Understanding TAM (and SAM and SOM)


Total Addressable Market (TAM) is a telling metric to examine when trying to gauge your startup’s growth potential. Let's talk about what TAM is, and how to calculate it.
As you learned in our article on product-market fit, choosing the right market is mostly about how big the market is and how fast the market is moving. But just exactly how big and how fast is a decision you’ll need to make as a founder. What kind of business are you looking to build? If the answer is one that can catch on like fire (in a good way), you’ll need to decide if your product has enough market potential. To assess that, let’s learn how to calculate your TAM.

In this quick guide, we'll talk about:
  • Understanding what TAM is, and why it matters
  • Different ways to calculate TAM for your startup

What is TAM?

TAM stands for Total Addressable Market, which is the total possible market for your company’s product or service. It’s a value usually represented not by the number of customers, but by dollar value: to illustrate why, a billion customers for a product people want for free has a smaller TAM than a market with only 10,000 customers paying $100 each annually. 
Why should you calculate your TAM? Well, in general, it’s good to get a sense of the size of the market in value and not just in size. But it’s especially important to know how to calculate your TAM if you’re pursuing funding, and if that’s the case, you’ll want to put it in your business plan and/or pitch deck. Investors want to see that there’s a sizable market and growth potential for your company. 

Calculating your TAM isn’t just about impressing investors with the biggest number you can come up with. It can help you determine whether or not you need to segment your market further. A good benchmark to aim for is between $10 to $300 million TAM. Any more than that as a startup and you’re probably aiming too big and too broad (or your data may be wildly off). Any smaller and you may not be capitalizing on a significant enough market opportunity. But again, what counts as significant depends on your business and personal goals.

Aside from TAM, there’s also SAM and SOM:

  • SAM = Serviceable Available Market, which means the TAM that is within reach, usually in geographic or cultural terms (i.e. your product is only available in a certain language). If your business operates online and services customers all over the world, your SAM may be the same or very similar to your TAM.

  • SOM = Serviceable Obtainable Market, which drills down even further to refer to the portion of the SAM you can realistically capture based on things like your available resources and market competition. Investors sometimes use SOM as a benchmark for a short-term goal to aim for.

How to calculate TAM

There are a few different ways you can calculate TAM.

Top-down: Using public industry data 

With this approach, you’ll look at existing data sources such as the World Bank, census data, or industry reports, then apply demographic, geographic, and economic filters based on existing customer research to narrow down your market.

For example, if your product is a widget for industry X, you can look at industry reports to determine how many customers globally that are currently purchasing widgets in industry X and how much they’re spending. You can then apply a filter of location and age range based on census data if, for example, your research shows that people 65+ in rural areas are underserved in this market. In other words, you’re starting from the broadest view possible then narrowing it down.

A disadvantage of using this method is that industry sources are not always available or up-to-date, especially in fast-moving markets. You’re also making a broad assumption with a number that may sound impressive but be unrealistic, and that’s where SOM and SAM come in handy.

Bottom-up: Based on projected use of your products

Here, you’ll use historical data from sales to determine TAM by multiplying your average sales price with the number of current customers, then multiplying that number by the total number of customers.

For example, let’s say the price of your productivity app is $20/month, and that in your first year, you had 2000 customers. $20 x 12 x 2000 = $480,000. From there, you could take the total number of people currently using any productivity app (let’s say it’s 7 billion downloads) and get your TAM. 

But is that right? A disadvantage to this method is that it could vary in accuracy because of the assumptions that need to be made. In the example above, we’ll need to get more specific about our data set: 7 billion downloads doesn’t mean 7 billion people, nor does it mean paying customers, nor does it make any reference to differences between productivity apps based on consumer preferences. So you’ll need to consider these things and dig deeper to find the information you need in order to get an accurate TAM.

Another obvious disadvantage is that you’ll first need sales to use this method. 

Value-theory: Estimated value provided by product 

With this method, you’ll be looking more closely at the value that customers receive from your product and their willingness to use your product over your competitors’. Translated into data, it’s based on analysis of your competitors (even if they’re indirect), research data, and your product’s price.

To calculate this, you’ll need to determine how many customers may be willing to switch over from the current solutions, and how much they are willing to pay using a sample size of the market as a whole. This estimation should be based on customer research and product research data, using surveys (“Would you switch to this product? How much would you pay?”) and/or existing sales data, even from a beta test group (how many people have converted to using your product and at what price?).

This is a calculation method that works well for startups that may not have enough previous sales data or for startups that bring something new and innovative to the market. For example, companies like Airbnb and Spotify, which brought a known outcome in a new way to the market (travel accommodation owned by people not hotels, and music streamed via subscription and not purchased per song or album) could use this method by determining how many people may be in the market overall (travelers and music listeners), then multiplying that by the data obtained from customer research and/or existing sales data on the percentage of people that would switch over and how much value, in dollars, is captured. 

It’s easy enough to determine how many people would switch over; as mentioned, you can use existing data of customers that have already converted or conduct surveys to get an estimation pre-launch. To get the “value captured”, you need to translate product price into annual revenue as TAM is usually calculated on a yearly basis. So for Spotify, that value could be the subscription price per month multiplied by 12. For Airbnb, that value may be the average amount spent per transaction multiplied by the average number of times the customer travels per year. 

With any TAM calculation method, assumptions are made but working through these calculations will help you better understand exactly how big your market is, not just in numbers but in monetary value. It can help guide business decisions too, like whether or not you need to drill down even further.
TAM obviously isn't the only metric that matters, but it can be incredibly helpful when evaluating growth potential. At this point, you should have a good understanding of:
  • What TAM (and SAM and SOM) are, and the differences between them
  • Why TAM matters to your business, and
  • How to best calculate it for your startup
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