How do you sell more, faster and better? Simple, by understanding who’s buying you today. To be able to do this, knowing how to calculate your TAM becomes essential.
But before we get to that let us understand what TAM really is.
What is TAM (Total Addressable Market)?
There are many different ways to define TAM. But in its simplest form, a company’s TAM can be defined as the estimate of the entire market size that could be catered to by their products and services. And by that definition, one could also say that it is the total market demand for a company’s products and services.
Your Total Addressable Market, Total Available Market, or TAM refers to the total revenue opportunities available for your company. However, it wouldn’t be practical to target your entire TAM even if you’ve created a new industry or you don’t have much competition. This is because there exists certain limitations within your business model that make targeting your entire TAM extremely impractical. A more realistic way to define your market would be to create subsets within the scope of your TAM on the basis of certain limitations.
The first would be to find the subset within your TAM that you can realistically target based on the limitations of your business model. This would be your Serviceable Addressable Market or SAM. An example of SAM would be picking out those businesses that operate using the English language as opposed to those that don’t, when considering your product only functions in English.
And within your SAM lies another subset that accounts for further limitations specific to your competition and other factors that make your product a viable option for this subset. This is called the Serviceable Obtainable Market or SOM. So unless you’re a monopoly business, identifying your SOM is the ideal way to define the market for your product.
Now, how do you calculate the TAM for your company?
How to Calculate TAM (Total Addressable Market)
There are 3 popular methods to calculate TAM, and all of them have their advantages and disadvantages. Here’s everything you need to know about them.
1. Top-Down Approach
The top-down approach is a method that begins with the entire population and filters it using existing information and statistics to establish the TAM of a company. It’s the same method I used to quickly explain the size of the market in the CRM example earlier. However, you’d ideally want to factor in other information that will dictate your business decisions, and include additional information that you can obtain from in-house surveys (that will help you understand who has a use for your product and who doesn’t), suggestions from third-party consultants like Gartner and Forrester, and other such sources such as publicly available data to come up with a more accurate number.
For example, if your CRM company acquires another business, lets say an integrating marketing analytics software, then your business’ TAM becomes significantly larger.
By factoring in companies spending behavior, competitors’ success, historical metrics, and disqualifying irrelevant target markets until you arrive at a number that accurately represents the size of the entire pie.
The advantage of the top-down approach is that it’s easy to work out your TAM this way, since most of this information comes from research that’s already been done. Assuming, of course, that you have all the information needed to gauge the TAM of your specific business model.
The disadvantage, however, is that you’re relying on external sources to calculate your TAM, and might find yourself in positions where you’re not able to get some vital data you might need to complete this exercise. It also relies on historical data to predict future data, and market trends, increase in demand, and several other factors might not be accurately considered while calculating this.
2. Bottom-Up Approach
The bottom-up approach starts out with data that you already have from running your business, that then leads you towards building a more macroscopic census of the demand for your product.
Understanding of Macro Economy: There’s nothing like using your own data as building blocks to arrive at your TAM. It’s the most accurate approach since the basis for it is the first-hand data you have and it represents the real-time demand that exists for your exact product/service. This method further allows you to take into account how the journey of your product/service thus far has affected its market.
Competitiveness and Penetration: You can then identify buying patterns within your business and your competitors to see how this behaviour could flow into other markets.
Addressability: Finally, you want to segment these markets and quantify the number of customers that will actually buy your product in each segment, helping you arrive at your TAM.
There’s nothing like using your own data to arrive at your TAM. It’s the most accurate approach since the basis for it is the first-hand data you have and it represents the real-time demand that exists for your exact product/service. This method further allows you to take into account how the journey of your product/service thus far has affected its market.
The bottom-up approach to calculating TAM uses the following formula:
TAM = (Average Contract Value) * (Total Number of Potential Accounts)
Let’s say you’re a B2B SaaS business that sells software to restaurant chains within the United States. Based on your historic sales data, let’s say your average ACV is $10,000. Now bring into the picture the ~700k restaurant chains that exist in the US as of 2021 and you’re staring at a TAM of at least 7 billion dollars (i.e. 10,000 * 100,000).
While this might be a lot more “personal” to your company, the equation can never be as simple as the formula listed above. You might want to split your prospects by industry segments or geographic areas to come up with a more accurate estimation of your TAM. It also doesn’t actively consider the things that will change as you move forward (mixed pricing models, expansion into markets you’ve previously not been able to move into, etc.) to come up with an accurate number.
3. Value Theory Approach
The Value Theory is an approach that factors in the value addition that future versions of your product can add over time.
For example, new features in your product roadmap, enhancement of product quality, additional pricing plans and future avenues of expansion can alter your TAM. These probabilistic outcomes are accounted for in the Value Theory approach by way of assumptions. Ideally, this approach should also account for variables that may adversely affect your market and hurt your business, to bring in both sides of the coin.
The Value Theory Approach, although highly probabilistic in nature, allows you to add foresight to the equation, helping you be more proactive in the development of your product and business functions.
One last thing
While capturing your entire TAM might be your long-term goal, remember that only 3% of your TAM consists of active, high-intent buyers. If you want to own the entire pie in the long term, you’ve gotta focus on capturing it chunk by chunk starting now.
You can always use Slintel to find out the 3% of your business’ TAM that are actively searching for a product like yours. We predict your next customer while you’re busy chipping away at your company’s TAM 🙂