As the engine room of any business, sales is all about growth. At the end of each quarter, you want to see bigger numbers than you saw three months previously.
When this doesn’t happen, it’s easy to become frustrated. But what if you are simply running out of people to sell to?
The only way to know for sure is by calculating your total addressable market (TAM). In this post, we’re going to take a look at what this term means, and how you can calculate the TAM of any service or product.
What Is Total Addressable Market (TAM)?
For any product or service, there are only so many people who are likely to become customers, and they only have so much money to spend.
Your total addressable market (TAM), or total available market, is the total amount of revenue you could generate from all of these deals combined. Alternatively, it can be expressed as the number of companies that could become customers.
TAM is obviously a theoretical figure. Even if you have a monopoly within a specific niche, the chances of finding and converting every single eligible prospect are impossibly small.
However, it’s still important to calculate the TAM for your particular product or service, for several reasons.
Why TAM Is Really Important for Your Business
When you’re trying to forecast sales and set goals for growth, it might be tempting to base your calculations on the competition.
But the truth is that every product or service has a unique TAM. Even subtle differences can make a big impact on the number of people who might be interested in making a purchase.
Calculating the TAM of your product or service has several benefits:
- Understand your potential for growth – Have you cornered a niche or are you only just getting started? TAM can answer this question and help you adopt the optimum business model
- Identify business opportunities – By putting resources into new products and services (or new markets) with a higher TAM, you’re more likely to see a healthy return on investment
- Impress potential investors – If someone is thinking about sinking cash into your business, you may be able to seal the deal by illustrating your potential for growth using a TAM calculation
You can even run TAM analysis on proposed products and services. This can reveal whether your idea has legs, or whether it will die due to a lack of potential customers.
TAM vs Market Segmentation
On a surface level, the process of market segmentation might seem similar to calculating TAM. However, there are some key differences.
While TAM tells you the total market size of a product or service, market segmentation reveals the various types of customer within that market. These groups can be based on a variety of factors, including demographics, budget size, online behavior, or location.
The Limitations of TAM
Clearly, TAM analysis can be a very powerful tool for businesses. But as with any metric, it has some limitations:
- TAM doesn’t consider competitors – The amount of revenue you see is never truly within your grasp, because you’re always going to have some competition
- TAM is only an estimate – At least a few of your assumptions about potential customers are likely to be wrong, meaning you may overestimate market size
- TAM doesn’t work well in emerging markets – If you operate in a very small niche or an emerging market, your TAM calculations are likely to be way off the mark
Even considering these possible issues, we still think most businesses can benefit from TAM analysis.
How to Calculate Your Total Addressable Market
There are three main ways to find the TAM of any product or service. Each method uses a different source of information, and has its own pros and cons. Your choice should depend on how accurate you want to be, how much time you want to spend, and what kind of business you have.
Let’s take a closer look at the options for now.
1) Top-Down TAM Method
By far the easiest way to calculate TAM is using the top-down method. This involves taking existing market studies or demographic data, and filtering the data to pick out potential customers.
For this method to work, you obviously need a reliable source of information for your specific market. The data also needs to be precise enough that you can pinpoint your particular slice of the pie.
Even then, top-down TAM produces only very rough estimates. It’s a technique that is designed to give you a macro-level overview, rather than a super-realistic analysis.
Example of Top-Down Approach
Imagine you run a software company out of San Francisco, and you want to find the TAM for your project management tool aimed at small businesses in your domestic market.
- Initial market research tells you there are 31.7 million small businesses in the U.S.
- You estimate that 80% of small businesses could benefit from using a project management tool
- Each business that signs up for your software subscription would be worth $240 per year (the annual contract value, or ACV)
- So your TAM calculation is…
- 31.7 million × 0.8 × $240 = $6,086,400,000 a year
2) Bottom-Up TAM Method
The complete opposite approach to calculating TAM is the bottom-up method.
This involves using your own data, or sourcing industry-specific data from sources like Gartner and Forrester. You then calculate your TAM based on analysis of your existing customer base.
The bottom-up approach is more labor intensive than the top-down method, or the value-theory method (see below). However, it provides the most accurate assessment of your total addressable market.
Example of Bottom-Up Approach
Let’s look at a slightly different example this time. Imagine you own a surf shop, and you want to figure out the TAM for a particular style of men’s board shorts in your local area:
- Say you sold 340 pairs of shorts in the past year
- And you sell them for $45 a pair
- Multiply the two: 340 × $45 = $15,300 per year
- Then, we multiply this figure by the number of surf shops in your town where those shorts are sold: $15,300 per year × 5 shops
- We end up with the TAM: $76,500 a year
If you run a service where you earn ongoing revenue from each customer, you begin by multiplying the number of sales by the annual value of each contract.
3) Value Theory TAM Method
An alternative option for calculating your TAM is the value theory method. This is based upon the value that your product or service provides, or the price a customer is willing to pay.
The key advantage of this approach is that you can estimate the potential for future products based on current, real-world data. This makes it very well suited to new entrants, or startups in new markets.
Example of Value Theory Approach
Returning to the topic of surfing — maybe you decided to make your own brand of shorts, which would be stocked at shops within your local area. Obviously, you don’t have any sales data. So what would the TAM be?
First, you need to estimate how much customers would be willing to pay for your new shorts, or simply identify your ideal price point. Then, you have to use existing market sales data to estimate the potential volume of sales, and your total revenue.
- Your new shorts are made from better quality materials, so you decide you want to sell them at a premium: $50
- You estimate that 60% of people who previously bought the cheaper brand would consider buying your new shorts
- Based on your sales figures for the other brand, that would mean selling 340 × 0.6 = 204 pairs of shorts a year
- 204 pairs of shorts × $50 = $10,200 a year
- And in your local area: 5 surf shops × $10,200 a year = $51,000 a year TAM
TAM SAM SOM: The Big Three
While TAM can be useful for estimating your potential for growth, it is also a fairly blunt tool.
If you want a better understanding of what you’re likely to achieve, you may want to try calculating your serviceable addressable market (SAM) and serviceable obtainable market (SOM).
How to Calculate Serviceable Addressable Market (SAM)
Whereas TAM provides a single-figure estimate of all potential revenue, serviceable addressable market (SAM), or serviceable available market, allows you to focus on the primary market segment that contains your target customers. This means you get a far more realistic view on any revenue opportunity.
To calculate your SAM, follow this formula:
TAM for target market × annual contract value (or sale price)
Using an earlier example: while anyone might buy board shorts, your SAM should probably focus on the watersports community.
How to Calculate Serviceable Obtainable Market (SOM)
Both your TAM and SAM calculations provide a snapshot of the market as it stands today. But to understand what fraction of the market you can actually hope to capture, you need to calculate your Serviceable Obtainable Market, or Share of Market (SOM). The formula looks like this:
Last year’s market share × this year’s SAM
The resulting figure will give you a fair idea of the maximum revenue you can expect to generate in the current year. You can also extend the calculation to future years to make a short-term estimate of potential growth.
Enhance Your Data With Datanyze
Clearly, each of the metrics mentioned above can provide a unique insight into your business and reveal new market opportunities.
But be aware that your TAM, SAM, and SOM calculations are only as good as the data you feed into each formula. If your sources are way off the mark, your calculations will be equally wayward.
Datanyze can help to enhance your industry research by revealing key information about pretty much any target customer. This means you can conduct your own primary analysis, and calculate your growth potential more accurately.
Just as importantly, Datanyze’s Chrome Extension provides instant access to the contact details for any potential buyer — meaning you should be able to drive sales more efficiently.