What is TAM?
The Total Addressable Market (TAM) is the estimated market demand for a certain product or service, which can be used to size the implied revenue opportunity attributable to a particular company.
How to Calculate TAM?
TAM, shorthand for the “Total Addressable Market,” is representative of the entire revenue potential within a particular market.
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 calculate the market size to see if a market is even worth attempting to disrupt.
- Late Stage: Mature companies use the metric to evaluate their remaining “upside” potential and to look elsewhere if deemed appropriate (i.e. introduce new products/services).
The TAM of a company could sometimes be expressed in terms of the total number of potential customers, split out by customer sizes.
However, the far more prevalent method is for the TAM to be measured in terms of revenue.
If a startup seeks to grab 10% of its $1 billion TAM, that implies its target revenue is approximately $100 million.
How to Interpret TAM?
TAM figures, even if well-thought-out, are 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.
The real value of calculating the TAM stems from the basic principle of “knowing your customer.”
If a company does not know its TAM or did not even attempt to get to a ballpark figure, that implies the company does not 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 provide a defensible projection model to investors when raising outside capital.
Besides estimating the total potential revenue, other benefits of companies calculating their TAM are as follows:
- Identify New Revenue Opportunities
- Find Investors with Aligned Timeframes (i.e. Venture Capital, Growth Equity, Late-Stage Private Equity)
- Targeted Sales & Marketing Campaigns for Different Customer Segments
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)
- To break each down further, the TAM – as we defined earlier – is an all-encompassing, “birds-eye” view of the entire market landscape.
- 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)
- Next, the serviceable addressable market (SAM) is the proportion of the TAM that actually needs the company’s products/services.
- 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)
- Finally, 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 underlying assumption here in the SOM calculation is that the company can retain its current market share in the foreseeable future.
TAM vs. Market Share: What is the Difference
Since it is practically unattainable for a company to be a monopoly in a large market, that means all participants are forced to share the total addressable market (TAM).
Even if a market leader – let’s say, Google in the search engine vertical, for example – gains a new, small competitor, the TAM is regardless technically what is being “split.”
- Market Share → The market share refers to the amount of TAM attributable to a specific company.
- Total Addressable Market (TAM) → That said, the TAM is the revenue opportunity assuming 100% market share.
TAM Example: Airbnb Market Opportunity
For example, Airbnb estimated its serviceable addressable market (SAM) to be around $1.5 trillion.
Based on the company’s internal analysis on the travel market and experience economy, Airbnb arrived at a total addressable market (TAM) of $3.4 trillion, which comprises $1.8 trillion for short-term stays, $210 billion for longer-term stays and $1.4 trillion for experiences.
Airbnb Market Opportunity (Source: Airbnb S-1)
Flaws of TAM: Uber IPO Example (Bill Gurley)
The total addressable market (TAM) metric is often criticized for reflecting inflated figures to raise optimism (and capital) from investors, who tend to place minimal weight on the metric.
However, the opposite can also occur, as seen in the case of Uber, one of the leading companies in the modern transportation and delivery services verticals.
Early on, many passed on Uber, with much vocal criticism surrounding its valuation.
“How to Miss By a Mile: An Alternative Look at Uber’s Potential Market Size” – Bill Gurley (Source: Above The Crowd)
The reason is that many viewed it as just a black car service for affluent consumers – whereas other forward-thinking investors like Gurley considered the capacity for a startup to completely disrupt and create new sub-segments within a market.
“The most successful companies make the core progression—to first dominate a specific niche and then scale to adjacent markets—a part of their founding narrative.”
– Peter Thiel, Zero to One
Similar to Uber, many startups nowadays target a specific niche with plans to later scale into adjacent markets later on as management continues to improve upon the business model and market strategy.
By establishing a meaningful presence in one niche and then attempting to achieve massive scale across multiple markets, the chance of success is substantially higher than reaching for all markets at once.