What TAM (Total Addressable Market) Stands for?

May 28, 2020

The Definition of TAM

Total Addressable Market or TAM is the company's revenue opportunity in the market that managers and business development professionals use. TAM is used to calculate a company's revenue opportunity. This metric is a crucial first step in measuring the "pool" for its future development. Usually, it's accounted for in dollar amounts.

As a startup serving a small market, you might wish to neglect this metric, thinking that it might be impossible for you to grow as much. However, TAM has many benefits, especially for a new business. It gives you a bird's-eye view of the industry and allows for better goal-setting and planning.

Only monopolies achieve control over the whole TAM. Businesses with many competitors share the market with other companies in the same industry.

How to Calculate It

As we've already mentioned, TAM is the total amount of revenue available in your niche. It's crucial to understand that this metric is usually a yearly value. Thus, the Annual Contract Value (ACV) acts as its base. Multiplying it to the number of possible customers gives you the Total Addressable Market.

There are a few industry-standard methodologies for finding the acceptable product price and the number of users who need it.

Top-down

This option uses industry research and estimates. While using open-source data and reports is acceptable, it's a general approach. It might not be trustworthy for several reasons. The research source might be biased, or the criteria might not be pristine.

Bottom-up

The company does its research on the niche and accurately estimates the available market size. As the investigation originates at the firm that uses it, the numbers are more accurate. Due to the competitor research and in-depth knowledge of the industry, the company sees the market more thoroughly. However expensive, this method is a preferable one.

Value Theory

This approach views the product from the prism of added benefits. It involves a lot of guesswork, so you shouldn't consider it a primary research method for new company creation. It works better for new features and experimental product characteristics.

No matter which method you choose, the formula for the metric doesn't change:

TAM = (Annual Contract Value) x (# of possible accounts)

Now, let's use an example to get the calculation right. Suppose your company sold a custom task management software for music production companies with 100 to 500 employees at a flat rate of $1,000 per year. This number is your ACV.

Your Market research determines that there are 5,000 businesses that match the client criteria you’re after. This number is the maximum possible accounts you can acquire.

Thus, the Total Addressable Market for this business equals to $5,000,000 ($1000 x 5,000).

Why Is It Important to SaaS

SaaS businesses are fast-growing and innovative companies that use market peculiarities to adapt and change their product. Acknowledging the potential demand volume can be useful to them for marketing and development purposes.

Estimate Effort

Once you know the scale at which your company reaches the market's full capacity, you can start optimizing the available resources. Time and money are two of the top ones to consider. However, SaaS businesses also highly depend on expensive talent involved. The push to grow the business should be comparable to the opportunity that effort can bring.

Use For Guidance

While it's crucial to know the volume of resources to invest in a company, you also need to optimize their flow to specific pain points. Suppose you want to expand a customer segment. Knowing the potential of the market, you can push your strategic forces in the right direction.

Another place for the directed effort is the development of new product features. With the knowledge about segments and market potential, you'll be better positioned and ensure the changes stick.

Show Investors

Besides the current market share and company details, investors want to see growth and direction. As they learn about the competition, the number of customers, and industry trends, they also consider the business’s future. TAM is crucial in identifying the risks and growth trajectory. Plus, this knowledge will help them learn how the company is going to succeed.

Mistakes Founders Make When Calculating TAM

Nobody’s prone to mistakes, but there are ones that can cost you the startup's longevity and success. A founder's ability to predict market movements and industry changes act as the foundation for any successful business. Identifying TAM and finding the true niche size is the first stepping stone to more in-depth market analysis.

Here are a few mistakes startups make that drive them to the ground.

Being Too Narrow

In the beginning, accessing the scope TAM covers can be overwhelming. Thus, business owners might fall into the trap of selecting other, more tangible market characteristics such as Serviceable Available Market (SAM) or Serviceable Obtainable Market (SOM). Both market subsets are useful, but their power grows if viewed in the Total Addressable Market context.

Imagine that your niche is a cake, which you share with competitors in the same industry - only monopolies don't share. While TAM is the whole round pie, SAM is the part not yet shared amongst rival companies. Theoretically, it's still available for everyone to "eat."

While you might be eager to have the whole SAM to yourself, most of the time, it's not possible. Here comes SOM, which is the amount of the "cake" you can comfortably manage.

