Total addressable market (TAM), sometimes also referred as the total available market is a type of market sizing that helps companies to accurately define their holistic revenue opportunity provided from its product, service, or solution. Calculating TAM is an exercise that puts light on the level of effort and funding to be added into a new business line, as it offers critical guidelines about the largesse of its total economic potential.
In the current market, TAM has turned into a very important metric and a highly creative way of calculating TAM has surfaced because of the increased speed by which the new markets are evolving. The understanding of Moore’s Law (by Gordon Moore, co-founder of Intel) is reducing technological advancement cycles and adding uncertainty about the quick coalescence of the markets. For this, a thorough understanding of TAM enables business leaders to be more aware of the blurred lines between their markets.
The benefits of a thorough TAM understanding
The importance of a TAM exercise is mostly to thoroughly understand the total growth opportunity, but at the same time it also provides many secondary benefits;
- Provides a current waypoint for assessing product-market fit.
- Puts your competitors within a clear line of sight early on.
- Focuses business leaders on their product evolution and future roadmap.
- Attracts and appeases investors by showing accuracy and conviction.
Back in 2015, a debate started between investor Bill Gurley and NYU professor over a valuation that the former attached to the latter’s investment in Uber. Such low valuation that Bill Gurley was questioning came from Aswath Damodaran while calculating a TAM in which he assumed that Uber was only a taxi/limo service. Bill Gurley’s retort was that Uber was addressing a much larger market; as it was a transportation business.
This example of Uber shed light on the ambition many organization has when they are trying to tackle a market. Initially, under the context of people logistics, Uber’s MVP and their initial offering were just within cabs, which is a very small subset of the transportation services market. Later, the subsequent introduction of services by Uber, like Eats, Pool, X, and rush has demonstrated their desire to target a wider reach of the market and it also validated Gurley’s thesis. The Uber’s R&D into long distance hauling and self-driving cars demonstrate that they do not intend to stop expanding. Meanwhile, Uber has no mooted plans to enter into air travel/freight business, so they are not trying to tackle their entire TAM.
Calculating TAM will reveal the theoretical total market that could exist for a product or service considering free access to it and unlimited operational resources from the provider. Just within a monopolistic industry, where one provider has the resources that are required and scale to cater to the complete potential market would this be possible. And just the public utilities and government services get this advantage.
If it is almost impossible to reach 100% of TAM, then why is it added in almost every pitch deck? The reason is that a TAM will throw out a considerably large number that attracts eyeballs and stimulates conversation. So the key in this detail will be in the second and third layer analysis of the TAM; the serviceable obtainable market (SOM) and the serviceable available market (SAM). And the last measure is most important as it shed light on what is being realistically targeted to be captured by the company. Basically, it’s all about finding the tip of the iceberg.
The pitch decks can have the tendency to ignore SOM, SAM, and only try to hazard a guess for a TAM, leaving it at that. And by this omission, they usually make sweeping and poorly-defined generalizations about a customer base like “we are targeting millennial mobile phone users”. Eventually, a failure to have an actual guide of a TAM, SOM, and SAM, with the considerations competitive dynamics and customer segmentation can result in a poor product-market fit, and disappointing outcomes.
What is the total addressable market (TAM)?
The total addressable market, sometimes also known as the total available market, is the calculation that represents the overall revenue opportunity for a given set of product, service, or solution. TAM is mostly used to give “guardrails” for businesses gathering together their go-to-market strategies or those who are planning to present a pitch to potential investors.
TAM comes in very handy especially when it comes to estimating the total size of a specific market and painting a clear picture of the financial opportunity that could be.
TAM experts emphasize the importance of building “boundaries” or “fences” around your business opportunity that helps your team to focus more on the areas of best opportunity and narrow the environment in which your organization operates. And without fences, your company will wonder about running after each potential lead, either it’s good or bad, wasting resources and time trying to peruse the dead-end leads.
