Most startups grow from a great idea – or, at the very least, what seems like a great idea to the founders. But how many other people might be interested?
That’s an essential question to ask, because, after all, it helps to know how much growth potential is on the horizon for your startup. Total Addressable Market (TAM) is an excellent metric to look at when trying to gauge your startup’s growth potential.
What is total addressable market (TAM)?
The total amount of money you can make selling what you’re selling is called the total addressable market, also known as total available market, or TAM for short. Another way of thinking about it is the total amount of demand that exists in the market for your product or service.
Before entering a new industry, startup founders need to know what the total addressable market is – and how to calculate total addressable market for their product or service. Doing a thorough TAM analysis is a crucial step for any startup attempting to forecast revenue growth or gauge the profit potential of a specific industry.
If you run a monopoly, you will be able to capture the entire total addressable market. In that case, all of those who want the type of thing you’re selling will buy it from you since there’s no other choice. People will say things like, “Acme Sprockets has cornered the $30 billion sprocket market!”
Total addressable market vs. market share
Like most companies, it’s unlikely your startup will operate as a monopoly, which means you will be forced to share the total addressable market. If you gain even a single competitor, you’ll have to split the TAM. How much of the TAM you’re left with is called your market share. If you have a lot of competitors, you’re likely to have a small market share since you’ll be splitting the TAM into many small pieces.
Total addressable market vs. served available market (SAM)
When the total addressable market is split into many smaller pieces, different companies are each able to serve different segments of the entire TAM. Each of these individual segments are referred to as the served available market, also known as serviceable available market, or SAM for short.
SAM is the portion of the TAM that a given business is servicing. For example, let’s say your company sold bluetooth headphones in the United States. The total addressable market would be the worldwide headphones market, and your served available market would be limited to the bluetooth headphones market in the United States.
The served available market gives you a much better sense of how much revenue you can realistically bring in with your product, but the TAM is useful in indicating how much room there is for potential growth.
Total addressable market vs. serviceable obtainable market (SOM)
The serviceable obtainable market, or SOM for short, is the portion of the served available market you can realistically capture. Using the above example, your SOM is the portion of the bluetooth headphones market in the United States that you are able to capture, after taking into account all of your competitors who are also selling bluetooth headphones in the U.S.
SOM = % of SAM you can realistically obtain
How to calculate total addressable market
It can be difficult to calculate the total addressable market, especially if many of the competitors in the space are privately held and opaque about sales figures. There are three options for calculating TAM:
Top-down, which extrapolates the size of the TAM from industry research
Bottom-up, which uses data from your company’s early sales to estimate the market
Value theory, which estimates how your product’s value will affect buyers’ behavior
Let’s delve into these three options on how to calculate total addressable market.
Top-down TAM analysis
Top-down total addressable market calculations are often based on existing work by market-research firms, such as Gartner and Forrester. However, to draw specific conclusions about particular markets, the broader research these firms have done often must be supplemented or refined by extra assessments, such as phone or email surveys, completed by third-party consultants.
Using this strategy has various pitfalls, not the least of which is that potential investors may not find the numbers trustworthy. Can the research and the surveys be reliable when they may be based on not-entirely-transparent company info and self-reported data?
Using a “canned” TAM number also ignores the fact that the introduction of some products can change the TAM simply by entering the market. Ride-sharing companies, for example, expanded the TAM beyond the traditional taxi market, because non-taxi-users started seeking rides once they realized they could use an app to get picked up anywhere and avoid messing with loose change. Uber and Lyft increased the TAM, which made any calculations they might have done about the total addressable taxi-riding market obsolete.
Bottom-up TAM analysis
The bottom-up total addressable market strategy will give you more accurate numbers, in part by allowing you to include any salient factors — such as the growth of the TAM due to your entrance into the market — from the very start.
You calculate this number by extrapolating from your data on your current pricing and usage. Take that number and apply it to the larger customer base of your target market.
You can figure out your target market by researching the type of customers that you think will buy your products. For example, if you sell a B2B software solution that works best for mid-size firms with a certain number of employees, you can calculate the number of those firms in the appropriate sector, the number of employees they have on average, and the number of those who will be likely to use your software.
TAM = (Annual Contract Value) x (# of possible Accounts)
Let’s say your company sold a custom employee management software suitable for music production companies with 100 to 500 employees at a flat rate of $1,000 per year. If your annual contract value (ACV) is $1,000 and you determine there are 5,000 possible accounts (total number of music production companies with 100 to 500 employees), your total addressable market would be $5,000,000 ($1,000 x 5,000).
Doing this type of TAM analysis forces you to think carefully about product-market fit, so that the TAM figure you finally come up with is built on a solid sense of who exactly makes up that market. You can even break down your TAM into various industry segments, or geographic areas, to demonstrate the way you can approach different aspects of the market to win as much of the TAM as possible.
Value theory TAM analysis
The value theory method of calculating total addressable market relies much more on supposition and guesswork, so its conclusions tend to be a bit murkier, but still useful. To calculate TAM using value theory, estimate the value that your product provides to certain users and whether you can sufficiently capture that value through pricing.
This method of estimating is best for getting a sense of the TAM for new features or upgrades to existing products, or when you are bringing a novel product to market that will effectively create its own category. To use this approach, it’s important to think carefully about what customers find valuable and how much they may be willing to pay for that value. Next you need to estimate how many customers may find that amount of value in the product and choose it over alternatives.
Using total addressable market calculations
Figuring out your total addressable market is worthwhile in various ways beyond simply estimating the size of your opportunity. The process can also allow you to do a deep dive on the make-up of your market, so you can better segment and target its constituent parts. You can use this analysis as guidance as you market your product, and to gain a reliable sense of where to put the most effort – and where you can expect the most robust return.
A specific and well-thought-out TAM calculation is also the best way to convince potential investors of your startup that you understand the playing field and are prepared to market your products effectively.
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