That said, businesses need to assess the broader picture to get a fair market share in the end. Otherwise, they might leave many growth opportunities on the table.

Being Too Broad

While the cake metaphor illustrates the relationship and dependencies between TAM, SAM, and SOM, there’s more to the market. We also need to talk about its ability to grow or shrink. Founders should account for the moving pieces and adapt. Still, it's only possible if they avoid guesswork and have a strong factual foundation for decision-making.

While not seeing the whole picture can result in lost opportunities, thinking too big can cause the business to lose focus. Companies without proper targeting are blind to market changes, as they don't base decisions on research. They try to cover every segment, spreading too thin.

Investing in business analysis at the earliest stages of business inception is crucial. It gives you more opportunities to acknowledge the real build of the niche, which in its turn strengthens control over your company's future.

Being Too Complex

We live during a time when innovation is the driving force behind most businesses. Especially in the SaaS industry, if you're not finding and solving new problems, you might become dead weight. While this is an understandable issue, it complicates the market analysis process.

Sometimes, as companies are eager to present their inventions to the world, they don't spend enough time getting the data right. Here's why the process can be incomplete:

Unreliable information sources
Saying that there's no available data

Unreliable Information Sources

Any research used during decision-making should contain checked, reliable, and provable data coming from unbiased institutions. Reports from unreliable sources might include wrong calculations, falsification, and a biased approach to the research. This type of information is neither useful nor actionable. Moreover, it might hurt your business.

No Available Data?

Resolving issues that haven't been addressed before is hard enough. Problems you might face can range from not knowing how many people experience similar concerns to finding adequate pricing models for the proposed solutions. Finding information about a market that you're just creating cannot be easy. Still, you need to spend time and energy before carrying on with the rest of the startup preparations.

In industries like IT and SaaS, innovation might result in many companies entering open markets with no historical records. However, it's possible to find out at least something about the niche. One way to do it is to source information from adjacent markets. Keep in mind: if there's no data, there's no niche. Therefore, giving back to the business community in the form of thorough market research is the least you can do.

Examples of TAM Presented by Successful Entrepreneurs

Airbnb

Everybody in the world (at least) heard about Airbnb. It's a billion-dollar startup that took the world by storm and changed the travel business forever.

An early Airbnb pitch contains fundamental research around travel and housing markets. The presentation brings forth the data from temporary housing sites and Craigslist ads to find an initial market validation estimate. The following slide then goes on separating TAM, SAM, and SOM volumes.

It's enlightening to follow the thought process of Airbnb founders. They mark the volume of airline and tour bookings worldwide as their total available market (more than $1.9 billion). The next step is to narrow down their target by determining what kind of tourist would want to use their services. Everything comes to budget travelers, estimating their SAM at $532 million. Their possible obtainable market estimate on the slides was $10.6 million.

As we can see, this Airbnb pitch is one example of excellent market research and educated forecasting.

LinkedIn's Market Opportunity pitch offers another masterclass-level segmentation and TAM action. This 2015 report lays out all the available customer segments the social platform addresses:

Sales
Talent
Learning and development
Marketing

It then superimposes their actual, achievable, and globally available volumes on one another to create an excellent visual representation for each segment's growth opportunity. Take the sales solution slide as an example:

$15 billion - Total Available Market. Global sales opportunity, including sales professionals and product pricing
$8 billion+ - Serviceable Available Market. LinkedIn's visible pipeline, based on the number of members and product pricing.
$114 million - Actual market. How much LinkedIn sales solutions contributed to their bottom line in 2014

Here we presented only two successful examples of TAM usage and market share calculations to you. However, you can find hundreds of more such examples, mainly for SaaS niche businesses.

Conclusion

As a part of the initial research, TAM can be challenging to wrap your head around.

You have a few ways to learn more about the market. Still, whichever of our described methods you choose, make sure that you base the decisions on checked and up-to-date research. While the preferable way is to conduct your niche data collection, it's quite expensive, so you might have to search for more creative methods.

Another valuable takeaway from this article is always keeping a bird's-eye view on your business development. You should be searching for growth opportunities in changing markets to stay relevant.

As you're thinking and rethinking your new product's market potential, TAM opens up vast possibilities before you. Use it as a guide to finding the company's serviceable segments, and it'll balance your efforts to achieve the desired volume in your niche.