TAM - What is it, How to Quantify, and Why it Matters
TAM - this is probably an acronym that many of you have heard before. I see TAM used in almost any company pitch deck, yet the quality and application of TAM varies dramatically. Here are some views on what it is, some methods to calculate TAM, and what to do with it.
What is TAM
Total Addressable Market (TAM) is simply a calculation for how big a target market is (in terms of revenue) for a given product. It provides directional insight into how large (or small/niche) the market for your product could be. One important thing is to correctly define your TAM; a common mistake is to quantify a market that is way beyond scope of what your product is and problem it solves. The more specific and relevant you can define your market, the better and more realistic your TAM analysis will be.
Methodologies to Calculate TAM
There are many ways to arrive at a TAM, and the reality is there is no one correct way. Some people do a 30-second, cocktail-napkin analysis. Others do lots of market and competitive research to get to a very specific number.
I recommend starting simple, then building up complexity if necessary. Remember, this is meant to be directional analysis so whether the TAM is $925 million or $950 million does not matter … the point is it is ~$900 million vs. ~$90 million vs. ~$9 billion.
Two simple ways to start are a top-down analysis and a bottom-up analysis. In this example, we are trying to quantify the TAM for space supplies sold to small (<10 martian) firms across the universe.
For top-down, select a researchable macro figure, then filter down based on target market criteria to arrive at your TAM. For example, there are 200,000 martian firms in the universe of which 75% of firms are small (<10 martians), of which 50% would use space supplies. At $1,000 annual purchase the TAM would be ~$75 million.
For bottom-up, start with the opportunity at a single customer, then extrapolate across the larger potential universe of customers. Let’s say the target martian firm on your planet would purchase an average of 2 rounds of space supplies per year at $500/each, which equals $1,000 per firm. Your planet has 500 similar small firms, so your planet opportunity is $500,000. As you go across space, there are 150 similar planets (each with 500 target firms). Thus, the overall TAM would be ~$75 million.
Another common variant is to know your revenue/customers or a leading competitor’s revenue/customers and gross up based on share. For example, you know Space Jam Company has $15 million revenue and 20% share, therefore the total market is ~$75 million. Note: you can also factor-in market share estimates, but I prefer to keep TAM as total market and then separately define a company addressable market based on share.
I suggest applying both approaches and triangulating to a number in the middle that makes sense.
There are other external sources, analysts, research reports, company analysis, etc. that quote market sizes. From experience, some of these can be high quality while others are worthless. Be careful you understand how they are defining their market analysis, as well as the quality of their work before using it! One source I have found valuable is many industries have a “National Association of [insert your industry]”. These organizations often have industry companies as members and a better pulse on some of the key statistics of that space.
In the end, you want a realistic TAM range that is triangulated from multiple vantage points and passes the sniff test. Your main objective is to analyze the opportunity available within your target market and prioritize your efforts. Regardless of the number, remember that it can change over-time. Imagine a new product that the market is not yet ready for… that market may look small today but could explode in a few years. Remember that just because it is a large and growing TAM, it doesn’t guarantee you have a differentiated, must-have product or the right team to capture share. Lastly, remember that TAM is an exercise. Part of the value of the exercise is refining your thinking on how you define your target market, competitive landscape, and economic model to win in your space. Don’t forget to apply these learnings from your analysis to your overall business strategy!