What separates a jaw-dropping unicorn business concept ready for seed funding injections from an amateur-hour startup pitch no one takes seriously?
It might not be your first guess, but for me it is definitely a clear and concise TAM formula.
The potential of a product or service can be a strong selling point to show investors and stakeholders, especially if you have an actionable business plan that will complete the vision and alignment you’ll establish for your growth.
Therefore, calculating the Total Addressable Market of your business is your first step in creating a successful business. Let’s find out how you can do that together:
What is Total Addressable Market?
Total Addressable Market or TAM refers to the total market demand for a product or service; the overall revenue opportunity available in a marketplace for a product or service. In other words, it’s the eagle-eye view of where any new product or service will be introduced. Regardless of what we’re talking about and in every context, TAM is arguably the single most important piece of information in terms of understanding market potential.
Here, have a look at this simple diagram:
As you can see TAM is the overarching big picture – the TOTAL market potential.
From here, you should have a firm grasp on why this calculation is THE calculation investors are going to inspect first.
Why Are Proper TAM Calculations Invaluable?
In reality, reaching a proper TAM calculation is a worthwhile team-enlightening process in itself.
Along the way, as you ‘Narrow the Tam Funnel’ you’re going to define a number of other critical metrics, such as:
- Fundamental market data you should have anyway – i.e. potential size.
- A formula to attract and convert investors.
- Thorough competitor data, broken down in relation to your venture – market fit.
- Data-driven and formalized target customer information.
- The spectrum of currently available similar products/services.
- The major upward and downward trends influencing your TAM.
- Establish a clear go-to-market strategy or roadmap.
If your market, product, and service analysis is weak, your TAM will be weak. If your TAM is weak, so is your SAM and SOM. This is pretty much always going to lead to monstrous blunders across the board.
Before jumping into that, let’s include our two new key terms and some definitions.
- TAM – Upon reaching 100%, with every individual in your chosen geography using in your product or service, you become the proud owner of a market monopoly.
- SAM – Serviceable Available Market: This is your slice(s) of the market. The total segment of TAM you can feasibly or reasonably target. For example, your New York pizza shop’s 1-10% of the pie-lover TAM within twenty miles of your prime real estate.
- SOM – Serviceable Obtainable Market: Out of that SAM, this is the more refined slice of the TAM you can hope to achieve within the first 1-3 years of opening your doors or trying a new form of pizza in the local market; app, etc. For example, if you don’t sell thick crust for some reason, your SAM and SOM will need to continue narrowing.
Another crude example could be the worldwide transportation market, which is gigantic – over $5 trillion. Imagine having a monopoly there… Fortunately, an unlikely scenario. Even for Uber, they were initially targeting the Taxi & Limo Sector (SAM), coming way down to a smidgen over $4 billion. Then the SOM they aimed for within the first 5 years was around $1 billion.
From $5 trillion, to $1 billion.
Their TAM refinement didn’t stop there though, as in their original pitch deck they were only targeting a certain area of one city. If that went well, the next step was a second major city, and so on.
You can also take huge six and seven-figure TAMS and break them down into the different sub-sectors.
For example, clothing. Here are three TAM-SAM-SOM diagrams showing different pathways to approach along the supply chain.
Right, with a basic foundation and core terms all laid out, let’s get to the soft gooey center in the middle of today’s subject.
Your goal when ironing out the TAM for a product or service is to make this calculation the most educated, de-risked (as close to the truth), and data-driven estimation possible. And yes, it’s nearly always going to be an estimation rather than a fixed concrete number, because TAMs are often projections.
How to Calculate Total Addressable Market (3 Ways)
- The Top-Down Approach: Not much calculating in this approach, other than coming to terms with the overall big-picture number without any real precision.
- The Bottom-Up Approach: Using as many sources as possible to start with the smallest, most refined picture of the market you can hope to capture (ex: the Central SF area like Uber). So, starting with your highly-specific SOM and working your way up.
- Value Theory Crafting: Using highly-educated, but nonetheless subjective or less reliable sources of data, to influence your calculation. Conjecture, opinions, base statistics, buyer WTP numbers (more on this below), etc.
“The best TAM formulations are the result of using all three methods, combined with studious, prudent due diligence.”
Total Addressable Market (TAM) Formula
In all of its glory, this is as simple as it gets.
[TAM = # of Customers x Pricing]
From leveraging distinguished industry and Wall Street-based analysts (paid and free), to using a huge assortment of publically available market and competitor data, there’s no excuse not to roll up your sleeves and do your homework – TAMwork.
Let’s take a look at these two variables.
- Geography: Where is the overall market (TAM), along with your SAM and SOM? Are we talking ecommerce? How many countries are we targeting, and where are your customers within them? Be specific, specific, specific!
- Relevancy: Why are these your customers? And no, you can’t count a competitor’s customers or users as your own.
