If you’re new to the business world, you may have heard the term “Total Addressable Market” but not know what it means. TAM is simply a way of calculating the market size for a product or service. In this article, we’ll teach you how to calculate TAM and perform your own TAM analysis.
Armed with this information, you’ll be able to make more informed business and product decisions and assess the potential success of your products and services—all very helpful for determining if a given initiative is worth pursuing!
Table of Contents
First, let’s take a look at why it is so important to make informed business decisions.
Before You Start: How to Make Informed Business Decisions
In order to make informed business decisions, you need to identify and gain access to accurate and timely information that is relevant to your product. This information can come from a variety of sources, including market research, customer surveys, financial reports, and more.
Gathering and interpreting this data is important because it allows you to:
- Understand your customers and their needs: By understanding your customers, you can better cater to their needs and wants. This, in turn, can help you boost sales and grow your product base.
- Identify opportunities and threats: By keeping up-to-date with industry trends, you can identify new opportunities to pursue or potential threats to avoid.
- Make sound strategic decisions: Keeping yourself informed can help you make better strategic decisions for your business. This includes decisions about expanding your business, launching new products or services, entering new markets, and more.
- Assess your competition: Keeping tabs on your competition can help you stay ahead of the curve and make better decisions.
- Develop strategies for marketing and selling your products or services: By understanding your target market and how to reach them, you can develop more effective marketing and selling strategies.
Total Addressable Market (TAM)
Now that we’ve gone over the importance of making informed business decisions, let’s take a closer look at Total Addressable Market.
TAM is the total potential revenue for a product or service in a given market. In other words, it’s the size of the pie that your business could potentially slice up. This is important for the following reasons:
- It provides a realistic goal to aim for: By understanding the potential size of the market, you can set more achievable goals for your business.
- It helps you assess the risks and rewards: Knowing the TAM can help you assess the risks and rewards associated with entering a particular market.
- It lets you know if there’s room for growth: If the TAM is large, it indicates that there’s room for your business to grow. Conversely, if the TAM is small, it may be time to look for new markets.
Total addressable market vs. market share
It’s important to note that TAM is different from market share. Market share is the percentage of the total market that your business currently controls. In other words, it’s the size of your current slice of the pie.
For example, let’s say that the TAM for a particular product is $100 million. If your business has a market share of 10%, that means you currently control $10 million of the total market.
The Advantages of a Thorough TAM Understanding
When it comes to TAM, there are a number of benefits, including:
- A more accurate assessment of your product’s potential: By understanding the TAM, you can get a more accurate assessment of your product’s potential. This is because you can compare your product’s performance to the size of the market.
- A better understanding of your competition: Knowing the TAM can also help you understand your competition better. This is because you can see how much of the market they are capturing.
- Improved decision-making: As we mentioned before, having a clear understanding of the TAM can help you make better business decisions. This includes decisions about product development, marketing, and sales strategies.
3 Ways to Calculate Your TAM
There are three different ways to calculate your TAM: top-down approach, bottom-up approach, and value-theory approach.
Top-Down Approach
In the top-down approach, to identify the TAM you make use of market reports, industry data, and research studies. You may use industry data from Forrester or Gartner to see which of your industry subsections align with the goals and offerings of your business. You’ll also be able to identify exactly how big those subsections are.
This doesn’t come without limitations. Sometimes, the data that is generated from the industry group is not kept as up-to-date as it should be. This also may not reflect the niche elements of your market. This is where a research consulting firm comes in. They’ll be able to conduct up-to-date research that is focused on your areas of need. This will likely come with a bigger price tag, but the return on investment is often worth it.
Bottom-Up Approach
Another way to calculate your TAM is from the bottom-up. In this method, you’re basing the TAM calculation on previous sales and pricing data. You’ll first need to multiply your average sales price by the total number of your customers. This will then give you your total addressable market. HubSpot has a great example of calculating TAM with the bottom-up approach.
Value-Theory Approach
This approach is built around how much value your customers will receive from your service or product. Then, it’s about how much they are willing to pay for these services or products in the future.
