You come up with a great business idea, so you are ready to go… right? Well, before you proceed, an equally important plan is to find out if there’s a market for it. Read this blog for the benefits of going through this process and get to know the concept of Total Addressable Market and how to use it to vet your business idea.
Definition of Total Addressable Market
As a company, your Total Addressable Market (TAM for short), is the number of people that can benefit from your product. It is an indication of whether you can satisfy your customers’ needs in a unique way. It is also an indication of whether you can go beyond being viewed as a luxury and be seen as a necessity instead.
Read on for multiple ways to calculate TAM and why you should do so in the first place.
Why total addressable market is important for business
The primary reason for identifying your Total Addressable Market is to uncover market opportunities. The better understanding you have of what’s available, the easier it is for you to pounce on straightforward chances.
1. A good TAM calculation can allow you to structure your sales and marketing efforts, starting with understanding the target market and leading to ultimately spotting the best opportunities for growth.
For example, this can happen by tailoring content to the specific audience within your niche. It could also help you conduct sales outreach to people who you could calculate or estimate would be more likely and willing to be converted as leads.
2. Investors, whether seed or venture, will always request to see your estimation of TAM before making a decision. There are two reasons for this:
a) for them to estimate their potential ROI;
b) for them to see your understanding of the business you're in and how realistic you are.
The figure will be an estimation but read on for the most accurate and simplest ways to estimate it.
How to calculate TAM
There are three common ways to calculate the Total Addressable Market:
- Value theory is one option. It is a speculation about buyer willingness or reluctance to make a purchase. For instance a software company trying to evaluate the value of their product on their own would estimate the value to customers of their software and use it to influence pricing. Value theory is used when a company is introducing new products into the market or selling related products (cross-selling).
- Top-down counts on industry research and reports. This approach would have you find trends that could be used to predict your future. You start with a large known segment of a target population at the top and narrow down to a smaller segment. To calculate it we can use the following example: if Sony finds through industry research that there are 1000 people in a market who prefer to use on-ear headphones and 40% of them didn’t own a pair, they would multiply 0.4 by 1000 and get 400. If 10% of those who are in the market for headphones only buy Bose headphones the 400 would be multiplied by 0.9 giving 360. This would then be multiplied by the 300 USD and give a Total Addressable Market of 108,000.
- Bottom-up multiplies total number of customers in a market by total annual revenue of each customer in the market. So if a dentist startup has market of 500 customers, where the customers have an annual revenue of 50,000 you would multiply 500 by 500,00 and get a TAM of 2,500,000.
One possibility for having an accurate TAM calculation is to combine two of the methods. Bottom-up and top-down both use statistics so you can easily use both and evaluate if you get the same results.
We’ve got more measurements for you, though.
How to estimate TAM (especially if you’re just getting started)
- When you are getting started, knowing your Total Addressable Market can help you understand if you are on the right track but also show others that your business idea is worth investing in. There’s a challenge though. It’s difficult to get your hands on market research, industry reports, or actual numbers on revenues per customer, especially if you’re just getting started and preparing your product. It may all seem overwhelming and you may not know who to look to for help.
So what do you do when you need to know your TAM and you have these limitations?
- A good way to frame your TAM estimation is to look at other similar companies (they sometimes have their pitch decks or similar presentations publicly available) these can teach you two things: what similar companies consider the relevant market as well as what numbers they came up with.
So borrow from them, get a rough idea and estimate your TAM.
TAM in the greater picture (+related terms)
TAM is often mentioned in connection with the related terms SAM and SOM. Before you get fed up and lost in abbreviations, we promise it will make sense in a bit. These concepts are important for understanding each other.
The SAM – Serviceable Available Market are those served by your product or service.
The SOM – Serviceable Obtainable Market is the portion of those that are realistic for you to get based on the following calculation. It is found by dividing your revenue from the previous year by your industry’s Serviceable Available Market from that year.
Once you choose one or several calculation methods, you can use your results to evaluate and make decisions. Along with the Serviceable Available Market and Serviceable Obtainable Market, you can make an informed choice on whether it is worth proceeding with your business idea. Or as will later be discussed, it can be used to try to secure further investment once your business is already established.
Common pitfalls (is there such a thing as a TAM Market?)
Where TAM can struggle is when that innovative new startup comes up with a game-changer that disrupts the market. On the other hand if you are the disruptor that say, comes up with a new software to communicate with your doctor, you will impact the Total Addressable Market for your competitors. People who come up with a similar idea afterwards will come across a more saturated market with a competitor already established.
Similarly, new technology can lead to market changes as we saw with the iPod that was a great product until the iPhone came around and delivered all the same things plus a phone.
A technical mistake is that the concept is sometimes referred to as a TAM Market, which literally means a Total Addressable Market… Market.
As the following example will highlight, sometimes companies set very lofty predictions of the size of their Total Addressable Markets, to secure more investment. “Does it work?” you might ask.
Market size examples
Two market size examples show the consequences of overstating TAM. Uber estimates its Total Addressable Market to be 12 trillion dollars including personal movement, food as well as shipping. This exorbitant figure would mean they had 15% of global economic activity.
They preface their claim by saying they are in the early stages of capturing this market. Readily available figures show Uber’s recent decline in growth, so this strategy of overselling could easily backfire.
Lyft competes with Uber as a driving service but not with food and shipping. Lyft presented a market size figure that included a 17% increase from 2017 to 2018. This controversial statistic was calculated by Lyft investors Rakuten and challenged by Uber the following year.
Unconventional ways to think of TAM
Technology now allows us to roughly estimate markets by looking at the competition. The simple idea is that if there is a market for a specific type of service, that market will be serviced eventually. Looking at the number of similar companies and their size in terms of traffic, number of employees, investment, and revenue allows you to grossly estimate if a specific niche or vertical is worth pursuing. Add in how that number has progressed over time and you can see if the market is growing and by how much.
At Ocean.io, our core capability is to understand the similarities between businesses. Using our search engine, you can see how saturated a market is and, by looking at all of the details that we provide along with a bit of your own research, you can get a rough idea of what your Total Addressable Market would be.
Ideally, you would want to identify a market space that is growing, has investment and traffic/social media traction because this would indicate that people are interested in it. The market being a growing one would also indicate that is not yet saturated by a lot of late-stage funded companies.
Adding it all up
To sum up, figuring out the Total Addressable Market and making realistic calculations will serve your business well. For example, it can be calculated in a bottom up and top down combination that will boost accuracy. If the numbers seem too overwhelming, you can simply look at what your competitors have done so you can get a head start.
When you pick a method, you can estimate the market for your business while appealing to investors who will ask you for your TAM figures.