- Testing?: How do you know these are your customers? Be sure you’re ‘showing your work’ and proving these assumptions as best you can. Show the logic.
- Pricing Basis: What is the basis for your pricing? How are you coming to these conclusions? Again, show how the math plays out step by step.
- Units of Measurement: Depending on your situation, this can be a great number of things. The point is to be ultra-definitive with how your pricing is structured.
- Customer WTP: This is the basic number your customers or users are Willing To Pay. Typically WTP numbers are based on competitors so they aren’t really sources for YOUR pricing, since you are not your competitors. But, they can help paint a market picture.
Congratulations, you’ve now swept through the pillars of TAM, why it’s important, and how to properly calculate it.
Let’s finish this off by looking at the most common mistakes inexperienced startups and entrepreneurs make as they set out to tackle the numbers.
Some of this will be repetitive, but that’s a good thing. Stamp these details into your business mind!
Common TAM Calculation Mistakes
Inexperienced startups in the pre-seed, seed, and Series A funding round are where to look for pricing metrics that are WAY off.
It’s so common, yet they NEED to nail these concepts.
Most often it’s a mixture of being too swept up into the product or business concept itself without crunching numbers or having no one who is really considered a number cruncher on the team.
For investors, the first thing they want to KNOW, is how de-risked the numbers are and what kind of feasible ROI they can expect in the short and medium-term. At the end of the day, that’s where the rubber meets the road. No matter how mind-shatteringly-insane your new product concept might seem, if these numbers:
- Don’t exist, or,
- Do exist, but they’re obviously way off,
Then you’re going to be sent back to the drawing board, heads hung low.
Nobody wants that, so here are the big three mistakes to steer clear of.
1) Not Proving the Math – Going Top Down Only
“Listen, it’s a no brainer. We’re going to waltz in and nab up at least 3% of this $375 BILLION Market. Yep, that’s right folks, grab your wallets because we’re talking $11.5 BILLION smackaroos. You’ve got to get in on the ground floor before this puppy REALLY takes off!”
That’s what a corny top down-only pitch sounds like. Experienced investor eyes begin glazing over instantly, waiting for you to dial things down and prove your TAM.
- How EXACTLY do you plan to enter into and capture this 3% of the market?
- How EXACTLY do you figure these are all your customers when the new product or service doesn’t exist yet?
Investors will begin firing off questions, testing each and every assumption that comes baked into that $11.5 billion top-down number you threw out. If they have to do your math for you, that’s a bad sign, and it’s likely your TAM will fall… dramatically.
What if your team is left standing there, realizing you were focusing on a product that had a TOTAL product-lifespan value of only $11.5 MILLION?
What if it’s only $1.5?
#2) Basing Your Math on Competitor TAMs
“We’ve created the absolute best accessory for jeep owners in the known universe, and the jeep owner market worldwide is…cosmic.”
Those aren’t your jeeps and those aren’t your customers.
Don’t base any of your math on competitor numbers, because it’s sloppy and you end up with a horribly misleading formula.
- What kinds of jeeps are ideal for your accessory?
- What country or countries will you choose to target first?
- What specific kind of jeep owner are you REALLY targeting?
Starting to see how powerful this calculating ability is and why shows like old school ‘Shark Tank’ or ‘The Apprentice’ have become so popular (and educational)?
#3) Mistaking ‘Market Pain’ for TAM
“Smoking is a gigantic problem that in total creates X trillion….”
“Too many bicyclists are getting hit in big cities because…”
Problems are not TAMs.
If you attempt to base your math on the size of a social pain, rather than the response to your solution within a specific marketplace impacted by the problem, you’re starting off on the wrong foot.
By avoiding these three mistakes, you can stay on the right path and provide a FAR more de-risked formula to base decisions, time, and money on.
Before you take any action on a new product or service venture, know the TAM… be the TAM.
Projecting revenue growth using huge numbers is fun, but to attract genuine investor interests, or get serious stakeholders on board, or really just have a real shot at success, you need to REALLY see what is possible. Let your TAM + SAM + SOM calculations serve as your guiding light, always keeping your financials firmly rooted in reality, not steeped in hyperbole or hype.
Frequently Asked Questions
What to do if your Total Addressable Market is too low?
A low amount of TAM doesn’t always signal the end of a business. If you have a TAM that your business can’t continue on, try to find ways to expand your user base by repositioning your product or creating similar products with your existing resources. Adjacent user theory might help at this point.
How can I make a Total Addressable Market chart in Excel?
You can replicate examples of TAM spreadsheet you find online or use one of the ready-to-use TAM calculation templates on the internet.
What is the difference between Server Available Market (SAM) and the Total Addressable Market (TAM)?
TAM refers to the total market demand for the products and services such as yours while SAM is the segment of TAM that is in your reach geographically.