No matter which method you choose, it’s important to remember that the TAM is just a starting point. In other words, it’s not the be-all and end-all of your business strategy. Rather, it’s a tool that you can use to assess your product’s potential and make better business decisions.
The TAM Sizing Formula
Once you’ve decided on the method you’re going to use to calculate your TAM, it’s time to get into the nitty-gritty of the TAM sizing formula.
To calculate TAM, you need to multiply the total number of potential customers by a pricing metric. For example, this pricing metric could be the annual contract value, average order value or average selling price, and more.
Let’s say you are looking to use the average revenue per customer as your metric and you have a product that costs $100. You believe that there are 10,000 potential customers in your market. This means that your TAM would be $1 million (10,000 x $100).
It’s important to note that the TAM sizing formula is just a starting point. Once you have your TAM, you’ll need to dig deeper to understand your product’s potential. This includes understanding your competition, your customer’s needs, and your industry.
How to Interpret TAM
Once you’ve calculated your TAM, it’s time to start interpreting the results. Here are a few things you should keep in mind:
Having a large TAM doesn’t mean your product will be successful.
A large total addressable market doesn’t mean your product will be successful, but it is a proxy to your revenue and market opportunity. There are many factors that go into whether or not a product is successful. This includes things like the quality of your product, your marketing strategy, and your sales process.
A small TAM doesn’t mean your product will fail.
Similarly, having a small TAM doesn’t mean your product will fail. But, it can indicate that in the short-term, your revenue opportunity is lower, which could affect your analysis of TAM for your new business or business opportunity. Again, there are many factors that contribute to a product’s success. So, don’t write off your product just because the TAM is small.
TAM can change over time.
It’s important to remember that TAM is not static. It can change over time based on things like technological advancement, changes in the economy, and more. This means that you’ll need to regularly assess your TAM to ensure you have the most accurate data.
TAM is just one piece of the puzzle.
As we’ve mentioned, TAM is just one piece of the puzzle. To make sound business decisions, you’ll need to consider other factors like your competition, your customer’s needs, and your industry.
Now that you understand how to calculate Total Addressable Market and how to interpret the results, it’s time to put this knowledge into practice
Why You Should know your TAM before taking action
It’s important to know your TAM before you take action with your product for a number of reasons.
First, as we mentioned before, it can help you set more achievable and measurable goals. For example, your finance department could estimate your projected annual revenue for your product/service. Second, it can help you assess the risks and rewards associated with entering a particular market. And third, it can help you understand if there’s room for growth in your chosen market.
Knowing your TAM is an important part of any product strategy. By understanding the potential size of the market, you can make better decisions about product development, marketing, and sales strategies. This will inform your ultimate product vision.
So, if you’re looking to grow your business, be sure to calculate your TAM first.
Questions to Ask When Defining Your TAM
When you’re trying to define your TAM, there are a number of questions you should ask. These include:
What is the size of the overall market?
This is the first question you should ask when trying to define your TAM. By understanding the size of the overall market, you can get a better sense of how big your potential customer base could be.
What is the growth rate of the market?
Another important question to ask when defining your TAM is what the growth rate of the specific market is. This will give you a better sense of how fast the market is growing and if there’s room for your business to grow.
Who are your target customers?
It’s also important to understand who your target customers are. This will help you identify which subset of the specific market you should be targeting.
What needs does your product or service address?
Another important question to ask when defining your TAM is what needs does your product or service address. This will help you narrow down your target market and identify potential customers.
What are the substitutes for your product or service?
It’s also important to understand what substitutes there are for your product or service. This will help you assess the competition in the market and determine if there’s a need for your product or service.
By asking these questions, you can get a better understanding of your TAM and use it to your advantage through every stage of your business strategy.
How a TAM Analysis Drives Results
There are a number of ways in which a TAM analysis can drive results.
First, it can help you set more achievable goals. Second, it can help you assess the risks and rewards associated with entering a particular market. And third, it can help you understand if there’s room for growth in your chosen market.
