Total Addressable Market (TAM)

What is the total addressable market (TAM) and how does it help startups and investors? These are questions many first-time startup founders may be asking. In short, the total addressable market (TAM) is the total demand or market size for a good or service in a given market. In this article, we explore what total addressable market (TAM) is, how to calculate it when to use it, and more.

What is total addressable market (TAM)?

Total addressable market (TAM) is the total potential market size of a product or service. It is the sum of all the potential consumers, users, and revenue that a company can capture, which makes it useful for understanding the long-term potential of a product or service. TAM is a combination of both the “total available market” (also known as “TAM”) and the “serviceable addressable market” (SAM).  It is useful for early-stage startups when forecasting future revenues using the top-down method and for prioritizing specific products, customer segments, and business opportunities. It becomes less useful as an organization matures and gathers hard data around its true market opportunity.

Use of total addressable market in finance?

TAM is an important concept in finance, it helps investors such as venture capitalists, angel groups, and angel syndicates understand the long-term potential of a product or service, which can then be translated into an estimate of the current value of a company. It may also be used by the internal finance teams of a startup to evaluate the potential opportunity of entering a new vertical or market or expanding a product line.

Use of total addressable market in marketing?

TAM is also an important concept in marketing. Marketers use TAM to evaluate potential customer segments—prioritizing those that are “low-hanging fruit”. It may also be used by marketers to understand the investment required to tap into a particular market and how big of a return they may be able to generate.

What do startups use total addressable market for?

Startups use TAM to understand the long-term potential of their product or service. They can use TAM to analyze the size of the market and the total potential revenue that they can generate, as well as determine which market segments to go after first. In general, the larger the TAM, the larger the valuation a startup has and investors are willing to agree to.

What do investors use total addressable market for?

Investors use TAM to evaluate potential investment opportunities. Startups with a larger TAM generally have a larger revenue potential, and thus are “worth” more. However, TAM is just one of the hundreds of factors that investors consider before investing in a startup.

Questions startups should ask when defining their total addressable market?

When defining the total addressable market, startups should ask the following questions:

• What are the characteristics of the potential customers that may benefit from this product/service?
• How many of those potential customers exist in the world today, and what is the anticipated growth rate for this group of people over the next 1, 3, 5, or 10 years?
• What might those potential customers be willing to pay for this product/service?

By asking these questions, startups can get a better understanding of the total addressable market and the potential of their product or service.

How to calculate the total addressable market (TAM)?

TAM can be calculated by looking at the total number of potential customers, and the estimated revenue opportunity generated from each customer in a given segment. The general formula for calculating TAM is as follows:

TAM = Total Number of Potential Customers x Average Revenue per Customer

The total number of potential customers can be estimated by looking at the total population of the target market, the size of the target market, and the penetration rate of the current products or service providers. The average revenue per customer can be estimated by looking at the average purchase price of the existing products or services.

Methods of calculating the TAM?

There are three methods used to calculate the total addressable market, they include top-down, bottom-up, and value theory. 

• Top Down Approach: This method involves dwindling a known population to specific segments by eliminating portions of the population based on common characteristics. 
• Bottom Up Approach: This method involves primary market research, such as estimated usage and pricing from current market participants or surveys to determine the TAM. 
• Value Theory Approach: As the name implies, this method relies on an estimation of the value provided by a startup to its customers, and the related revenue generated from said product or service.

Use of total addressable market in financial modeling & valuation?

Total addressable market (TAM) is an important concept in financial modeling and valuation. 

Ultimately, TAM is a number, and as such the TAM of a business can be used in a financial model. One of the ways TAM may be used is to estimate the potential revenue that can be generated by entering a new vertical or market or expanding a product line. In this case, the TAM would be entered into a financial model with several other metrics and based on the outcome, the team would decide whether or not to pursue an opportunity.

TAM may also be used in discounted cash flow calculations, among a host of other factors, to determine the valuation of a startup. In general, the larger the TAM, the higher the potential for a large valuation down the line.

Common pitfalls to avoid when determining your total addressable market?

When determining your total addressable market, it is important to avoid the following pitfalls:

• Underestimating or overestimating the total potential market size – e.g. if you sold pencils, yes, hypothetically everyone in the world could use them, but realistically not everyone would want to.
• Underestimating or overestimating the potential revenue of your product or service — e.g. if you sold peanut butter, hypothetically you could charge $100 per jar, but realistically not everyone could afford it.
• Not accounting for the growth potential of the market—make sure to validate your growth assumptions with a reputable third-party data source such as Statista, IBISWorld, or McKinsey.

By avoiding these pitfalls, startup founders can get a better (and more accurate) understanding of the total addressable market and the related potential demand for their product or service.

Compared: total addressable market vs serviceable addressable market?

Total addressable market (TAM) is the total potential market size of a product or service. It is the sum of all the potential customers, users, and revenue that a company can attract, while the serviceable addressable market (SAM) is the portion of the TAM that can be realistically served. TAM is a combination of both the total available market and the serviceable addressable market.

For example, if a company wants to launch a new product in the United States, the total addressable market would be the total number of potential customers in the US multiplied by the average revenue generated per customer. Whereas, the serviceable addressable market would be the portion of TAM that could be realistically served by the company.

Compared: total addressable market vs service obtainable market?

Total addressable market (TAM) is the total potential market size of a product or service. It is the sum of all the potential customers, users, and revenue that a company can target, whereas the service obtainable market (SOM) is the portion of TAM that can be realistically served by the company. The SOM should always be smaller than the TAM.

For example, if a company wants to launch a new service in the United States, the total addressable market would be the total number of potential customers in the US multiplied by the average revenue generated per customer. The service obtainable market, on the other hand, would be the portion of TAM that could be realistically served by the company.

Final thoughts on total addressable market?

Total addressable market (TAM) is an important concept for startups and investors. The TAM provides an estimate of the total size of a market that a startup may capture so that founders and members of an executive team can prioritize opportunities. TAM also provides investors with a glimpse into the amount of revenue potential a startup has, should they capture the entire market—which can influence the ultimate valuation they assign to a startup. SOM and SAM help paint a much more accurate picture of the future potential of a startup, which explains they are more frequently used by investors than TAM.