Total Addressable Market: A Practical Guide to Crunching the Numbers
If you’re an angler, you might be interested to know that the newest estimates say there are about 3,5 trillion fish currently living in the world ocean. If you’re a B2B sales professional, you probably don’t care about things like how many salmons there are in the Pacific Ocean. What you want to know is the number of companies that can be successful with your product or service, and what revenue these potential customers can generate you–your total addressable market.
Knowing your total addressable market is imperative to set realistic revenue goals and enter only those markets that are worth your time and resources. Read on to learn more about what total addressable market is and the best ways to calculate it.
What is total addressable market?
Total addressable market, or total available market, (TAM) refers to the total market demand for a product or service. It’s the maximum amount of revenue a business can possibly generate by selling their product or service in a specific market.
Why total addressable market matters
A company’s total addressable market is often used to gauge the industry’s profit potential by companies putting together a go-to-market strategy. It can also be used to forecast a realistic revenue growth goal for your business. If you don’t root these figures in reality, you could either enter a market that doesn’t have a large enough market size to make your business profitable, or you could set an unrealistic revenue goal for your business–a safe road to failure.
How to calculate your total addressable market
Before you can calculate your total addressable market you’ll need to have a clearly defined market segment alongside a well-defined profile of the target end user. Additionally, you should have a very specific understanding of your ideal customer profile(s). The less specific the inputs used for the calculation, the less meaningful the resulting calculations will be.
There are two main methods used to calculate total addressable market, bottom-up and the top-down analysis.
The most effective way to calculate your total addressable market is by running a so-called bottom-up analysis of an industry. A bottom-up analysis involves counting the total number of customers in a market and multiplying that number by the average annual revenue of each customer in this market. By adding up the number of customers each company in your market has, you can get a rough estimate of how many customers there are in your market.
Total number of customers in a market x Average annual revenue of a customer in the market = Total addressable market
The top-down approach to calculating total addressable market uses industry research to estimate the size of your total addressable market. Research that has already been conducted doesn't often meet the exact specification for your addressable market. Leveraging this type of research is the easiest and fastest approach to determining your total addressable market. It’s fine for high-level estimates but carries a lot of uncertainty. One way to get a more tailored view is to hire a third-party consultant to size your market. However, this method is costly and you’re not guaranteed to get any actionable findings.
TAM, SAM, SOM ... WHAT?
TAM, as you already know, is short for total addressable market. SAM stands for serviceable addressable market and SOM is an abbreviation for share of market.
No worries if reading the spelled out versions of SAM and SOM makes you none the wiser. I’m about to walk you through what they mean, why they matter and how they differ from one another.
Serviceable addressable market
Knowing that there are 3,5 trillion fish in the sea hardly helps a local fisherman in Norway to estimate the size of his draught this year. Serviceable available market, or market size, is the segment of the total addressable market targeted by your products and services which is within your reach.
Just like no angler can cast a net wide enough to catch every fish in the world oceans, your business will probably never capture every prospect in your total addressable market. That’s unless a monopoly. No matter if you have only one, a handful or over a hundred competitors, it would be extremely difficult to persuade your entire market to only buy from you. Because of this, you should also calculate the maximum amount of revenue you can possibly generate by selling your product or service to the companies who would really benefit from using your product or service–your service addressable market.
To calculate your serviceable addressable market, count up all companies matching your ideal customer profile and multiply that number by the average annual revenue of these types of customer in your market.
Total number of companies matching your ideal customer profile in a market x Average annual revenue of these types of customers = Serviceable addressable market
Share of market
Dreaming that you’re catching a fish with a rod is said to mean that you will have progress in your affairs. If you’re a spiritual person, a big draft made in your sleep might be enough for you to rest assured that your business will blossom in the future. Call me a pessimist or a realist, but I suggest that you don’t blindly trust the dream-readers but instead use your share of market (also frequently referred to as serviceable obtainable market) to predict the amount of revenue you can actually generate within your market. Share of market is the size of your actual customer base or the realistic percentage of your serviceable addressable market that you can capture.
You calculate your share of market by dividing your revenue from last year by your industry’s serviceable addressable market from last year. This will provide you with the percentage of your market share from last year. Then, multiply that number by your industry’s serviceable addressable market from this year.
Last year’s revenue / year’s serviceable addressable market = Last year’s market share
Last year’s market share x This year’s serviceable addressable market = This year’s share of market
How many fish are there in your sea?
While there may be plenty of fish in the sea, nobody ever said that they were all swimming your direction.
Whether you’re releasing a new product, looking for venture capital, or creating new sales goals, take the time to understand your total addressable market, serviceable addressable market, and share of market. If you want to follow a realistic path towards success, you need to first understand what’s actually possible.