Total Addressable Market (TAM)

How to Calculate Total Addressable Market (TAM)

The TAM, a shorthand abbreviation for “Total Addressable Market”, is a measure of the entire revenue potential within a particular market (or sub-market).

In simple terms, the total addressable market (TAM) reflects the revenue that a company could theoretically generate, assuming a 100% market share.

For companies of all sizes—ranging from early-stage startups to established, low-growth companies—market sizing is an essential step in determining the growth potential of the company.

• Early-Stage ➝ Startups estimate the market size to see if a market, and the implied revenue opportunity, is worth undertaking the risk.
• Growth-Stage ➝ Growth companies track the market size to measure their progress at capturing market share and to estimate the remaining upside potential that can be attained.
• Late-Stage ➝ Mature companies are attentive to the market size to decide if the current revenue is sustainable or if a strategic pivot is necessary via market expansion (i.e. introduce new products or services, expand into international markets).

The total addressable market (TAM) of a company can be expressed in terms of the total number of potential customers, split out by customer types (e.g. SMBs, large enterprises).

However, the far more prevalent method in practice is for the TAM to be measured in terms of revenue rather than potential customers.

Total Addressable Market (TAM) Formula

The most basic method to estimate the total addressable market (TAM) is the top-down method.

The top-down approach provides a broad estimate by multiplying the average revenue per user (ARPU) by the total number of potential customers.

Of course, the market size must be further analyzed and distilled to arrive at a more accurate figure. But as a “back-of-the-envelope” method, the formula should suffice.

The average revenue per user (ARPU), on the other hand, is an assumption that should be based in accordance with historical precedence and market data on comparable products (or adjacent offerings).

In short, the ARPU must reflect the pricing that customers should be willing to pay, which should be a function of the value delivered to the customer.

Conversely, the revenue metric can be switched with the annual average contract value (ACV), which pertains to the SaaS industry and subscription-based businesses.

If a startup seeks to acquire 10% of a market sized at a $1 billion TAM, that implies a target revenue of approximately $100 million.

• Implied Revenue = 10% Take Rate × $1 billion = $100 million

Market Sizing: How to Analyze TAM

The implied total addressable market (TAM), even if well-thought-out, is simplified calculations at the end of the day. Hence, market sizes are never taken at face value, especially for startups pitching to venture capital (VC) firms.

In fact, the real value of measuring the TAM stems from the basic principle of “knowing your customer”, as part of performing market research.

If a company cannot quantify a range for the TAM of its product offerings (or perhaps did not even attempt to arrive at a ballpark figure), that implies the company does not even know the number of potential customers there are.

Furthermore, a company that does not know how many customers can be obtained, in all likelihood, cannot build a defensible forecast model and share the extracted insights to investors in the process of raising outside capital from institutional investors.

The other benefits of companies calculating their TAM, aside from estimating the total potential revenue,, are as follows:

• Identify New Opportunities for Growth and Market Expansion
• Build Connections to Investors with Aligned Interests (i.e. Venture Capital, Growth Equity, Late-Stage Private Equity)
• Create Sales and Marketing (S&M) Campaigns per Customer Segment (i.e. Targeted Marketing)

Over time, as a byproduct of TAM analysis and the proper implementation of the data, a company should see improved growth from well-defined strategies and better customer retention (i.e. low churn rates).

TAM vs. SAM vs. SOM: What is the Difference?

The TAM, SAM, and SOM represent subsets within a market, with each listed in descending order.

• TAM ➝ “Total Addressable Market”
• SAM ➝ “Serviceable Available Market”
• SOM ➝ “Serviceable Obtainable Market”

1. Total Addressable Market (TAM)

• The total addressable market (TAM) is an all-encompassing, “birds-eye” view of the entire market landscape.
• The total addressable market (TAM) demonstrates the entire revenue opportunity that exists within a particular market segment for a product or service.
• TAM is thereby the maximum amount of revenue that could be generated within a specific market, with the least strict filters applied in terms of counting potential customers.

2. Serviceable Available Market (SAM)

• The serviceable available market (SAM) is the proportion of the TAM that actually needs the company’s products or services.
• The serviceable available market (SAM) carves the TAM into sub-markets that cater towards different types of customer segments.
• From TAM, we start with the largest potential revenue value and then subsequently reduce it using company-specific information and market assumptions to arrive at the SAM.
• The SAM attempts to depict the percentage of the TAM that could realistically become customers someday given their customer profile and need for the company’s offerings and/or the business model (e.g. based on location, pricing tiers, technical capabilities, accessibility).

3. Serviceable Obtainable Market (SOM)

• The serviceable obtainable market (SOM) calculates the current market share of the company to account for the portion of the SAM that can realistically be extended as the market grows.
• The serviceable obtainable market measures the revenue that can realistically be captured by a business in the near-term (or perhaps, long-term).
• The underlying assumption here in the SOM calculation is that the company can retain its current market share in the foreseeable future.