Total Addressable Market (TAM) — how to calculate market size for your pitch
Total addressable market (TAM) demonstrates ‘the entire revenue opportunity that exists within a market for a product or service’.
Why a large Total Addressable Market (TAM) is important
It shows investors you are chasing a big enough opportunity.
All things equal, the larger the Total Addressable Market (TAM), the bigger the potential revenue opportunity. When pitching, you need to convince investors that your business is chasing a sufficiently large opportunity to justify their investment risk.
Some VCs will invest in companies going after a smaller TAM but the bigger the TAM the greater the eventual upside.
The best pitches see founders leverage their TAM analysis to provide insights into how they think about the market and their product-market fit.
Free Download — Pitch Hive market size sensitivity analysis tool to calculate your estimated TAM, SAM and SOM.
How big should your TAM be?
$1bn +
For investors to achieve outsized returns, their investments need to be in companies operating in large markets. Not all businesses need to operate in huge potential markets (think lifestyle business), but if you are seeking investment for a startup then the potential opportunity needs to be large enough to outweigh the high risks. A TAM of under $1bn won’t be a deal-breaker for all Investors but it will be for some.
Before we explain the ways to calculate the Total Addressable Market, let’s identify a few other key terms when pitching to investors about the potential market size you are targeting. These are Serviceable Addressable Market (SAM) and Serviceable Obtainable Market (SOM)
Serviceable Addressable Market (SAM)
SAM = % of TAM being targeted
This is the portion of the TAM that is being targeted. For example, Patch offers houseplants and pots throughout the UK. Their TAM would be global houseplant sales, but they are only currently targeting UK based customers so their SAM would be Total UK house plant sales.
Serviceable Obtainable Market (SOM)
SOM = % of SAM you can realistically obtain
This is the portion of SAM that you can realistically capture in the short to medium term.
Startups often start by targeting a specific market segment or group of customers that they believe will provide most initial traction.
The diagram below provides a visual representation of the TAM, SAM and SOM relationship.
How to calculate Total Addressable Market (TAM)
The two main variables to identify in the TAM calculation are average revenue and number of customers.
TAM = average revenue * total number of potential customers
There are four main ways to calculate TAM
- Top-down
- Bottom-up
- Value theory
Top-down
Start with a universal data set and apply, macroeconomic and demographic data alongside third party research to define your Total Addressable Market.
In this methodology, reference is made to work done by established research firms such as CB Insights or Gartner. They may have already calculated the TAM for the market you operate in. You can then logically apply macroeconomic and demographic data to eliminate irrelevant segments. There is a vast trove of data available from government bodies, charities, international trade organisations and think tanks, just as an example.
Advantages:
- Quick
- Credible
- Detailed analysis
Disadvantages:
- Access can be expensive
- Not conducting your own research may impair your understanding of the market
- Research methodology may not be totally clear
Bottom-up
Local primary data is extrapolated across the broader population.
A primary research method where you start by quantifying a subsect of a market, either via customer surveys or by use of existing data (e.g. company reports), and then extrapolate that across the broader population. For example, if a business operating in the market has a 10% market share and their revenue for that sector equals £100m, then you could extrapolate that number to give a TAM of £1bn.
Advantages:
- Primary research
- Potential for improved accuracy
- You will gain a solid understanding of the market you operate in
- Improved competitor analysis
Disadvantages:
- Risk of sampling error
- Extrapolation inaccuracies
- Time-consuming
- Data collection difficulties
Value Theory
The value theory is used when assessing a market for a totally new or improved product or service that has not existed before. It requires an estimate of the buyers willingness or reluctance to make the purchase, or the ‘value-add’ of the product. It is this assigned ‘value’ figure that enables you to estimate willingness to pay and therefore the number of customers and price point to assess your market size.
Advantages:
- Useful for totally new products or services
- Flexible
Disadvantages:
- Abstract, by necessity
Free Download — Pitch Hive market size sensitivity analysis tool to calculate your estimated TAM, SAM and SOM.
Conclusion
The Total addressable market (TAM) concept is important for your pitch. Typically VC Investors look for large TAM opportunities in the tune of $1bn+. TAM can be calculated using the ‘Top-down’, ‘Bottom-up’ and ‘Value Theory’ methodologies.
Once you have calculated your estimated TAM, you can then identify your SAM and SOM.
Assessing the potential market opportunity can be difficult and require some ‘guesswork’, however, it is well worth the time to include a TAM slide in your pitch deck and elevator pitch and to fully research the market you are operating in.
Pitch Smarter. Raise Money Faster.
Originally featured: https://pitchhive.com/total-addressable-market-tam-how-to-calculate-market-size-for-your-pitch/
