Deciding to start or expand a business can be risky. Hence, gauging the business profit potential or being able to forecast a realistic revenue growth goal for your business is important. Which is why understanding the Total Addressable Market is a crucial first step in this venture.
The Total Addressable Market (TAM) in simple words pertain to the total available market where your business can thrive. It defines the overall revenue opportunity that is available to your business if 100% market share was achieved. It can give you an idea of how much effort and funding you can put into your business.
Why Is It Important?
Understanding this concept is vital if you are starting a business because the estimates of effort and funding required can guide you in prioritizing specific finances, customer segments, and business opportunities. It can provide a viable value proposition for your potential investors by showing a picture of the market size, size of the overall investment, competition, growth expected and amount of revenue your business can possibly generate when operating in the market.
To break it down, these are the 3 methods in calculating the Total Addressable Market:
TOP DOWN
Focuses on industry research and reports to get an estimate of the population.
Using the process of elimination: take a large population size of the known size of the target market and narrow it down to a specific market segment.
An example of this simply taking the statistics of sale of a product and multiplying it to the number of customers you are targeting. The result is always an assumption with no tangible proof.
BOTTOM UP
A more reliable approach that utilizes primary market research – tangible data on the current pricing and usage of a product, then projects it into a larger consumer base.
In simpler terms, “this is the price and how many units of that price we can sell”.
Example: A software business selling its service at $20 per employee per month. TAM can be estimated by taking the number of employees in its target market and multiply that by pricing to estimate the revenue.
VALUE THEORY
This is a TAM result from using the conjecture about buyer willingness to pay. It is an estimate from the buyer’s value of the product and how much that value is reflected in the price.
Applicable when a company is introducing new products into the market. Or cross-selling certain products to the existing customers.
Example: Uber has an option where customers can drive themselves. Since users are willing to pursue all these alternatives and choose Uber, the company can estimate the value that these users derive from using Uber. This allows them to determine how to capture the value in its pricing.
Recap
Lastly, This is a representation of the various subsets of a market and their differences.
TAM = Total Addressable Market
SAM = Serviceable Available Market: the target addressable market that is served by a company’s products or services.
SOM = Serviceable Obtainable Market: the percentage of SAM that is realistically achieved
Understanding the value of each category for your business definitely requires market research. Do you know the TAM in your niche? Do you feel this is an important aspect to know? Let us know!
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