Whether starting a new business or trying to grow an established one, you must understand and assess the overall opportunity available to you if you can achieve 100% market share.
You can do this by understanding your total addressable market (TAM).
What is a total addressable market (TAM)?
The total addressable market (TAM), sometimes called the total available market, is the overall demand for a product or service and the revenue opportunity you can achieve if you get 100% market share.
TAM helps you calculate and forecast the realistic profitability of a business line or product and service once released to the market. It also helps in setting tangible and measurable business goals.
It’s vitally important that every business owner and marketer understands TAM and how to calculate it.
Over the past several decades, the crowdspring team has launched many businesses and has mentored, coached, and helped thousands of entrepreneurs launch their businesses. In each case, it was critical to measure and assess the total addressable market to build a strong business plan when starting the business. This comprehensive guide shares our insights on TAM.
The ultimate guide to TAM
Why TAM is important
Calculating your TAM is crucial in estimating the potential scale of your target market in terms of sales and revenues. It helps break down the numbers into manageable levels, especially for startups and smaller companies.
You must be objective in estimating the available market of the product or service you’re launching. Staying objective helps you avoid producing products or services that are not marketable or in demand.
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Difference between TAM, SOM, and SAM
Total addressable market (TAM), serviceable obtainable market (SOM), and serviceable available market (SAM) are related concepts, but each serves a different purpose.
TAM is revenue or sales demand for a product or service.
Serviceable available market (SAM) helps you assess how many customers your business can reach with marketing and sales efforts.
Serviceable obtainable market (SOM) refers to the percentage of the serviceable available market (SAM) businesses can realistically achieve.
Think of these three market subsets as interrelated concepts where TAM encapsulates the bigger picture, helping businesses to know if a market is worthy of venturing into. While SAM and SOM are smaller parts with specific purposes.
How to calculate your Total Addressable Market
Calculating your business’s TAM allows you to estimate the amount of funding and effort that needs to be put into specific products or services, business opportunities, and more. It’s vital to your budget and holistic business health.
There are three ways to calculate the total addressable market:
1. Top Down
The top-down approach requires professional data such as industry data, market reports, and research to help identify the TAM. It uses a sizeable known population size to narrow down to a specific market segment.
You can get industry data from companies such as Gartner, Forrester, and IDC that offer comprehensive research and industry reports, usually containing statistics, revenue opportunities, and more, to help you determine if a market is viable for your business.
But industry groups aren’t always up to date and may not necessarily reflect the specific elements of your target market. And those reports are expensive. If you want to get detailed information on the particular market you want to venture into, hiring a market research consulting firm or an independent consultant to do research tailored to your needs is one of the best ways to go. This is also expensive but will save you time and help you focus on the best opportunities.
The bottom-up analysis relies on existing data, such as previous sales and pricing data.
To calculate the TAM using the bottom-up approach, follow the formula: multiply your total number of customers by your annual contract value (ACV).
To find your ACV, you need to multiply the number of your current customers by your average sales price.
For example, you’re a cosmetics brand selling a tube of lipstick for $20, and you sell 15,000 tubes a year. You multiply $20 multiplied by 15,000 to get an ACV of $300,000. Finally, you consider how many cosmetics brands are in your competitive market. Let’s say there are 200 competitive cosmetics brands. Assuming every brand has a roughly equal market share, multiply 200 by $300,000 to get a TAM of $60,000,000.
Some businesses consider the bottom-up approach more accurate than other analyses because it’s based on a proven data point and can be magnified to discover the whole TAM population. But this approach is difficult for new businesses that are just starting and have no customers.
3. Value Theory
The value theory approach is based on how much value your customers can receive from your products or services and how much they’re willing to pay for that in the future.
For example, suppose you are a phone case brand and have added a unique piece of patented technology that helps make your phone cases different from your competitors. In that case, you can identify your value theory by estimating how much customers will pay for your product.
Let’s say it costs you $10 to manufacture a phone case with your patented technology. How much would consumers be willing to pay for your case? Would customers be willing to pay $30 or $40 for your unique phone case?
Use the value theory analysis to calculate your TAM and to determine whether you should enter a specific market. Find the right balance between a market that is too small or a market size too saturated to help your business thrive.
Questions to ask when determining your TAM
Asking the right questions can help you understand your TAM better and leverage it in your business strategy.
1. What is the overall size of the market?
This is the top question you should ask when defining your TAM. Knowing the overall size of the market helps set your expectations upon venturing into the market and lets you know how extensive your potential customer base could be.
For example, an industry market size of $30 million to $200 million per year is generally an excellent industry to enter, as there’s always room for business growth. Meanwhile, a market below $5 million is considered too limited, while over $1 billion is generally considered too competitive.
2. Who is your target market?
Understanding your target market is essential when determining your TAM. You need to know what kind of customers you wish to target to help you identify which part of a specific market you should concentrate your efforts on. This enables you to better understand who your potential customers will be and start thinking of ways to approach and market to them.
3. What is the growth rate of your target market?
Research and analyze the growth rate of the market you wish to enter. You need to know how fast a market’s growth rate is to determine if there’s room for business growth and opportunities.
4. What makes your product or service different and valuable to your target customers?
Your product or service should be the answer to people’s needs. Ask yourself, what needs can my product or service address? How does it add value to people’s lives? Understanding your business’s strengths can help you narrow your target market, strengthen your brand pillars, and understand your potential customers.
5. Who are the possible competitors to my product or service?
Know if there are other alternatives to your product or service. Remember, you’re looking for a market with a potential for growth, especially as a startup. Assess your competition and analyze whether it’s a market worth entering.
Risks of not conducting a TAM analysis
If you’re considering foregoing a TAM analysis before entering a new market, consider how these risks could harm your business in the long run.
1. Missed opportunities for growth. Conducting a TAM analysis can help you assess the strengths and weaknesses of a market. By calculating the TAM of a particular market, you can foresee the gravity of risks and the kinds of rewards you can gain when venturing into it.
2. Wasted time and resources. Knowing your TAM can help you see the market’s overall size and create better-informed decisions regarding your funding and efforts. You can make better estimates of how you can allocate resources when you know what you’re dealing with instead of diving head-first into an unknown market that could hurt your business.
3. Set unrealistic goals. Not knowing the size of the market and the risks that come with it can lead to overestimating your decisions. You could end up overspending or losing profit without calculating your TAM and setting aside appropriate resources to help you achieve realistic goals.
4. Make wrong decisions. Without knowing your TAM, you may make incorrect decisions that do not fit the niche you’re targeting and end up overspending your allotted budget or entering an oversaturated market that won’t help you gain profits.
5. Fail to find product-market fit. A TAM analysis can help you create better estimates for potential profits for a particular market and also help you gain insights into potential customers. If you forego calculating your TAM, you might struggle to find product-market fit for your products and services.
There’s no such thing as overpreparing when running a business. You need all the information and insights you can get to help your business grow and avoid wasting unnecessary resources.
So, spend some time researching and analyzing your total addressable market to boost your chances of success and help arm your business with the right tools to deal with the challenges to come.