Launching a new startup requires a lot of effort, time, and money. Imagine starting your business and putting in all the needed hard work only to realize later that the market size is too small and that the possible revenue opportunity is not significant enough. This is one of the reasons why calculating the total addressable market (TAM) should be one of the first steps you take as an entrepreneur when starting your business.
What is TAM?
The Total Addressable Market, also referred to sometimes as the total available market, is the overall revenue opportunity or total market demand available for a product or a service if 100% of the market share is attained.
However, no company can probably achieve that; therefore, we can conclude that your TAM will include your market share, your competitors’ market share, and the potential customers who choose not to use or purchase your product or your competitors’ product.
It’s also important to specify what TAM is not. TAM is not the size of the problem you’re trying to solve and it's not the size of the whole market. It's just the size of your market.
Let’s consider that you own a cyber security company that targets small enterprises. After doing your research, you realize that the size of the cybercrime problem is estimated at 6 trillion USD annually and that the global cyber security market is valued at 140 billion USD; this doesn’t mean that your TAM is 6 trillion USD or even 140 billion USD.
Why is TAM important?
Not only is TAM important to determine the opportunity size of your product or service, but it can also help you estimate your revenue and growth possibilities.
It will give you an idea of what type of company you should build. For example, if your TAM is 10 billion USD, you might want to raise a lot of funds as there’s a big growth opportunity for your startup. On the other hand, if your TAM is only 10 million USD, you shouldn’t spend or raise a large amount of money or hire a big team as the revenue opportunity is not big enough.
Equally, TAM is an important metric for investors, it will let them know that the market is big enough and that they can get a good return on their investment. Most investors tend to check the TAM metric to compare the opportunity size to other investment opportunities they may be considering. A venture with a low TAM will not be attractive to them.
How to calculate the Total Addressable Market (TAM)?
There are two ways to calculate your TAM: the top-down approach and the bottom-up approach.
1- Top-down approach
The top-down approach follows a process of elimination where you start by taking a large market size and narrowing it down to a specific market segment. You can use industry research and reports from third parties and market-research firms to get your numbers.
You own an online sports shoe e-commerce business in the US. After doing your research, you realize that the global sports shoe market size is estimated at 80 billion USD and that 20% of all shoe sales are in the US which is equivalent to 16 billion USD. Not all sales take place online; in fact, only 25% of all sales occur online which corresponds to 4 billion USD. You can conclude that your TAM is equal to 80 * 0.2 * 0.25 = 4 billion USD.
2- Bottom-up approach (price-based approach)
The bottom-up total addressable market strategy will give you more accurate numbers than the top-down approach because it uses your numbers. It takes the number of your total potential customers and multiplies it by the annual price of your product or service.
TAM = Price * Total Potential Customers
Your price can be your product price or annual average revenue per user, and you should always use your price and not your competitors’ prices. You should specify the unit as well at all times, for example, your price is 4,000$/year/store.
In order to calculate the right number of total potential customers, think rigorously about your target customers and your targeted geography.
You own a cyber security company that offers a SAAS solution targeting small to medium-sized banks in the MENA region. You charge 4,000$ per bank branch per year. Let’s consider that after doing some research, you estimated that there are 5,000 small to medium-sized banks in the targeted geographic area and that there is an average of 4 branches per bank. You calculate your TAM by multiplying the price by the total number of branches:
Your TAM = 5,000 * 4 * 4,000 USD / year = 80,000,000 USD
TAM vs SAM vs SOM
Calculating your TAM is not enough to give you the realistic size of your market. You should also take into consideration your serviceable available market (SAM) and your serviceable obtainable market (SOM).
Your serviceable available market is the portion of TAM that is targeted by your product. It is calculated by taking certain constraints into consideration like your competition that already has a portion of the market or markets that you are unable to service due to distribution obstacles.
Your serviceable obtainable market is the portion of SAM that can be realistically attained. It’s your short-term target market that you are able to reach with your current resources.
Since markets shrink and grow, your prices might change, or even the products or the services that you’re offering might differ over time, it’s important to keep revisiting and recalculating your TAM regularly.