Before you start a business, it’s often a good idea to know about the overall market size and potential revenue opportunities for a product, service, or even an entirely new business idea. Enter the total addressable market, or TAM.
TAM helps you estimate the total demand and monetary value for your business idea, considering factors like market size, annual contract value, and industry alignment. This information, often gathered from industry reports or data generated from your own business line, can help you gauge the maximum revenue achievable if every single potential customer bought your product or service. It can also help you estimate your growth rate, should your product find success. Here are some ways to calculate TAM as you assess a potential business opportunity.
What is total addressable market?
Total addressable market (TAM) refers to the entire revenue opportunity for a particular product or service. It essentially estimates the total market size if every single potential customer bought the product at a given price. (Note that some people use the acronym TAM to refer to “total available market,” and this phrase is used interchangeably with “total addressable market.”)
Why is TAM important?
Whether you’re exploring new markets or focusing on your current customers, TAM provides a comprehensive picture of the revenue opportunities a product or service could generate. Potential investors are especially interested in TAM because it indicates the potential for growth and market share.
Calculating TAM is important for a few reasons:
- It helps you gauge market potential. TAM provides a high-level view of the overall market size, indicating the maximum potential revenue achievable.
- It allows you to make informed decisions. Understanding TAM lets businesses decide whether to invest in a particular product or service, considering the potential for growth and profitability.
- It helps you set realistic goals. TAM helps you chart a growth strategy and set achievable sales targets by understanding the market’s capacity.
- It provides a benchmark against competitors. By comparing TAM estimates with a company’s serviceable available market (SAM), which is the portion of the TAM it can realistically reach, a business can assess its market share and growth potential.
TAM does not negate the need for your business to offer a superior product to gain market share. But it is an important element of market research, helping businesses decide how and whether to pursue a business opportunity.
How to calculate total addressable market
There are multiple approaches to calculating total addressable market , each with its own advantages and disadvantages. Here are three ways to calculate TAM:
Top-down approach
The top-down method starts by considering the entire market and breaking it into subgroups to estimate the TAM. Here’s the formula:
TAM = (Total potential customers) x (Average revenue per user)
Here, total potential customers are calculated using market size and penetration rate. So:
TAM = (Total market size) x (Market penetration rate) x (Average revenue per user, or ARPU)
Where “total market size” is the entire population in the relevant market (e.g., population of Miami), “market penetration rate” is the estimated percentage of the total market that will adopt your product or service, and “ARPU” is the amount of revenue you expect to generate from each customer.
The advantages of this approach include a quick and high-level view of the total market opportunity. The formula also makes good use of existing industry data.
However, this method can include unreliable assumptions about market penetration rate. It also may not accurately assess niche markets or demand for innovative products—the types you might see offered by a fledgling startup.
Bottom-up approach
The bottom-up method assesses a company’s total addressable market through the lens of market segments.
Here’s how you’d calculate TAM using the bottom-up approach:
1. Identify a well-defined target market segment, for example, parents of children under five.
2. Estimate the number of potential customers within that segment.
3. Determine the average revenue per customer. For most companies, this means leveraging previous sales reports about existing customers. This gives you the annual contract value (ACV).
4. Multiply the ACV by the number of potential customers.
5. Repeat steps one to four for all relevant customer segments.
6. Sum the TAMs of all segments to get the total TAM.
The major advantage of a bottom-up analysis is that it’s a more granular and potentially more accurate way of accounting for specific market segments.
However, it’s a more labor- and time-intensive method, which starts with amassing detailed customer data. This approach may also miss unidentified segments of potential customers, or even entire emerging markets.
Value theory approach
The value theory approach estimates TAM based on the value proposition of your product or service. Here’s how to calculate TAM using the value theory approach:
1. Clearly define the value proposition of your product or service.
2. Identify the total population or entities that could benefit from your value proposition.
3. Estimate the maximum price customers would be willing to pay to solve the problem your product addresses.
4. Multiply the total potential customer base by the maximum willingness to pay to get the TAM.
This approach can be advantageous when considering innovative products or services that target new markets. What’s more, it considers the customer’s perspective and potential value perception when assessing a TAM.
Disadvantages to this approach include relying on assumptions about customer willingness to pay. An over-reliance on this can make it challenging to quantify the true value proposition of a product or service.
TAM vs. SAM vs. SOM
- Total addressable market (TAM)
- Serviceable addressable market (SAM)
- Serviceable obtainable market (SOM)
- Relationship between TAM, SAM, and SOM
Total addressable market, serviceable available market, and serviceable obtainable market are three interrelated metrics used in business and marketing to estimate the market size and potential revenue for a product or service. They represent progressively narrower segments of the overall market, each with its own implications for strategic planning and resource allocation. Here’s a breakdown:
Total addressable market (TAM)
TAM represents the entire potential market for a product or service, encompassing all potential customers. It’s a hypothetical scenario where the company has no competition and can reach every possible customer. In the real world, no business can enjoy total market demand, no matter the appeal of the company’s products. Still, many companies start their survey of the market landscape by calculating TAM. The TAM calculation process typically takes a top-down approach, considering the overall market size and potential adoption rates.
Serviceable addressable market (SAM)
SAM stands for “serviceable addressable market,” but it can also stand for “serviceable available market.” It’s a subset of TAM that focuses on the segment of the given market that a company can realistically target and serve. This includes factors such as geographical reach, product-market fit, marketing capabilities, and the competitive landscape. SAM typically is determined by considering your company’s resources, capabilities, and target audience. From this, you can assess your place in the competitive landscape and estimate the market share you can expect to claim.
Serviceable obtainable market (SOM)
SOM represents the portion of the SAM that a company can realistically capture within a given timeframe. This is the most achievable and measurable market segment, reflecting the company’s current market share, sales goals, and competitive positioning. You calculate SOM by considering historical data, market potential, and competitive analysis. You may need to research companies that share your specific market, taking note of their average sales price per item.
Relationship between TAM, SAM, and SOM
You can visualize relationships among TAM, SAM, and SOM by picturing concentric circles. SOM represents the innermost circle, SAM is the middle circle, and TAM is the outermost circle. Each circle represents a smaller and more achievable market segment. Your primary market research might start with a total addressable market calculation, but as you narrow down toward the serviceable obtainable market, you’ll have a more realistic sense of your target audience, potential scale, and revenue opportunity.
Total addressable market FAQ
What is an example of a TAM?
What is the formula for calculating total addressable market?
Is TAM the same as market size?
TAM stands for total addressable market. It is slightly different from the term market size because it considers the entire market, even if it’s not reachable by a specific business.
What is the formula for calculating total addressable market?
TAM = (ARPU) x (Total potential customers)
In this formula, ARPU equals the average revenue per user (essentially, average customer spending), and total potential customers is the total number of all potential customers in the market.
