What Is Total Addressable Market: How To Perform a TAM Analysis
If you're a product manager and you've performed market research analysis, you know that there's no one size fits all approach. Back when I used to work for a software development startup, I learned this the hard way.
We once rushed a feature release to match competitors at a client's insistence, believing it would capture more market share. Despite our doubts, we secured extra funding and conducted a TAM analysis. I struggled to find clear target market data, often finding myself off track. Under pressure, I reported a potential million-dollar market. We met the deadline, but the feature's user adoption and revenue fell short of our projections, proving our market assumptions were flawed.
As painful as that experience was, I grew to understand that instead of looking for market specifics on what has happened, we should be looking for market potential based on what is happening.
Identifying a market requires identifying context. You have to strive to identify how you can address the target market over a specific period of time. Understanding this distinction is what ensures that discovering a Total Addressable Market (TAM) can actually lead to real sales.
What is Total Addressable Market (TAM)?
In regard to principles of business, "Total Addressable Market" or “TAM” is a way of calculating the potential market size for a specific product or service. Think of it as a way to identify the total number of potential customers you could reach with your idea.
TAM is the total potential revenue for a product or service in a specific market. In other words, it's the size of the pie that your business could potentially slice up. Calculating your TAM is important for the following reasons:
- It provides a realistic goal to aim for: By understanding the potential size of the market, you can set more achievable goals for your business.
- It helps you assess the risks and rewards: Knowing the TAM can help you assess the risks and rewards associated with entering a particular market.
- It lets you know if there's room for growth: If the TAM is large, it indicates that there's room for your business to grow. Conversely, if the TAM is small, it may be time to look for new markets to enter.
Why is TAM Important?
TAM allows product managers to fully understand the “shape” of a specific market. To ascertain the market shape, you get a sense of various aspects such as the competitive landscape, number of competitors, their market shares, the total number of potential customers, and how the buyers and sellers behave within that market.
Building this level of insight from your market analysis will inform your product strategy given your estimate of the total available market, demographics, and other key data points. Discovering your TAM can also help identify opportunities and threats, assess competitive pressures, and make informed decisions about pricing, go-to-market positioning, and product differentiation.
Once you have a grasp on your TAM, you can build your product strategy for a specific market and fine-tune how to differentiate your company’s product from the competition.
The Difference Between TAM Versus Market Share
It's important to note that TAM is different from the market itself, and market share. Let’s clear up the distinctions between the three.
- The market itself is a result of what has happened. It’s defined by the current sales of the product or service category your business falls into, and the performance of all the businesses in competition.
- Market share is the percentage of the market that your business currently controls. In other words, it's the size of your current slice of the pie compared to all the other businesses that are in competition with you. Not only do your competitors want a greater piece of the pie, they also want the piece that you have.
- TAM is the total demand within a specific market segment. This demand is the potential revenue to be made within a market if all the potential customers spend money on the product or service. This is what businesses also compete for, and is also described as “market opportunity.”
For example: Say that the TAM for the rideshare segment in the transportation market is $200 million. If Uber has a market share of 60%, that means Uber controls $120 million of potential revenue in the market segment.
5 Questions to Ask When Defining Your TAM
When you’re working to define your TAM, here are some questions you should ask:
- What is the size of the overall market? This is the first question you should ask. It’s how you get a sense of the size of your potential customer base.
- What is the growth rate of the market? By finding out the market growth rate, you get a sense of how fast the market is growing and if there's room for your business to grow. If you learn that the market does not show potential for growth, then it means that the market will shrink, so get the answer to this question ASAP.
- Who are your target customers? Understanding who your target customers are helps you identify which customer segment of the market you should target. It helps to distinguish between the buyers, the users, and in light of social media, the influencers. If possible, also find out their reasons for wanting the product. These groups have different demographics, subsets, and motivations so you'll want to understand how the people in these groups contribute to your goals for conversion.
- What needs do your specific product or service address? By understanding the needs, it will help you to narrow down your target market and identify potential customers. You can use a jobs-to-be-done approach and uncover what the customers are trying to accomplish in their respective situations.
- What are the substitutes for your new product or service? Identifying the substitutes helps you to evaluate the competition in the market and determine if there's a need for your product or service.
How to Calculate Your TAM: 3 Methods
There are three different ways to calculate your TAM: top-down approach, bottom-up approach, and value-theory approach. The one you choose will depend on your market niche, your business model, and your company’s maturity.
1. Top-Down Approach
In the top-down approach, you make use of market reports, industry data, and research studies to measure your TAM. You may use industry data from Forrester or Gartner to see which of your industry subsections align with the goals and offerings of your business. You'll also be able to identify exactly how big those subsections are.
This doesn't come without limitations. Sometimes, the data generated from the industry group is not kept as up-to-date as it should be. It also may not reflect the niche elements of your market. This is where a research consulting firm comes in. They'll be able to conduct up-to-date research that is focused on your areas of need. This will likely come with a bigger price tag, but the return on investment is often worth it.
2. Bottom-Up Approach
Another way of calculating TAM is from the bottom-up. In this method, you're basing the TAM calculation on previous sales and pricing data. You'll first need to multiply your average sales price by the total number of your customers. This will then give you your total addressable market.
3. Value-Theory Approach
This approach is built around how much value your customers will receive from your service or product. Then, it's about how much they are willing to pay for these services or products in the future.
The TAM Sizing Formula
Once you've decided on the method you're going to use to calculate your TAM, it's time to get into the nitty-gritty of the TAM sizing formula.