The best companies initially focus their TAM on niche markets and then demonstrates their success in an area of their expertise- prior to expanding their TAM “fence” to add their next opportunity.
The capability to define the core characteristics that make up your market, and then define the market where you want to challenge, is very important.
Let take an example; someone put together a menu of all the different meals he liked that his mother usually cooked, and added some additional genres he likes in general like Chinese and Italian food. She likes to cook and is quite good at it, but she doesn’t like to come up with the ideas of what to cook. So, he provided her with a TAM of food that he would like to eat. She then prepared a rather smaller ingredient-oriented list of grocery based on a subset of that TAM, which she took to the grocery store.
Calculating TAM for business means asking questions
- What size of companies buys our solutions?
- What industries are we likely to sell into?
- Where is growth expected?
- What are the characteristics of our current and potential customers?
- How is the market growing? Are there new entrants? Bigger budgets?
- Where are those companies located?
Use data to create filtered searches that specify industry, geographical location, and company size. Then highlight the significance of striking a balance between building boundaries narrow enough to move your organization towards a clear objective but not so narrow that the market opportunities become very small.
For example, Infotanks Media markets to businesses of all sizes and across all industries. It is extremely broad; that’s why for calculating TAM, we will limit our dimensions to a set of industry groups that includes Telecom, Technology, Transportation, Media, and Services. We sell our offering to many businesses that don’t meet these criteria, but we focus our targeted outbound prospecting within these industries that provide us with a more realistic fence for accurately calculating TAM.
Different approaches for calculating TAM
There are three primary methods for calculating TAM;
- Value Theory
The Top-Down method for calculating TAM uses industry research to calculate the size of your TAM.
Commonly, the secondary market research form companies like Gartner, Forrester, or some other consulting group are usually used to calculate the total number of users that meets your market criteria, as well as how big that industry is.
Although, the research which has already been conducted doesn’t always meet the exact specification for your TAM and estimations are usually made to add or carve out segment estimations. The approach that leverages research that has already been completed is the fastest
and simplest method and is good for high-level estimates, but it is commonly not that actionable and at the same time it also carries a lot of uncertainty.
To get a more tailored view of TAM, the third-party consultants are usually hired to size a market. The third-party consultants may conduct phone or email surveys make more educated assumptions and analyze other research, but the cost is much higher. At the bottom line, unless the findings are actionable, you may still just have a revenue number or/and a number of companies. Commonly, the way to operationalize that insight is still missing.
The Top-Down method for calculating TAM is represented by an inverted pyramid, the narrowest part of the pyramid representing TAM represents the end user profile of the company. The Top-Down method is presented in the form of “according to the secondary market research, the (industry XYZ) is a $XX billion market” and results into how your organization manages a percentage of that market.
The Top-Down method is a generic process to calculate TAM and lacks specific examples of market change or value.
The more accurate method for calculating TAM is the Bottom-Up approach. The method uses your own company data to create reliable market fences and sales goals. Experts prefer this method as it provides a more accurate estimation of market growth and the sums of revenue. And in this case, you are using the food that is already in your refrigerator, so to speak.
When calculating your TAM using a Bottom-Up method, multiply the annual contract value (ACV) of your company service or product and the total number of accounts in your industry.
Example, let’s say that my beverage manufacturing company sold lemonade at an average of $30 per case to the vendors; they purchased 50 cases annually, on average (ACV of $1,500); and there are a total of 1,000 vendors on the West Coast.
Meanwhile, I can also calculate the TAM for my beverage manufacturing company: 1,000 vendors multiplied by $1,500 which is equal to a market of $1,500,000.
Many TAM experts consider the Bottoms-Up method as the most accurate method; nevertheless, TAM experts demonstrate how to build even more value from this equation by doing this exact same calculation for accounts grouped by size.
