Total addressable market (TAM), also called total available market, is a term that is typically used to reference the revenue opportunity available for a product or service. TAM helps prioritize business opportunities by serving as a quick metric of a given opportunity’s underlying potential.
What is Total Addressable Market (TAM)?
Total Addressable Market (TAM), also referred to as total available market, is the overall revenue opportunity that is available for a product or service if 100% market share is achieved. Because it represents the potential opportunity, it is often used to determine the level of funding or resources that a company should invest into a new product or business line.
The concept of total addressable market is important for both startups and existing businesses because it allows them to prioritize specific products, customer segments, and business opportunities, taking into consideration the required resources and potential revenue impact.
Evaluating if a business opportunity is viable involves estimating the market size, overall investment needed, competitive landscape, unique differentiators, and expected growth rate. For example, when a private equity firm intends to acquire a company, it can use TAM to estimate the revenue generation potential of a product or service offered by that company in order to determine if the company is likely to produce a return on investment.
TAM estimations can take untapped markets, products and customer segments into consideration. The assessment helps to determine the actual size of the available market.
Calculating the Total Addressable Market
There are three methods used to calculate the total addressable market. They include:
1 Top Down- The top-down analysis follows a process of elimination that starts by taking a large population of a known size that comprises the target market and using it to narrow down to a specific market segment. Top-down analysis can be represented by an inverted pyramid that shows the large population of a known segment at the top and the narrowed-down segment at the bottom. The method uses industry research and reports to gather population data.
2 Bottom Up- A bottom-up analysis is a reliable method because it relies on primary market research to calculate the TAM estimates. It typically uses existing data about current pricing and usage of a product. For example, for a startup company with a free accounting mobile app and annual subscription option for $100, the business can take a reasonable estimate of the number of businesses in its target market to obtain the TAM.
3 Value Theory- Value theory relies on estimating the value provided to customers by the product and how much of that value can be reflected in product pricing. A company estimates how much value it can add and why it should capture this value through pricing. Value theory is used to calculate TAM when a company is introducing new products into the market or cross-selling certain products to existing customers.
Differences Between TAM, SAM, and SOM
TAM is an acronym for Total Addressable Market
SAM is an acronym for Serviceable Available Market
SOM is an acronym for Serviceable Obtainable Market
TAM, SAM, and SOM represent various subsets of a market.
- TAM refers to the total potential market for a product or service that is calculated in estimated annual revenue.
- SAM stands for Serviceable Available Market, and it is the target addressable market that is served by a company’s products or services.
- SOM is an acronym for Serviceable Obtainable Market, which is the percentage of SAM that can be realistically achieved.
- Identifying these subsets within an industry requires some market research to understand the proportions of each area.
Importance of TAM
The Total Addressable Market is one of the essential metrics that companies use to estimate the potential scale of the market in terms of total potential sales and revenues. When a company is considering releasing a new product, reaching a new customer segment, or cross-sell an existing product to existing customers, TAM helps show the potential outcome and returns on the endeavor.
Applications in Financial Modeling & Valuation
Financial modeling requires building a forecast for a company, which is dependent on the company’s total addressable market. When developing or analyzing a forecast in a valuation model, it’s important to perform a “sanity check” against the size of the market. Detailed operating models will typically include a build-up from market size to addressable market, to customers, and finally to revenue.
FAQs
How do you determine the potential customer base for TAM?
Identifying the potential customer base involves analyzing the demographics, characteristics, and needs of the target market. This can include factors such as geographical location, industry type, and customer segments.
Why is TAM analysis important for investors?
Investors use TAM analysis to assess the growth potential of a company and its scalability. Understanding the TAM helps investors make informed decisions about the market size and the company’s ability to capture a significant share.
How does TAM impact business strategy?
TAM influences strategic decisions related to product development, marketing, and expansion. It helps businesses allocate resources effectively and identify opportunities for growth.
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