Why Calculating Total Addressable Market Is Useful for More Than Startups
They say knowing is half the battle. It’s hard to think of an area of life where this age-old platitude is more relevant than business. No self-respecting entrepreneur would dare march blindly into the future without at least a rudimentary business plan. Where have we been, where are we going, and how are we going to get there? These are questions any good business plan will attempt to answer. And, when it comes to answering those questions, few measurements are more fundamental than Total Addressable Market.
Key Points:
- Total Addressable Market is a measurement of business opportunity in a market.
- The term is often used when discussing startups and companies in the early business planning stage.
- But more established companies can also make use of this market size measurement.
- Any company that is considering entering a new market could get valuable insight from calculating their Total Addressable Market.
TAM
Total Addressable Market is a measurement of business opportunity, in simplest terms. It’s a measure of the potential revenue available for capture by a product or service. It’s calculated using two points of data: the total customers in the market and the average cost of the product or service in question. It’s worth mentioning here that TAM measures the maximum potential revenue available for capture in a perfect world, where no stone is left unturned and no sale is out of reach. Because of this, while being a useful jumping off point, TAM is not the end all be all of market sizing.
SAM and SoM
For that reason, there are a few more terms that will be useful to bring up in this discussion. Namely, Serviceable Addressable Market (SAM) and Share of Market (SoM). Both are measurements that essentially narrow down the unwieldy TAM into smaller, more realistic, and more targeted numbers. Serviceable Addressable Market is reached by whittling down your TAM by factors that take into account how much of the market you could realistically reach. For B2B companies, this means taking into consideration how many companies out there could realistically benefit from your product or service and how many are within the reach of your marketing efforts. Total Addressable Market is global and indiscriminate, Serviceable Addressable Market is segmented.
Share of Market represents how much of the market you have captured as it relates to the total addressable potential. It’s a ratio that compares how much of the market your product or service has achieved in the past with how much opportunity there is for further market penetration.
One thing you might notice about the SAM and SoM is that they both intuitively seem like they’d be more applicable to an established company than a startup. Calculating a relatively accurate Serviceable Addressable Market relies on having some insight into what constitutes a reasonable reach for your company. A brand-new company is going to have to do more guesswork when figuring out how to segment their addressable market whereas an established company will have years of real statistics and first-hand experience to pull from. Even more so, you have Share of Market, which relies entirely on knowing how much of the market you currently have a hold on. Calculating an Estimated Share of Market that looks into the future is possible, but without any past data to draw from, doing so less analytical and more aspirational.
So, it’s safe to say that TAM is just part of a bigger picture and its use is far from limited to startups. To drill further into this, let’s take a look at what calculating TAM, Serviceable Addressable Market, and Share of Market involves.
Find Your TAM
So, your company is throwing around the idea of expanding your market? Maybe you want to take the same products and services to a new region? Maybe introduce a new service? Maybe go after clients in a different industry? Regardless of the type of market expansion, you’ll want to do some market analysis before you start putting significant resources towards this endeavor.
Specially, you’ll want to know what potential to thrive there is for you in this new market. TAM is a perfect tool for this. Let’s calculate it.
The first step to calculating your TAM is to define your customer profile. The more specific your customer definition is, the more accurate your TAM calculation will be. Then, you need to estimate how many customers are in this market. This can be done by extrapolating from data on your current customer base or by counting potential customers in a small area and extrapolating globally. The method is going to depend on the type of market you’re looking at and the data currently available to you.
Finally, you calculate your TAM by multiplying the number of potential customers by the average selling price of the service or product. You’ll notice that TAM doesn’t take into consideration factors such as whether a potential customer has already solved for the problem that your product or service addresses.
That’s called the bottom-up approach. There’s another method of calculating TAM that’s referred to as the top-down approach. It involves using third-party data and industry reports as a reference to estimate the size of the market you’re looking at. It’s generally considered a less accurate method, largely because with the first approach you can tailor the calculation very specifically to your potential market. Some recommend using a combination of the bottom-up and top-down approach for the best estimate.
Turning TAM Into SAM
Now you have a rough estimation of the total possible revenue available for capture in the market you’re thinking about entering. It’s a solid start. Let’s whittle that number down to something more realistic and manageable now. Once you’ve got your TAM, Serviceable Addressable Market is not far off.
For B2B businesses, going from TAM to SAM means cutting out businesses that are not feasibly reachable by your company, either due to location or because the product or service you will offer is not a fit for them.
For example, if a printer is looking to add wide-format printing to their offered services, their TAM would be a broad estimate that multiplies the average amount that a wide-format print buyer spends on the service per year by the number of customers potentially in the market for wide-format printing. Their SAM would be a more targeted estimate that estimates the number of wide-format print buyers in the same region as the printer who don’t already have a wide-format print provider or are shopping for a new one. Getting good numbers here is going to take a combination of diligent research and smart data collecting. Conducting surveys and using buyer interest data gained from the surveys to extrapolate to the larger market is one popular strategy.
SoM and Expected SoM
Once you’ve collected data and calculated a TAM and Serviceable Addressable Market, you’re well on your way to getting a grasp of what your market opportunity is. These numbers by themselves can be used to forecast profit potential for investor purposes, to asses budget changes in regard to staffing and resources, develop a 5-year growth plan, and so on. You get the picture.
But, we can get even more analytical juice out of this process by calculating the Share of Market. Share of Market is a measurement that defines the percentage of the potential market that a business has or is expected to capture.
Share of Market is more grounded in hard numbers than TAM and SAM. Just as no anti-bacterial hand sanitizer is going to get that last 1% of bacteria, no company will ever capture 100% of the potential revenue in their Serviceable Addressable Market, much less the Total Addressable Market. Share of Market is a measure of that delta. To calculate your current Share of Market (the share of the market you currently sell services and products in), just divide last year’s revenue by last year’s Serviceable Addressable Market. That will give you the percentage of the Serviceable Addressable Market you captured.
This number is valuable because it gives an objective look at what you could call your company’s “reach.” No guessing involved, no estimates, no third-party industry reports. Just a hard data point that says, “this is how much of the pie we got.” If you extrapolate that data towards the Serviceable Addressable Market of your proposed expansion project, you can get a reasonable revenue forecast of that project.
Wrapping It Up
TAM, SAM, and SoM; it’s a lot of acronyms, high-level business analysis, market research and such. What it really boils down to is this: businesses grow, evolve, and find themselves approaching new markets that they have not encountered before. When that happens, it can be useful to take some of the tools from the startup/business planning toolbox, reconfigure them a bit, and squeeze some insight out of them.
By calculating your Total Addressable Market, you can start to build a framework for your company’s expansion into a new market, be that a vertical or horizontal expansion. Gauge profit potential and plan a realistic growth goal using the Total Addressable Market as a starting point. Total Addressable Market, Serviceable Addressable Market, and Share of Market can all be highly useful market sizing tools, helping you plan next steps when company growth has reached a crossroads.
And More: Printers and TAM
Many print service providers in the earlier phases of growth will find themselves tackling the B2B or B2C question. Some printers split their business model and do both. Some focus on B2B, others on B2C. Regardless, the vast differences between B2B and B2C print services mean this is a vital issue to consider. This is especially true for PSPs looking into adding a web to print strategy. Printers in this stage of development could get a lot of mileage out of calculating their TAM, SAM, and SoM. Using these market sizing measurements, a print provider could approach the B2B or B2C question with greater clarity.
