How to Calculate Total Addressable Market (TAM)?
What is Total Addressable Market?
Total addressable market or TAM refers to the total market demand for a product or service. It’s the most amount of revenue a business can possibly generate by selling their product or service in a specific market.
Unless they’re a monopoly, most companies can’t capture the total addressable market for their product or service. Even if a company just has one competitor, it would still be extremely difficult for them to convince an entire market to only buy their marketing product or service.
That’s why most companies also measure their serviceable available market to determine how many customers they can realistically reach with their marketing and sales channels. Additionally, they gauge their share of market to understand the size of their actual target market.
However, total addressable market is still useful because businesses can use TAM to objectively estimate a specific market’s potential for growth.
Why is TAM important?
It will give you an idea of what type of marketing company you should build. For example, if your TAM is 10 billion USD, you might want to raise a lot of funds as there’s a big growth opportunity for your startup. On the other hand, if your TAM is only 10 million USD, you shouldn’t spend or raise a large amount of money or hire a big team as the revenue opportunity is not big enough.
Equally, TAM is an important metric for investors, it will let them know that the digital market is big enough and that they can get a good return on their investment. Most investors tend to check the TAM metric to compare the opportunity size to other investment opportunities they may be considering. A venture with a low TAM will not be attractive to them.
How to calculate the Total Addressable Market (TAM)?
There are two ways to calculate your TAM: the top-down approach and the bottom-up approach.
1- Top-down approach
The top-down approach follows a process of elimination where you start by taking a large market size and narrowing it down to a specific market segment. You can use industry research and reports from third parties and digital market-research firms to get your numbers.
2- Bottom-up approach (price-based approach)
The bottom-up total addressable market strategy will give you more accurate numbers than the top-down approach because it uses your numbers. It takes the number of your total potential customers and multiplies it by the annual price of your product or service.
TAM = Price * Total Potential Customers.
Your price can be your product price or annual average revenue per user, and you should always use your price and not your competitors’ prices. You should specify the unit as well at all times, for example, your price is 4,000$/year/store.
In order to calculate the right number of total potential customers, think rigorously about your target customers and your targeted geography.
3- Value-theory market size
The value-theory method begins by asking what a buyer would be willing to pay for a product or service, based on the value it delivers.
You then multiply this by the total number of people or companies that perceive the same value and would be willing to adopt your solution in place of the competition. Here are some things you want to know to determine TAM using this method:
- How many people would get value out of your latest idea.
- How much they would be willing to pay for it.