To calculate TAM, you need to multiply the total number of potential customers by a pricing metric. For example, this pricing metric could be the annual contract value, average order value or average selling price, or something else that makes sense in your context.
Let's say you are using the average revenue per customer as your metric, and you have a product that costs $100. You believe that there are 10,000 potential customers in your market. This means that your TAM would be $1 million (10,000 x $100).
It's important to note that the TAM sizing formula is just a starting point. Once you have your TAM, you'll need to dig deeper to understand your product's potential. This includes understanding your competition, your customer's needs, and your industry.
How to Interpret TAM
Once you've calculated your TAM, it's time to start interpreting the results. Here are a few things you should keep in mind:
- A large TAM doesn't mean your product will be successful, but it is a proxy to your revenue and market opportunity. There are many factors that go into whether or not a product is successful. This includes things like the quality of your product, your marketing strategy, and your sales process.
- Similarly, having a small TAM doesn't mean your product will fail. But, it can indicate that in the short-term, your revenue opportunity is lower, which could affect your analysis of TAM for your new business or business opportunity.
- It's important to remember that TAM is not static. It can change over time based on things like technological advancement, changes in the economy, and more. This means that you'll need to regularly assess your TAM to ensure you have the most accurate data.
- Remember, TAM is just one piece of the puzzle. To make sound business decisions, you'll need to consider other factors like your competition, your customer's needs, product-market fit, and your industry.
How a TAM Analysis Drives Results
There are a number of ways in which a TAM analysis can drive results for your business:
Setting More Achievable Goals
One of the benefits of conducting a TAM analysis is that it can help you set more achievable goals for things like annual revenue, acquisition targets, and more. By understanding the potential size of the market, you can better assess how much market share you can realistically achieve.
This information is important when setting marketing, sales, and product development goals. Without a clear understanding of the potential size of the market, it's easy to set goals that are either too small or too ambitious.
Assessing Risks and Rewards
Another benefit of conducting a TAM analysis is that it can help you assess the risks and rewards associated with entering a particular market.
By understanding the potential size of the market, you can better assess the potential rewards of entering the market. However, you should also be aware of the risks associated with entering a new market. These include competition, regulatory hurdles, and customer acquisition costs.
Understanding Room for Growth
Finally, a TAM estimate can also help you understand if there's room for growth in your chosen market (i.e. total market demand). By understanding the potential size of the market, you can better assess if there's an opportunity to increase your market share.
This information is important when making decisions about expansion plans. Without a clear understanding of the potential size of the market, it's easy to make decisions that lead to oversaturation or underexploitation of a market.
Differences between TAM, SAM, and SOM
It's important to understand the difference between TAM, SAM, and SOM when conducting a market analysis.
- TAM, as we've already covered, is the total potential market for a product or service. This includes all customers who could potentially use the product or service.
- SAM, Serviceable Available Market or Serviceable Addressable Market, is the target addressable market that is served by the services or products of a company.
- SOM, Serviceable Obtainable Market, is the percentage of SAM that can realistically be achieved.
The Importance of Serviceable Available Market (SAM)
SAM is important because it represents the portion of the market that a company can realistically target. By understanding SAM, companies can better assess their opportunities for growth and make informed decisions about their business strategies.
In order to calculate SAM, you need to first identify your TAM. Once you’ve done this, you can then identify the portion of TAM that your products or services can realistically reach. This will give you your SAM.
It's important to remember that your SAM will change over time as your products and services evolve. As such, it's important to regularly review your SAM and make adjustments to your business strategy as needed.
The Importance of Serviceable Obtainable Market (SOM)
SOM, on the other hand, is important because it represents the portion of the market that a company can realistically obtain. As with SAM, this allows companies to make informed decisions about where they are looking to take their business and what opportunities lie ahead for them.
When conducting a market analysis, it's important to understand the difference between TAM, SAM, and SOM. This will help you assess the potential size of the market and set more realistic goals for your business.
What Are the Risks of Not Conducting a TAM Analysis?
Dynamic economic conditions, changes in customer behaviour, and continued advancements in technology can all contribute to failing to get an adequate TAM calculation. This is why it’s important to implement strategies designed to mitigate risks. And the biggest risk is to not conduct a TAM analysis at all.
If you do not prioritize a TAM analysis, here are tradeoffs you need to consider:
- You could set unrealistic goals: Without a clear understanding of the growth potential of the market, it's easy to set goals that are either too small or too ambitious.
- You may miss out on opportunities for growth: A TAM analysis can help you assess the risks and rewards associated with entering a particular market.
- You might make decisions that lead to oversaturation or underexploitation: Without TAM, businesses lack the data needed to strategically align their offerings with market needs.
- You could waste time and resources pursuing markets that are not viable: A TAM analysis helps you assess the viability of a market before investing time and resources into pursuing it.
- You might miss out on important insights about your customers, competitors, and the market landscape: A TAM analysis provides valuable insights into your customers, competitors, and the overall market landscape.
TAM Analysis Makes the Difference Between Product Success and Failure
A TAM analysis is a valuable tool for product managers at companies of all sizes. By performing a total addressable market calculation to determine the growth potential of the market, companies can better assess their opportunities for growth and make informed decisions on business opportunities for their product or service.
If you're not already conducting TAM calculations, it could be the difference between product success and failure. If you don’t already, subscribe to our newsletter below to learn more about TAM analysis techniques and other topics.
