Total Addressable Market, TAM, is one of the available market sizing and identification forms. Less commonly referred to as a total available market, TAM identifies revenue opportunities from a particular product or a service. Today, TAM is an important business analytics metrics since it highlights growth opportunities and helps businesses allocate most of their efforts to market segments that bring the most revenue.
One more reason to calculate the total addressable market for a business model is an opportunity to see the most rapidly growing market segments. Once again, it should help businesses with proper budget and effort allocation, giving them a chance to boost their revenue while cutting down on their expenses.
Top Benefits of a Thorough TAM Analysis
As we already established, revenue generation is the primary reason to calculate TAM. Still, if approached wisely, this analysis can result in several additional benefits:
- Give business owners a chance to create a roadmap for the future product/service evolution
- Offer a clear perspective on the available market segments
- If necessary, paint a clear picture to the investors, boosting the business’s chances to attract funding
- Outline any competition and offer solutions on improving customer service
If we get to more specific examples of what TAM is, let’s talk Uber. When the company first emerged, most saw it as a taxi service. Still, some experts would point out that Uber had a transportation service potential. And, as the company started to introduce additional services — X, EATS, RUSH — it became clear that Uber has done its market research right. On the other hand, the company is not addressing their whole available market because it would imply getting into freight and air transportation.
So, even if global enterprises are not serving their total addressable markets, what’s the point of TAM analysis? The main thing to understand here is that TAM gives insight into a business’s potential theoretical market. In a highly competitive business world, no single company could possibly hope to serve their whole addressable market. If it could, we’d be talking monopoly — like government or utility services.
Still, thorough TAM analysis is vital to understand the entire pool of opportunities for any business. Later on, based on the competition analysis and product review, businesses get a chance to segment markets and audiences they will actually be serving.
So, the real point of TAM analysis is to segment two more available market layers from total addressable one — serviceable available market (SAM) and serviceable obtainable market (SOM). As you can guess from the name, the last aspect is the most important one because that’s where most of your business efforts will go.
We will discuss the main features of the serviceable market a bit further in this article. Right now, let’s focus on how businesses can calculate their total addressable market because it all starts with this figure, anyway.
How to Calculate Total Addressable Market?
The most basic formula for TAM calculation is the average revenue from one customer multiplied by the total number of customers in your market segment.
Let’s say you supply wine to local vendors. One bottle costs $10, and an average vendor gets 100 bottles a year. This means your average revenue is 10100=1000 USD. Now, your area may have a total of 200 wine buyers. That gives an average revenue (1000) multiplied by 200 sellers, 1000200=200,000. In theory, this would mean that your total addressable market revenue is estimated at $200,000. But in practice, there is a little more TAM analysis.
For starters, there are two different approaches to TAM calculation — bottoms-up and top-down.
Besides, TAM analysis may rely on additional techniques, including external research and value theory. Let’s go through all of those in more detail.
External Research
It is very difficult to calculate the total addressable market without third-party research and case studies. While these two can be quite expensive, it is often viable to pay for already conducted research materials than spend long hours of human work on collecting and analyzing your own material.
The biggest plus of using material from reliable resources, like Forrester and IDC, is that the process is quick, and the data is usually reliable. The biggest downside of this approach while presenting your analysis to the investors is that they usually would be interested in the rationale behind any data. So, external research while calculating TAM is best suited for internal use rather than presenting your business plan to investors.
Top-Down Approach
Top-Down Approach when analyzing TAM relies heavily on third-party research. This method implies considering a large share of the available market, starting from population figure and gradually chipping down to market segments applicable to your business or product. While relatively simple to calculate, this approach is rather broad, even after segmentation. Besides, third-party research, even when it comes from established databases like UN, is not always tailored to your business specifics.
Bottoms Up TAM Calculation
Bottoms-up approach when calculating TAM is considered more accurate. This approach is based on the formula we discussed above, where the total number of business clients is multiplied by average revenue or annual contract value.
The main benefit of this approach is that you work with already existing, proven data. By identifying the revenue that’s already in your pocket, you can, later on, expand to larger market segments and outline opportunities for growth.
