Total Addressable Market or Total Available Market is the maximum revenue opportunity available to a product or service. It can also be thought of as the total demand for the product or service in the market. It does not measure actual customers or revenue but gives a sense of how large the market is before it gets divided between various competitors.
TAM shows theoretically the total market that exists for a product. The term assumes free access and unlimited operational resources from the product or service provider, meaning the market value when you capture 100%. Unless it is a monopoly and a single player possesses the resources and scale to cater to the entire market, TAM cannot be captured by a single company.
With even a single competitor, the TAM becomes split into segments realistically available to a company. Understanding how much of the market is available to you and how much of it is realistically obtainable is vital when creating a market strategy. Let us compare TAM with respect to other terms to better understand its meaning.
Unless you can monopolize the market, you will likely be sharing the Total Addressable Market. With even a single competitor, the TAM is split, and market share is the TAM attributable to you. Many competitors mean a small market share, and the TAM is split into many small pieces.
With multiple competitors, the TAM is split into small pieces, with different companies catering to different segments. Each of these small segments is a SAM, a Serviceable Available Market, or a Serviceable Addressable Market.
SAM is a part of TAM that a particular company is servicing, the part that needs the company’s products or services, and thus its target market. TAM is the highest potential revenue, decreased to SAM - the percentage of TAM that a company can acquire as a customer base, based on the location, pricing tiers, accessibility, etc.
For example, if your company sells accounting software in the United States, the TAM would-be business owners worldwide, and the SAM of your company is the market of the United States.
The revenue calculated using SAM is more realistic, while the TAM represents the growth potential.
While the SAM is the market available to you, the SOM or the Serviceable Obtainable Market is the fraction of the SAM that you can realistically capture. SOM is the current market share to account for the part of SAM that can be realistically extended. A company must succeed in its SOM before branching into the TAM, as it serves as a short-term target.
Continuing the above example, SOM would be the part of the market in the United States that you can obtain, keeping in mind all competitors selling accounting software in the US.
SOM = % of SAM you can realistically obtain.
TAM is an important metric for startups and new businesses to understand the revenue opportunity before entering the market. TAM analysis is required to forecast revenue growth, assess profit potential and validate estimates. Other advantages to using TAM are allowing business owners to map their product evolution, assessing the product fit for the market, and accounting for competitors early on.
Potential investors and buyers need a viable value proposition to be convinced. Market size, size of overall investment, competition, expected growth, and the available market is estimated for creating a value proposition. TAM estimate is useful in creating an accurate and convincing value proposition.
Upon entering the market, TAM calculation shows the growth potential of the market. It acts as a motivator to increase your market share.
Total Addressable Market calculation can be difficult if competitors in the market do not make sales figures public.
There are three methods to calculate TAM:
This method uses industry data, market reports, and research studies to determine TAM. A large population comprising the target market is narrowed down to a specific market segment. Industry research and reports from Forrester or Gartner can be used to estimate the population. Based on your offerings, goals, and pricing, the population can be narrowed down to a specific market segment. The downside to using this approach is:
As an example, consider a company that sells e-commerce shop-building software to small businesses. Industry research shows that there are 1 billion businesses worldwide, out of which only 50% are interested in E-commerce, 50% of 1,000,000,000 = 500,000,000 potential customers.
Further research reveals that 50% of these already have E-commerce websites and online portals. The potential businesses now stand at 50% of 500,000,000 = 250,000,000. If the application is offered for free but with a subscription of $100 per year, the estimated TAM is $25 billion (250,000,000 x 100).
(All figures are based on assumptions)
The bottom-up approach is more reliable than the top-down as it uses primary market research to calculate TAM estimates. The current prices and performance of your company predict how much of the market you can reach. The numbers are more accurate as important factors like competitors and the expansion of TAM due to a company entering the market are included at the start. A total population of buyers is discovered by extrapolating the data from your current usage and pricing. Since it is based on the unique data of a business, it offers more realistic insights into why some customer segments are prioritized, and others left out. The data is from the company's research and thus more relevant and accurate.
A disadvantage is that due to vast assumptions made from a relatively small subset, the TAM can be incorrect, particularly applicable for a global TAM calculation, where population density, economic prosperity, and customer preferences vary significantly.
The TAM calculation here is based on previous sales and pricing data. Your average sales price is multiplied by your number of current customers; this gives your Annual Contract Value(ACV). ACV multiplied by the total number of customers yields the Total Addressable Market.
Continuing the example of a company selling e-commerce shop building software, the ACV is $100, and if you determine 50,000 possible companies that fit your criteria, your Total Addressable Market would be $5,000,000 ($100 x 50,000).
The TAM formula here is:
(# of possible Accounts) x (Annual Contract Value) = TAM
The value-theory approach relies more on supposition and guesswork, determining what the target customer base finds valuable. The value of the product or service is to be discovered, and how to capture this valuation through pricing.
Research is conducted to find what customers desire, how much they are willing to pay for it, and even how much more they would be willing to pay.
This method is usually applied to predict the performance of new products or upgrades, factors key in deciding whether to expand the product base or focus on existing products.
The Total Addressable Market is the foremost information to consider when considering any business opportunity. While entering a new market, building a new product, or adding a new feature, TAM estimates the revenue impact, revealing whether the market opportunity is lucrative or not. TAM calculation leads to informed decisions on where to invest for maximum returns.
TAM is also valuable for calculating the impact of a pricing change or a new entrant. Recognizing how the market will change will give a better sense of the revenue projections for the future.
It is an important data point for potential investors and buyers, giving a value for opportunity size to compare other investments they may be considering.
TAM forces a company to define itself and its products and place itself in the overall landscape.
TAM can be calculated for a snapshot of time, but it is a changing value that must be revisited and calculated regularly as markets shift and demographics change.