1. Setting More Achievable Goals
One of the benefits of conducting a TAM analysis is that it can help you set more achievable goals. By understanding the potential size of the market, you can better assess how much market share you can realistically achieve.
This information is important when setting marketing, sales, and product development goals. Without a clear understanding of the potential size of the market, it’s easy to set goals that are either too small or too ambitious.
2. Assessing Risks and Rewards
Another benefit of conducting a TAM analysis is that it can help you assess the risks and rewards associated with entering a particular market.
By understanding the potential size of the market, you can better assess the potential rewards of entering the market. However, you should also be aware of the risks associated with entering a new market. These include competition, regulatory hurdles, and customer acquisition costs.
3. Understanding Room for Growth
Finally, a TAM estimate can also help you understand if there’s room for growth in your chosen market (i.e. total market demand). By understanding the potential size of the market, you can better assess if there’s an opportunity to increase your market share.
This information is important when making decisions about expansion plans. Without a clear understanding of the potential size of the market, it’s easy to make decisions that lead to oversaturation or under-exploitation of a market.
Differences Between TAM, SAM, and SOM
It’s important to understand the difference between TAM, SAM, and SOM when conducting a market analysis.
- TAM, as we’ve already covered, is the total potential market for a product or service. This includes all customers who could potentially use the product or service.
- SAM, Serviceable Available Market or Serviceable Addressable Market, is the target addressable market that is served by the services or products of a company.
- SOM, Serviceable Obtainable Market, is the percentage of SAM that can be achieved realistically.
If you need more clarity on these concepts, the Corporate Finance Institute has a great visual for TAM vs. SAM vs. SOM.
The importance of Serviceable Available Market (SAM)
SAM is important because it represents the portion of the market that a company can realistically target. By understanding SAM, companies can better assess their opportunities for growth and make informed decisions about their business strategies.
In order to calculate SAM, you need to first identify your TAM. Once you have done this, you can then identify the portion of TAM that your products or services can realistically reach. This will give you your SAM.
It’s important to remember that your SAM will change over time as your products and services evolve. As such, it’s important to regularly review your SAM and make adjustments to your business strategy as needed.
The importance of Serviceable Obtainable Market (SOM)
SOM, on the other hand, is important because it represents the portion of the market that a company can realistically obtain. As with SAM, this allows companies to make informed decisions about where they are looking to take their business and what opportunities lie ahead for them.
When conducting a market analysis, it’s important to understand the difference between TAM, SAM, and SOM. This will help you assess the potential size of the market and set more realistic goals for your business.
What Are the Risks of Not Conducting a TAM Analysis?
There are a few risks associated with not conducting a TAM analysis.
1. You may set unrealistic goals: Without a clear understanding of the potential size of the market, it’s easy to set goals that are either too small or too ambitious.
2. You may miss out on opportunities for growth: A TAM analysis can help you assess the risks and rewards associated with entering a particular market. By understanding the potential size of the market, you can better assess the potential rewards of entering the market.
3. You may make decisions that aren’t appropriate for the market size: Without a clear understanding of the potential size of the market, it’s easy to make decisions that lead to oversaturation or under-exploitation of a market.
4. You may waste time and resources pursuing markets that are not viable: A TAM analysis can help you assess the viability of a market before investing time and resources into pursuing it.
5. You may miss out on important insights about your customers, competitors, and the market landscape: A TAM analysis can provide valuable insights into your customers, competitors, and the overall market landscape.
Why is TAM Important for Product Managers?
TAM allows product managers to fully understand the “shape” of a market, this will inform your pricing strategy given your estimate of the total available market, demographics, and other key data points collected in your TAM analysis. Once you have a grasp on your TAM, you can build your product strategy for a specific market.
Conclusion
A TAM analysis is a valuable tool for PMs at companies of all sizes. By understanding the potential size of the market, companies can better assess their opportunities for growth and make informed decisions on business opportunities for their product/service.
If you’re not already conducting a TAM analysis, we recommend that you start today. It could be the difference between success and failure for your business model and product. If you don’t already, subscribe to our newsletter below to learn more about TAM and other product topics.