Have you ever started a business venture only to realize the actual market was smaller than you anticipated? Or perhaps you undershot capabilities needed to fully capture your industry’s potential customers and revenue? The risks of misjudging market realities plague both new and established companies alike.
In this comprehensive guide, we eliminate the guesswork by walking you through an essential process – calculating your company’s Total Addressable Market (TAM). Get ready to discover realistic opportunities for exponential growth previously hiding in plain sight.
What is Total Addressable Market (TAM)?
Your Total Addressable Market encompasses the total revenue opportunity across your product and customer segments according to broader market conditions. Essentially, TAM answers a pivotal question – given the perfect set of capabilities and resources, what’s the maximum possible money you could make?
While an enticing prospect for any business leader, determining an accurate TAM requires avoiding the common mistake of inflated projections detached from real-world constraints like competition and consumer behavior. Ground your analysis in facts and master both the art and science of calculation. We show you how step-by-step in this guide.
First, let’s examine why TAM deserves a place at the forefront of your strategic planning in the first place.
Why Total Addressable Market Matters
Getting TAM right provides a blueprint for dominating your niche and extracting full value from your company’s potential. Specifically, an accurate assessment empowers you to:
- Set growth expectations aligned with market realities – Rather than vain hopes or overly conservative estimates, TAM grounds projections in empirical data on consumer behavior. Target realistic opportunities.
- Optimize spending to capture your maximum obtainable market share – Don’t overextend capabilities prematurely or risk leaving money on the table. Prune back low ROI outlays.
- Attract investors with transparency into profit trajectories – Demystify futures valuation conversations with simple, logical models tied to TAM data.
- Uncover hidden opportunities for business model expansion – Look to not just your core market but also periphery spaces and underserved niches prime for disruption.
In short, TAM fuels data-driven decision making across all facets of company building and investing. Now let’s examine step-by-step how to calculate this invaluable metric for your unique business.
Proven Methods to Determine Your Total Addressable Market
While simple in principle, arriving at an accurate TAM requires synthesizing market data, financial reports, consumer research, and business fundamentals into a cohesive forecast. Four primary methods exist:
Top Down Analysis
This approach evaluates total market size for your industry first, often relying on existing research firms. Leaders like Gartner regularly compile TAM reports across countries and sectors.
You then progressively trim down based on likelihood to buy your specific offerings. Eliminate consumer groups based on financial constraints, how your pricing aligns with income distributions, sentiment towards benefits, and so on.
For example, a luxury watchmaker would ignore lower income tiers when calculating TAM based on inability to afford premium pricing.
This method works well for quick estimations but risks overlooking disruption potentials. Use top down analysis as a starting point rather than an ending one.
Bottom Up Analysis
Instead of a market-first perspective, bottom up analysis adopts a ground level view, starting with:
- Your existing customer base
- Average transaction sizes
- Profit margins per sale
- Repeat purchase levels across periods
- Growth rates based on historical performance
Project future linear growth based on relationships identified across the above datasets. For example, 20% quarterly revenue increases over the past 2 years based on 10% more customers making 15% higher ticket purchases.
Continue projections until hitting theoretical maximums constrained by manufacturing capabilities, operational bandwidth, distribution saturation, or 100% ownership of target market share.
Because it leverages your company’s proprietary data, bottom up analysis delivers reliable forecasts tailored to actual demonstrated performance. Requirements include sufficient transaction history and resources to scale accordingly.
Value Based Analysis
Rather than customer volume, this approach focuses on the monetary value consumers assign to improvements or enhancements to existing market offerings.
Companies test willingness to pay higher than average prices for additional benefits. In electric vehicles for example:
- +15% pricing for increased range
- +8% for additional warranty coverage
- +20% for luxury interior options
Multiply premiums by projected purchasers to quantify expanded revenue potential above existing market baselines.
