Total Addressable Market (TAM)
Most businesses grow from a great idea. But for an idea to be truly great, you need to know how many customers might actually be interested in it — and this is where Total Addressable Market comes in.
Total Addressable Market (TAM)
Total Addressable Market is a valuable metric that helps you gauge growth potential for start-ups and existing businesses alike. In this entry, you will learn more about the total addressable market, what it is, and how the TAM is calculated.
What Is Total Addressable Market (TAM)?
Total Addressable Market (TAM) — also referred to as “total available market” — is a calculation which represents the overall revenue opportunity that exists for a product or service. TAM helps determine the level of effort and funding which you should put into a new business line. You could also think of this as the total demand that exists in the market for your product or service.
TAM is one of the most important metrics for start-ups and existing businesses alike. It allows you to prioritize specific products and services, customer segments, and business opportunities. For example, when a business is in the process of releasing a new product or planning to cross-sell an existing product to existing customers, TAM helps break these numbers down into manageable proportions.
Total Addressable Market can also be used to provide a viable value proposition where there are potential investors and buyers of the business. This involves estimating the sizes of the following:
- Overall investment,
- Expected growth, and
- The available market.
For example, a private equity firm intending to purchase a start-up company can use TAM to estimate the potential revenue which products or services offered by the company might generate.
TAM is particularly useful because it also takes into account the products and customer segments which the start-up has yet to tap into. This enables the private equity to determine the actual size of the market as well as the current competition for the products which the start-up offers.
Market Share and Market Subsets
Most companies are unlikely to operate as monopolies. You’ll likely be sharing the total addressable market, as gaining just one competitor means that you’ll have to split the TAM. The percentage of the TAM you’re left with is your market share.
The more competitors you have, the more pieces you’ll be splitting the TAM into — and the smaller your market share will be. Once the TAM is split into smaller pieces, different companies will be able to serve different segments of the market. This creates market subsets represented as follows:
- TAM: Total Addressable Market — the total demand for a product or service calculated in annual revenue.
- SAM: Serviceable Available Market — the target addressable market served by a company’s products or services.
- SOM: Serviceable Obtainable Market — the percentage of SAM which can realistically be obtained.
How do you Claculate TAM?
When it comes to calculating the total addressable market, there are three methods you can use:
- Top Down
- Bottom Up
- Value Theory
Method #1: Top-Down Analysis
The top-down approach follows a process of elimination. Taking a large population of a known size comprising the target market, you can use this to narrow down specific market segments of customers that are unified by characteristics of using a certain product or service.
Top-down TAM analysis can be represented by an inverted pyramid: the large population of a known segment is represented by the top, and the narrowed-down segment by the bottom. The top-down approach uses industry research and reports to estimate the size of your addressable market.
There are certain pitfalls associated with top-down TAM analysis. For example, potential investors may not find the numbers trustworthy, as they are based on research, surveys, and self-reported data that may not be fully transparent.
Method #2: Bottom-Up Analysis
More reliable than the top-down method, the bottom-up approach uses primary market research to calculate TAM estimates. It gives you more accurate numbers, in part by allowing you to include important factors, such as the growth of the TAM due to your company entering the market, from the beginning.
The bottom-up total addressable market calculation is done by extrapolating from your data on your current pricing and usage of products. This method allows you to explain why you chose certain customer segments over others. It also forces you to think carefully about product-market fit, ensuring that your final TAM figure is built on a solid understanding of who exactly makes up that market.
This analysis method also enables you to break down your TAM into various industry segments or geographic areas, demonstrating how you can approach different aspects of your market to win as much of the TAM as possible.
Method #3: Value Theory
The value theory approach to calculating the total addressable market relies more on supposition and guesswork than the top-down and bottom-up methods. Even so, value theory can still provide you with useful insights.
Value theory TAM analysis relies on an estimate of the value which your product provides to your customers, and how much of that value can be captured in the pricing of your product. This estimation method is particularly useful for getting a sense of the TAM for new features or upgrades to existing products. It can also be used when you’re bringing a new product to market that will create its own category.
To use the value theory method, you need to think carefully about what customers find valuable and how much they may be willing to pay for that value. You also need to estimate how many customers may find that the product you offer provides the amount of value necessary for them to choose your product over alternatives.
Whether you’re releasing a new product, creating new sales goals, or looking for funding, taking the time to understand your TAM can provide you with insights valuable to start-ups and existing businesses alike.
Going beyond the revenue number or the calculation of accounts, you’ll gain a deeper understanding of those accounts. Not only will your well-defined total market size calculation result in greater sales success — it’ll also give you a strong starting point for your account-based marketing strategy.
Your sales and marketing teams will be able to target only best fit accounts, improving your customer retention and increasing your renewal rates. This way, the value you gain from TAM resonates throughout your sales cycle.