Start-ups take birth from what seems like an excellent idea – at least the founders think so. But is that what your target customers think of your product? Well, this is an especially important question that you need to ponder. The answer to this question helps you devise the next steps that you should be taking to climb up the start-up ladder.
But how do you get the answer to the question – by understanding and analyzing the Total Addressable Market (TAM).
This article will discuss all you need to know about the Total Addressable Market (TAM), including the formula and the examples.
What is the Total Addressable Market (TAM)?
In the simplest terms, the Total Addressable Market (TAM) refers to “the total demand for a product or a service across all market segments, potential substitutes, and distribution channels.
Another way of defining it is to say that “TAM is the total demand that a supplier would be able to meet if they were the only supplier of the product or service with zero options.
The Total Addressable Market (TAM) is an important metric to gauge when trying to enter a new industry, especially for B2B start-ups. The start-up founders need to know what TAM is and what the formula to calculate it is for their offering. This understanding and calculation help the start-up founder forecast the revenue growth and the profit potential.
Additionally, the Total Addressable Market is extremely useful for B2B SaaS sales companies. B2B SaaS companies have exceptionally long sales cycles. At the same time, the deal sizes are long too.
Considering this, the SaaS organization can benefit heavily from knowing the potential customers and the market size to focus on. In addition to this, the investors will also evaluate your TAM calculations to access your market understanding and your product’s placement.
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Benefits of Calculating TAM
There are several benefits that an organization can have by calculating and analyzing TAM. They include –
- Identifying new opportunities to earn revenue
- It helps calculate the potential revenue accurately
- Helps find investors
- Assists in planning market outreach
- Generate more B2B leads
- in setting achievable goals
- Gives you necessary input about the competitors
Total Addressable Market (TAM) vs. Other Measures
Start-up founders often confuse the Total Addressable Market with the concepts like market share and served available market (SAM) and serviceable obtainable market (SOM).
Total Addressable Market (TAM) vs. Market Share
While a few start-ups enjoy monopoly in the market/industry, monopoly is often a rarity. So when you have competitors in the market that you are addressing, you will have to share your TAM with the competitor. And the TAM that you are left with would be your market share.
Start-ups with a lot of competitors will have to split their TAM with all of them and thus have a smaller market share.
Total Addressable Market (TAM) vs. Served Available Market (SAM)
While TAM refers to the total market for your product or service, the Served Available Market (SAM) is a narrower measure. In simple words, SAM refers to the precise target market for your product or service. When comparing it with TAM, SAM can be defined as the part of the total addressable market offered to a business for serving the market.
For instance, in case you run an electric toothbrush company in the US, your Total Addressable Market (TAM) would be the global electronic toothbrush market. At the same time, your Served Available Market (SAM), which is more precise, will be the electronic toothbrush market in the United States.
Businesses should be evaluating the Served Available Market (SAM) to better understand the total revenue their offering could bring in. At the same time, TAM helps to identify the potential scope for growth.
Total Addressable Market vs. Serviceable Obtainable Market (SOM)
The term “Serviceable Obtainable Market” describes the client base from which you could legitimately expect to generate sales. While you could identify the target market as a Served Addressable Market (SAM), the Serviceable Obtainable Market (SOM) is only a portion of the SAM.
For instance, if you are a business offering digital advertising services in the US, your SOM would be part of the portion of the digital advertising services market in the US that you manage to capture. This will be after taking your resources and your competitors in the US market into account.
As a start-up, you might not be able to penetrate the entire market. In such cases, you can focus on the Serviceable Obtainable Market (SOM) as a short-term goal. Your SOM will also serve as an interesting measure for investors to gauge your potential to progress and grow.
All three measures are especially important when measuring your potential to grow and earn profits. Coming back to TAM, there are a few questions to ask yourself when defining TAM
Questions to ask yourself when defining TAM
Having the answers to the following questions comes in handy when trying to define TAM –
- What are the industries that you will be selling in?
- Do you have an understanding of the characteristics of your current customers?
- Do you have an understanding of the characteristics of your potential customers?
- Where are your competitors located?
- What size are your competitors?
- How is the market growing?
- What markets can you expect to grow in?
When trying to analyze all the companies you have to share your TAM with, it is advised that you use your B2B database and filter the competitors based on the company size and location, and industry of operation. This filtering will also help you prioritize what should be focused on first.
Calculating your TAM
Total addressable market can be computed using three methods:
- The top-down approach
- The bottom-up approach
- The value theory
The top-down approach
The top-down approach to calculating TAM involves considering the existing research data. The method involves taking data from leading market research companies such as Gartner and Forrester and applying industry-specific filters (like geographic and demographic filters) to get a market subset.
It is often considered the quickest and easiest way of calculating TAM. However, it is also associated with several pitfalls. The first major pitfall is the reliability of the information – there could always be the chance that companies or industries may have self-reported data. At the same time, the approach does not account for disruptive products (for example, Uber), that create brand new markets.
The bottom-up approach
The next approach is the bottom-up approach. This is not only the reverse of the top-down approach but is also considered more reliable. When using the bottom-up approach to calculate the TAM, you should start with a smaller market segment and extend from there to get the entire population of purchasers to perform a bottom-up TAM analysis. The bottom-up calculations are calculated in the form of revenue.
Bottom-up TAM, as opposed to top-down TAM, is based on your original research (primary research). The bottom-up approach is best suited for B2B companies. However, since it involves a primary approach and goes from a small subset to an extended one, it is time-consuming.
The value theory approach
The value theory approach analyzes a customer’s willingness to pay for an offering based on the perceived value. You then multiply this by the overall number of customers that share your value perception and would be willing to accept your solution over the alternative.
Total Addressable Market (TAM) = Potential Market Size x Company/product’s Competitive Position
Potential Market Size = The number of potential customers in the market
Competitive Position = The share that your company will get from the total number of possible customers.
Examples of TAM
TAM for a Smartphone company
If you are a smartphone company operating in the United States, your TAM would be –
TAM = The number of people who use smartphones, which could roughly be 80% of the population in the US.
Now, imagine that you have four competitors in the market, and all four of you have an equal market share; then, you can reach out to 20% of the customers with your product.
TAM for a B2B SaaS company
If you are a SaaS company offering cloud services to other SaaS businesses, the Total Available Market would include all service providers offering Cloud services and their alternatives.
Conclusion
On a closing note, it can be said that the Total Addressable Market (TAM) is particularly important for businesses, especially for start-ups, as it helps them understand their growth potential. At the same time, it also gives a fair idea of the product’s capability and its expansion as well as the geographic expansion.
We have provided all the details that you need about TAM and how to calculate it. Now, it is your turn to calculate it and develop growth ideas.
Rohan has over 11 years of experience in client services, marketing and hospitality field. Previously, he was head of digital marketing for a hi-tech mobile application. Rohan is driven by new challenges and the possibility of making an impact on individuals and businesses.
Published September 05, 2022, Updated September 05, 2022
