Whether starting a new business or trying to grow an established one, you need to understand and appreciate the overall opportunity available to you if you can achieve 100% market share.
You can do this by understanding your total addressable market (TAM).
What is Total Addressable Market (TAM)?
The total addressable market (TAM), sometimes called the total reachable market, is the total demand for a product or service and the revenue potential you could achieve if you got 100% market share.
TAM helps you calculate and predict the realistic profitability of a business line or product and service once it reaches the market. It also helps to set tangible and measurable business goals.
It is critical that every business owner and marketer understand TAM and how to calculate it.
Over the past few decades, the crowdspring team has launched multiple businesses and mentored, coached, and helped thousands of entrepreneurs launch their businesses. In each case, it was important to measure and evaluate the total addressable market in order to create a solid business plan when starting the business. This comprehensive guide shares our understanding of TAM.
The definitive guide to TAM
Why is TAM important?
Calculating your TAM is critical to estimating the potential scale of your target market in terms of sales and revenue. It helps break down the numbers into manageable levels, especially for startups and small companies.
You must be objective in assessing the available market for your product or service. Staying objective helps you avoid producing products or services that are not marketable or in demand.
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Difference between TAM, SOM and SAM
Total addressable market (TAM), serviceable market (SOM), and serviceable market (SAM) are related concepts, but each serves different purposes.
TAM is revenue or sales demand for a product or service.
Serviceable Market (SAM) helps you estimate how many customers your business can reach with your marketing and sales efforts.
Serviceable Market (SOM) refers to the percentage of Serviceable Market (SAM) that businesses can realistically reach.
Think of these three market subsets as interrelated concepts, with TAM summarizing the bigger picture, helping businesses know if a market is worth entering. Whereas SAM and SOM are smaller parts with specific purposes.
How to calculate your total addressable market
Calculating your business’s TAM allows you to estimate the amount of funding and effort that should be invested in specific products or services, business opportunities, and more. It’s vital to your budget and overall business health.
There are three ways to calculate the total addressable market:
1. From top to bottom
The top-down approach requires professional data such as industry data, market reports and research to help identify the TAM. It uses a significant known population size to narrow down a specific market segment.
You can get industry data from companies like Gartner, Forrester, and IDC, which offer comprehensive research and industry reports that typically include statistics, revenue opportunities, and more to help you decide whether is the market viable for your business?
However, industry groups are not always up-to-date and may not necessarily reflect the specifics of your target market. And those reports are expensive. If you want to get detailed information about a specific market you want to be involved in, hiring a market research consulting firm or an independent consultant is one of the best ways to do the research that suits your needs. This is also expensive, but will save you time and help you focus on the best opportunities.
2. Bottom up
Bottom-up analysis is based on existing data, such as past sales and pricing data.
To calculate TAM using a bottom-up approach, follow the formula: Multiply your total number of customers by your annual contract value (ACV).
To find your ACV, you need to multiply the number of your current customers by your average sales price.
For example, you are a cosmetics brand that sells a tube of lipstick for $20, and you sell 15,000 tubes a year. You multiply $20 by multiplying by 15,000 to get an ACV of $300,000. Finally, you consider how many cosmetic brands are in your competitive market. Suppose there are 200 competing brands of cosmetics. Assuming each brand has roughly equal market share, multiply 200 by $300,000 to get a TAM of $60,000,000.
Some businesses find the bottom-up approach more accurate than other analyzes because it is based on a proven data point and can be scaled up to identify the entire TAM population. But this approach is difficult for new businesses that are just starting out and have no customers.
3. Theory of value
The value theory approach is based on how much value your customers can get from your products or services and how much they are willing to pay for it in the future.
For example, let’s say you’re a phone case brand and you’ve added a unique piece of patented technology that helps your phone cases stand out from your competitors. Then you can identify your value theory by estimating how much customers will pay for your product.
Let’s say it costs you $10 to make a phone case with your patented technology. How much can consumers pay for your business? Are customers willing to pay $30 or $40 for your unique phone case?
Use value theory analysis to calculate your TAM and determine whether you should enter a particular market. Find the right balance between a market that is too small or a market size that is too saturated to help your business grow.
Questions to ask when determining your TAM
Asking the right questions can help you better understand your TAM and use it in your business strategy.
1. What is the total market size?
This is the most important question you should ask when defining your TAM. Knowing the overall size of the market helps you set your expectations for entering the market and lets you know how large your potential customer base might be.
For example, an industry with a market size of $30-$200 million per year is generally a great industry to enter as there is always room for business growth. Meanwhile, the market below $5 million is considered too limited, while above $1 billion is usually considered too competitive.
2. Who is your target market?
Understanding your target market is important when determining your TAM. You need to know what type of customers you want to target to help you figure out which part of the market you should focus your efforts on. This gives you a better understanding of who your potential customers will be and start thinking about ways to approach and market to them.
3. What is the growth rate of your target market?
Research and analyze the growth rate of the market you want to enter. You need to know how fast the market is growing to determine if there is room for business growth and opportunities.
4. What makes your product or service different and valuable to your target customers?
Your product or service must be the answer to people’s needs. Ask yourself, what needs can my product or service solve? How does it add to people’s lives? Understanding the strengths of your business can help you narrow down your target market, strengthen the pillars of your brand, and understand your potential customers.
5. Who are the potential competitors for my product or service?
Find out if there are alternatives to your product or service. Remember that you are looking for a market with growth potential, especially as a startup. Evaluate your competition and analyze whether it is worth entering the market.
The risks of not performing a TAM analysis
If you’re considering abandoning TAM analysis before entering a new market, consider how these risks could hurt your business in the long run.
1. Missed opportunities for growth. Conducting a TAM analysis can help you assess a market’s strengths and weaknesses. By calculating the TAM of a particular market, you can predict the severity of the risks and the kind of rewards you can get when you enter it.
2. Poor time and resources. Knowing your TAM can help you see the overall size of the market and make better informed decisions about your funding and efforts. You can make better estimates of how to allocate resources when you know what you’re dealing with, rather than diving headfirst into an unknown market that could hurt your business.
3. Set unrealistic goals. Not knowing the size of the market and the risks involved can cause you to overestimate your decisions. You can overspend or lose profits without calculating your TAM and setting aside adequate resources to help you achieve realistic goals.
4. Make wrong decisions. Without knowing your TAM, you can make bad decisions that don’t align with your goal and end up overspending your allocated budget or entering an oversaturated market that won’t help you make a profit.
5. Unable to find product and market match. TAM analysis can help you create better estimates of potential profits for a particular market, as well as help you gain insight into potential customers. If you neglect to calculate your TAM, you may struggle to find the right product market for your products and services.
There is no such thing as over-training when running a business. You need all the information and insights you can get to help your business grow and avoid wasting unnecessary resources.
So spend some time researching and analyzing your overall target market to increase your chances of success and help equip your business with the right tools to meet the challenges ahead.