They also suggest that totaling TAM by multiplying ACV by the number of accounts in mid-markets (MM), small and medium-sized businesses (SMB), and large enterprises (EE):
And by accounting for the variability in the size of accounts, the Bottoms-Up method gives out a more accurate estimation of the market size and about the insights into sub-segments that may be even more lucrative to pursue.
And if we further continue with the lemonade example, I would examine the different business accounts inside my own vendor list: out of the 1,000 vendors whom I sell to, I can clearly identify that 166 are mid-market (MM), 659 are small and medium-sized businesses, and 175 are large
enterprises (EE). So my ACV for midrange, enterprise, and SMB may be $2,000, $5,000, and $$500 respectively. As a result, I would calculate the sum of (166 MM x $2,000) plus (659 SMB x $500) plus (175 x $5,000) to equal a TAM of $1.7 million.
This version of the Bottom-Up method paints a more clear picture of my lemonade market, and the assumptions can be modified to model pricing adjustments, and factor in the assumptions about how much of every market segment can be captured within a year. And a more accurate, detailed picture of TAM translates to higher revenue as it shows opportunities that a more common estimation can’t find.
The Bottom-Up method relies on having good data in your systems, but also a realistic estimation of the number of accounts available that meets your TAM criteria.
TAM is not just a number for estimating market opportunity for your product or service or solution. Instead, it is a set of guideposts that can be used to operationalize list-building via further modeling, segmentation, and targeting.
Whether you are looking for funding or launching a new product, or setting new sales goals, take the time to understand your TAM, not just the calculation of accounts or the revenue number, but a deeper understanding of those accounts. The result of a well defined TAM is inevitably better sales success; you will also get higher renewal rates and increased customer retention as your sales team is targeting only those accounts that are a fit. The effect of a well-defined TAM resonates throughout the entire sales cycle.
Value Theory Method
Both the methods Top-Down and Bottoms-Up usually look at the current paradigms and assume that a new offering will fit into them. But, how can someone access the opportunity for, say, flying cars, when flying cars don’t even exist yet? For the products or services or solutions that can evolve a market into a new state or/and offer more value to different groups of customers, the value theory approach may be the best option.
So, with the value theory, one must access how much a customer would be willing to pay for the evolution/improvement of a product. Such an approach would have been more useful if music streaming subscription services, like Spotify, started to roll out. On the other hand, customers would pay a fixed price to purchase music, yet the additional value of nor owning a song but having access to a large library of them to “borrow” was as such that the general pricing we now see of $9.99 per month was deemed value-additive. And attaching that cost to the total number of music listeners would have shown the TAM properly than just looking at how much was spent at the time bought downloads.
Differences between TAM, SOM, and SAM
- TAM = Total Addressable Market
- SOM = Serviceable Obtainable Market
- SAM = Serviceable Available Market
TAM, SOM, and SAM represent the various subsets of a market. While TAM refers to the total demand for a product or service or solution, that is calculated in revenue annually. On the other hand, SAM represents the serviceable available market and is the addressable target market that is catered by a company’s products or services or solution.
Meanwhile, SOM stands for the serviceable obtainable market that is the percentage of SAM which is realistically achieved. Finding these subsets inside an industry requires market research to better understand the proportion of each area.
Example of this is a customer expenditure on food in the UK. Back in 2014, the value of this market was estimated at 200 billion euro. The customer market entails alcoholic drinks, fresh food, and non-alcoholic drinks.
Alcoholic drinks industry that served 49 billion euro is the SAM. This industry has many large manufacturer and suppliers who service the market. And an entire alcoholic drinks industry that is served by one manufacturer is the SOM.
Importance of the TAM
TAM is one of the core metrics that companies use to calculate the potential scale of the market in terms of revenue and total sales. When a company is going through the process of launching a new product or service to a new customer segment or is planning to cross-sell an existing product or service to their existing customer base, TAM helps in breaking these numbers into manageable levels. As a result, an investor should be objective while calculating the available market as an exaggerated value might result in markets having less potential growth.