External Research Firms
Finally, tap pre-modelled TAM data for quick approximations for your sector and ideal customer profiles. Reports compile global and regional market sizes, often with breakouts by specific features like price tiers:
- Low Cost Segment – $X billion
- Mid-market Segment – $Y billion
- Premium Segment – $Z billion
Just take care to still overlay internal metrics and bottom up management to account for real organizational constraints versus generalized theoreticals.
Now that you’re equipped with approaches to quantify your Total Addressable Market, let‘s compare TAM to two related metrics – SAM and SOM.
Compare TAM to SAM and SOM
Two additional factors further break down target markets for strategic planning:
- Serviceable Available Market (SAM) – The segment of TAM realistically addressable after accounting for competition, regulations, demographics, access restrictions and other delimiting factors.
- Serviceable Obtainable Market (SOM) – The portion of SAM reachable based on a company’s positioning, resources, operational capabilities and related advantages/constraints.
In visual terms:
- TAM = Entire Theoretical Market Size
- SAM = What’s Actually Attainable In Market Conditions
- SOM = Maximum Share For Your Company Specifically
Getting granular with SAM and SOM transforms high level TAM figures into precise strategic targets aligned to existing capabilities. Together, the metrics directly influence critical functions:
Go-To-Market Planning – Prioritize market segments within your SOM through phased expansions first before moving to new SAM domains.
Inventory & Production – Scale manufacturing output and component sourcing to match buying volumes within SOM forecasts.
Investment Valuations – Link funding rounds and projected returns to timing/cost of SOM capture.
Marketing Optimizations – Refine messaging and media allocation around personas with highest SOM contribution.
Let’s now walk through a bottom-up TAM analysis example to pull together everything we’ve covered so far.
Bottom Up TAM Analysis Example
As a refresher, bottom up TAM analysis adopts a ground up approach, starting calculations from a company’s existing metrics like sales, volumes, and growth rates. Follow along as we work through a sample for the fictional Extreme Windsurfing Equipment Company (EWEC).
Step 1) Gather Existing Business Metrics
- $2.5 million in sales in 2022
- 5,000 boards sold
- $500 average sale price per board
- 25% sales growth YoY past 3 years
Step 2) Make Future Projections
- Board sales growing 25% annually
- $625 future average price (25% inflation)
- Maintain 18% transactional profit margin
Step 3) Identify Market Constraints
- High end boards niche limits total yearly production to 50,000 units
- 100% market share unrealistic (3 major competitors)
- Set ceiling at 40,000 boards annually = 80% niche ownership
Step 4) Final 2027 TAM Projection
- 40,000 boards sold
- X $625 avg price per board
- = $25 million revenue
- X 18% profit margin
- = $4.5 million Final 2027 TAM
Now let’s examine why going through this analytical process pays such handsome dividends.
4 Core Benefits of Calculating TAM
More than a meaningless metric, properly harnessing TAM guides both immediate decision making and long-term strategic orientations. Specifically, TAM empowers leaders to:
Size Growth Opportunities
TAM analysis identifies untapped revenue hiding in plain sight, ready for the taking whether in existing segments or entirely new ones. Execute plans sized deliberately to capture this potential. Open your aperture beyond current operations.
Optimize Spending & Resource Allocation
Balance investments across production, inventory, marketing, and research budgets relative to your max obtainable share of the market. Don’t overspend prematurely or risk unmet demand from undershooting capabilities.
Attract Investors
Quantify market potential and demonstrate prudent management by grounding projections in empirical data. Model return timelines and condition raises based on TAM-justified growth curves.
Uncover Market Expansion Opportunities
View your baseline TAM as the beginning rather than the endpoint for analysis. Continually evaluate emerging segments, demographic shifts, ancillary products, and new use cases for future expansion upside, even into new sectors.
Taken together, TAM enhances both immediate decision making and long term business positioning.
Now discover even more techniques and resources for maximizing your organization’s money making potential with Geekflare’s business analytics blog.
