
The top-down approach starts with a wide view of the size of the market or industry, then uses factors such as geography and demographics to narrow this down. The end result is your TAM.
Typically, you begin by looking at industry data, market reports, and other studies. These may include your own research or secondary market sources, such as Gartner and Forrester. The goal is to use informed analysis to determine how many total customers meet your market criteria. Because it starts with such a big picture, this approach is usually represented by an inverted pyramid: the top is the total number of people or businesses, while the bottom is your target market.
This approach works best for companies operating in clearly defined segments or industries with a wealth of marketing data. However, this way of calculating your TAM carries a high risk of overestimating it.
VCs don’t like this approach as it is 100% reliant on 3rd party research with little information on how the data was collected.
“This is by far my least favorite way to frame a TAM discussion. It contains remarkably little information, and relies on my faith in the analysts at Gartner. They’re smart people, but market sizing is hard and often reliant on self-reported data or difficult-to-make estimates about the revenue of private companies.” - Jared Sleeper, VC at Matrix Partners
Instead of starting with a wide view, the bottom-up approach begins by focusing on a company’s previous sales and pricing data. From there, it extrapolates outward until you arrive at your TAM. This can be expressed by the following formula:
Annual Revenue Per User (ARPU) x Total Potential # of Clients = TAM
For example, say your customers purchase, on average, $100 of bicycle products a year. You live in a town with 10,000 people, 90% of whom can ride a bike. This means you have 9,000 total potential customers, which would give you a TAM of $900,000.
Because it is based on primary market data, rather than third-party research, the bottom-up approach is often considered a more reliable method. However, using this approach to come up with a valuable TAM requires you to think carefully about how your product or service fits within the market so that you can base your calculations on as accurate a segment as possible.
Done well, the bottom-up method can give you a precise number you can use to set goals and grow your business.
Whether you are a startup just entering the market or a large enterprise considering a new product, TAM is an essential metric that can help you plan for the future and develop a more strategic plan for success. Here’s why.
Most broadly speaking, TAM is important mainly because it gives you a good idea of what you can achieve – information that any business will want to know before creating a new product or entering a new market.
By taking the time to calculate TAM first, you may discover that the market isn’t nearly as large as you first thought it was. Or you may learn that a different and even more lucrative opportunity exists elsewhere.
TAM is also important when raising capital.
It gives them a metric to compare against other investment opportunities
Many VCs will look for a TAM of at least $1B before even reading your pitch
From an investor's perspective, a company that can show proof it has a high revenue potential will be a much safer wager than one that cannot.
More specifically, the process of calculating your TAM can also give you a much more nuanced view into your market. By taking the time to pick apart your potential opportunities, you may be able to more strategically segment and target your customers.
What you first thought was just a single, monolithic customer base may turn out to be a number of separate segments, each with their own unique needs.
Knowing this can inform how you market your product and where you choose to make the most investment. Even in a crowded marketplace, having this level of information can help you uncover underserved market segments and make better strategic decisions.