The only drawback of bottoms-up approach is that this method is more suitable for narrow, local markets. On the other hand, it will not work for large international corporations because the calculation margin will be way off across different states and nations. However, on a micro-scale, it is one of the best ways to calculate the total addressable market.
Besides, segmenting your customers can help come up with a more precise TAM figure. In our example of selling wine, businesses can segment their buyers into small, mid-size, and large clients. Let’s say, out of 200 total wine buyers, 20 were large businesses, 100 — small businesses, and 80 more — mid-size businesses. Now, you have to consider an average contract value within each category, multiplying by a respective amount each customer spends.
Say, 100 small business clients bring you $500 a year on average; 80 mid-size bring $1000 each; and 20 large-scale clients spend an average of $2000. As a result, we get:
(100500)+(801000)+(20*2000) or,
50,000+ 80,000+20,000=150,000
If we compare this to the figure from a non-segmented estimate, where we simply multiplied average revenue of $1000 by a total number of 200 buyers, we get a smaller TAM figure. However, it is way more precise. Besides, it clearly shows business owners that large-scale businesses do not bring as much revenue as one would think. So, this calculation proves that our imaginary wine seller should focus one’s marketing attention on mid-sized and small buyers.
This is the main perk of bottoms-up approach, especially if you take time to carefully segment the existing buyers. The result is more down to earth, and bottoms-up TAM analysis highlights the most profitable market niches.
Value Theory Approach
Value theory approach is a very specific TAM analysis example that only applies to non-existing markets. Here, one is dealing with a new and revolutionary product or service — something that never existed before and so does not have its market niche yet. Think of the first Apple touch phone back in the day, or a streaming service when everyone was still paying for DVD, or the first electric car when everyone drove gas-powered vehicles.
Here, the goal is to try and predict how much an average customer would be willing to pay for the product or service. Then again, multiply this figure by the number of customers you expect to serve. Of course, your result will be based on pure assumption, not on any proven facts. However, this is the risk some businesses have to take when they try to tackle new and emerging markets.
Serviceable Addressable Market Vs. Total Addressable Market
Now that you understand what TAM is and how it can be calculated, let’s get down to earth and discuss markets you will actually be serving. After all, TAM is a very theoretical figure in many instances.
For example, if you sell bottled water, you can assume that your potential market is the entire 7+ billion world population. In a way, that is true because everyone drinks water. So, when using a top-down calculation approach, your first layer of TAM will be estimated in trillions. But in practice, you will not be selling bottled water to every person on the planet. And that’s where SAM — serviceable addressable market — comes in.
SAM calculation refers to a market niche you can reasonably expect to address. While in a perfect vacuum-like world, TAM and SAM figures can be practically the same, no one can expect such a miracle to happen in real life. SAM figure will always be affected by the following parameters:
- Geography and economics: some products will never be in demand in developing countries. Take an electric car as an example. These vehicles are in demand in advanced economies and countries that charge taxes for carbon emissions. In developing countries, with low prices on gas, these cars simply won’t sell.
- Legal regulations: there is no point in launching a casino in a country that prohibits gambling. Some IT products, like WhatsApp and Telegram, are also banned in certain countries.
- Culture: some products are not meant for certain markets and cultures. For instance, fur is losing its cultural relevance in many countries worldwide. Similarly, a business would not have much luck selling bikinis in a country where exposing body parts is frowned upon by tradition.
Serviceable Obtainable Market as the Final Analysis Layer
The final market segment businesses can realistically hope to reach is SOM, serviceable obtainable market. It is very similar to a target market, so commonly discussed in the media.
To objectively evaluate their obtainable market, businesses should:
- Do some research to establish current market demand for a specific product or service.
- Consider each product’s historical performance over the last few years and come up with a sales and revenue estimate based on this data.
- Outline locations and target customers for the product or service in question.
As you can see, SAM analysis is not that different from actual targeting because it defines people and geographies that could realistically buy from your company.
Takeaway
All in all, it is important to consider all market layers to come up with reasonable revenue estimates. Even though businesses will always focus on their obtainable markets first, the total addressable market can be seen as a long-term business strategy. Besides, TAM analysis helps identify both short- and long-term goals, which is vital for any business development.
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