What is Total Addressable Market and How Do You Calculate It?

Have you ever wondered what the maximum revenue potential is for a product or service? Understanding the total addressable market (TAM) can help you determine just that

In this comprehensive guide, we’ll explain what total addressable market is, why it’s important, and how to calculate it using different methods By the end, you’ll have a clear understanding of this crucial business metric

What is Total Addressable Market?

Total addressable market, commonly referred to as TAM, refers to the total revenue opportunity available for a product or service.

It represents the overall demand for the product/service if 100% market share was achieved. Of course, most companies cannot realistically capture 100% of a market, but TAM helps set the overall size of the opportunity.

TAM helps businesses:

• Gauge the revenue potential for a new product/business line.
• Prioritize specific products, customers, and opportunities.
• Determine the level of investment required to capture a market.

For both startups and mature companies, understanding total addressable market is a vital early step to evaluate new opportunities.

Why Calculate TAM?

Here are some of the key reasons businesses should measure TAM:

• Size the revenue potential – TAM helps estimate the total revenue opportunity if you could reach 100% of potential customers. This helps determine if an opportunity is worth pursuing given the investment required.

• Set growth goals – Once you know your TAM, you can set realistic short and long-term growth goals for revenue and market share.

• Prioritize opportunities – A large TAM indicates major potential. You can focus energy and resources on high-TAM products/customer segments.

• Attract funding – TAM shows investors your market’s scale. A large, underpenetrated TAM can get investors excited about growth potential.

• Inform product development – Understanding your target customers helps tailor products to their needs and maximize adoption.

• Identify threats/opportunities – A changing TAM may indicate developing threats or new opportunities in your market.

Regularly updating your TAM estimates will help guide strategic decisions and prioritization. With realistic TAM forecasts, you can set achievable objectives and allocate resources efficiently.

How to Calculate Total Addressable Market

Now let’s look at methods to estimate total addressable market for a product or service. There are three main approaches:

Top-Down Approach

This method uses existing market research and data to incrementally narrow down the target market. The steps are:

1. Identify the total market – Research the total size/value of the broad market the product fits into.

2. Define your segment – Identify the specific segment you are targeting within that total market.

3. Adjust for accessibility – Factor in which parts of the segment you can realistically serve.

For example, a cloud storage provider’s TAM calculation may go:

• Total cloud services market size = $200 billion
• Cloud storage segment size = $50 billion
• TAM = $50 billion x 50% accessible market = $25 billion

This top-down approach is quick and leverages existing market data. However, secondary data may not be fully up-to-date or capture niche factors.

Bottom-Up Approach

This method involves primary market research to build up an estimate from the bottom. The steps are:

1. Estimate market size – Use surveys, interviews, etc. to estimate the number of potential customers.

2. Define your segment – Focus on the specific segment you plan to target.

3. Estimate pricing – Determine likely price points based on customer research.

4. Calculate TAM – Multiply your segment size by average price per customer.

A software company selling accounting software for $100/customer may determine:

• 50,000 potential customers in target small business segment
• TAM = 50,000 customers x $100 per customer = $5,000,000

The bottom-up approach takes more effort but can yield an accurate, customized TAM.

Value Theory

This method focuses on the value delivered to the customer and portion captured through pricing. Follow these steps:

1. Estimate value created – Evaluate how much value your product adds for the target customers.

2. Determine pricing potential – Based on the value created, set optimal pricing to capture a share of that value.

3. Calculate TAM – Multiply the target segment size by potential pricing.

For example, an on-demand delivery service may determine:

• Saves customers 2 hours per week of time = $50 value per week
• Can charge $10 per delivery and capture $500 of value per customer annually
• 1 million target customers -> TAM of $500 million

The value theory approach helps align TAM with the value proposition and optimal pricing. However, the value estimates may be somewhat subjective.

TAM vs. SAM vs. SOM

TAM refers to the total theoretical market size. Two related metrics provide a more realistic view:

• Serviceable Available Market (SAM) – The segment of TAM targeted and served by your products and services.

• Serviceable Obtainable Market (SOM) – The portion of SAM you can realistically capture.

For example:

• TAM = $1 billion
• SAM = $500 million (50% of TAM)
• SOM = $50 million (10% of SAM)

TAM establishes the total potential, while SAM and SOM focus on strategic segments you actually plan to pursue.

Real World Examples of TAM

Let’s look at some real world examples of companies analyzing their total addressable market:

• Netflix: Assessed global TAM for their streaming service at $500 billion per year including $100 billion in the U.S. Based on this, they saw substantial room for continued growth.

• Salesforce: Estimated their global CRM software TAM at $158 billion, with $54 billion in North America. Their market leadership and growing market size signaled strong prospects.

• Tesla: Views automotive TAM as $10 trillion with electric vehicles making up just 1% currently. Massive room for electric vehicle adoption makes their growth potential clear.

Regularly reevaluating TAM has helped these companies recognize growing opportunities to fuel their continued expansion.

Importance of Updating Your TAM

Markets are constantly evolving, so your TAM estimates will need to be updated to remain relevant.

Factors that may change your TAM include:

• New customer segments
• Changing demographics
• New use cases
• Increased access
• Competitor activities
• Technology shifts

Revisiting your TAM annually or biannually is recommended to keep your estimates current. Refresh the data inputs and research to capture any market changes.

Updating the TAM will ensure your decisions are guided by the most accurate view of the revenue potential moving forward.

Calculating your total addressable market is a key process to understand the scope of revenue opportunities. TAM, along with SAM and SOM, provides an objective view of your market landscape.

Leverage these best practices to accurately estimate your company’s total addressable market:

• Use multiple approaches to triangulate an estimate: top-down, bottom-up, and value theory.

• Conduct primary research for most reliable data inputs.

• Regularly update TAM to reflect market changes over time.

• Use TAM to inform strategic decisions and gauge growth potential.

Taking the time to research your addressable market will pay dividends through better planning and execution. Now get out there, size up your TAM, and capture the opportunities!