Whether you’re weighing your options before starting a new business or looking into expansion possibilities amid high growth, the level of market demand for what you’re selling is one of the top areas of consideration that you’ll need to examine.
Market sizing is perhaps one of the most essential preliminary metrics brands use to estimate the potential viability of entering a new market. For the most part, companies generally devote a considerable amount of time and resources to calculating the size of prospective future markets in order to obtain as accurate findings as possible.
Often, researchers will package their findings as a report for executive teams to mull over before making big strategic decisions. After all, the information retrieved from such an analysis might influence whether a firm pursues a new market direction or passes it up in favor of a more lucrative opportunity.
In general, there are three ways of quantifying market size that we look for when carrying out this type of analysis:
● Total Addressable Market (TAM)
● Serviceable Addressable Market (SAM)
● Serviceable Obtainable Market (SOM)
In this article, we will take a deeper dive into the Total Addressable Market (TAM), including the scope it covers and the different methods you can use to carry out calculations.
Total Addressable Market – What Is It?
Total Addressable Market is the overall revenue opportunity obtainable to a product or service if it manages to secure 100% of the market share. In other words, it is the total amount of revenue you can generate selling your product or service if you were able to meet the entirety of the current demand.
Of course, this is practically impossible to achieve unless you establish a monopoly. Nevertheless, it stands as a good benchmark for companies to understand the ceiling on the market they are potentially about to enter.
So what makes this metric so important? Well, mainly because it enables startups and existing businesses to forecast revenue growth and gauge the profit potential of a specific industry without the need for investing resources in unproductive ventures.
Subsequently, the data collected from this research allows key decision-makers to weigh up whether or not it is feasible to enter into the market in its current state. It also gives a clearer picture of the funding and resources they should allocate to their new endeavor through the consideration of the potential upside.
How to Calculate TAM
The three main methods for calculating the total addressable market are as follows:
● Top-down TAM analysis
● Bottom-up TAM analysis
● Value theory TAM analysis
Of course, to perform these analyses properly, you’d need access to heaps of intelligence data and sophisticated tools to collate it all. But to gain a better sense of the logic behind what each is all about, let’s take a look at these three methods in closer detail.
Top-down TAM Analysis
With this approach, companies utilize macroeconomic factors to determine a subset of consumers which can be used to define the TAM. As the name suggests, you must start at the very top of a macro data set and then keep narrowing it down and chipping away at the data until you find the adequate market subset.
Generally speaking, you start with the entire population and then logically and methodically apply demographic, geographic, and economic assumptions to eliminate the irrelevant segments.
One of the main benefits of using this approach is that you can use openly available statistics from trusted and reputable sources such as the UN, OECD, The World Bank, and global research companies such as Gartner and Forrester.
However, the major caveat to this method is its reliance on secondary data sets. As none of the information is acquired through primary research, you must rely on external sources, which aren’t always up to date and may not reflect certain nuances and niche aspects of the market.
Younger researchers, moreover, have come to trust data from social signals and user-generated reviews, for example, over periodical industry reports from consultancies. TrustRadius recently found that under 20% of millennials use analyst rankings and reports to inform their executive teams’ decisions.
Bottom-up TAM Analysis
The bottom-up approach requires working on a granular level to find certain waypoints that can be extrapolated towards the general population.
This method uses your own company data to build reliable market boundaries and sales goals, which is why bottom-up analysis is perceived as more accurate due to the fact that the basis is anchored around a proven data point, which is then expanded to uncover the entire TAM population.
To make this method as accurate as possible, companies should implement primary research methods as much as possible, including elements such as surveys and customer feedback to ascertain the granular data sets. With that said, one of the drawbacks to this method is the overreliance on a proportionately small subset of data, forcing companies to draw vast assumptions and extrapolate based on a narrow scope of information.
Value Theory TAM Analysis
The top-down and bottom-up methods both look at existing data sets when calculating the TAM in an attempt to see how a potential new offering will fit into an existing market. However, these methods aren’t very helpful if you plan to bring an entirely new product or service into the market since the current demand cannot be evaluated.
The same can be said for new upgrades, evolutions, or improvements to existing products, due to the fact there are no case studies or competitors to analyze. To circumvent this challenge, value theory analysis involves assessing your product’s value to certain users and whether you can sufficiently capture that value through appropriate pricing strategies.
Here, it’s important to think carefully about what customers find valuable and how much they may be willing to pay for that value. Rather unsurprisingly, one of the best ways to do this is to simply ask a buyer directly what they would be willing to pay for a product or service, based on the value it delivers.
Unfortunately, value theory is primarily dependent on speculation and guesswork, and as a result, its conclusions will never be 100% correct. Keep this in mind, and treat any findings with a healthy dose of skepticism.
The Final Word
The Total Addressable Market is one of the most important market sizing metrics used by startups and established businesses to assess the potential scope of a market in terms of total sales and revenue.
However, companies must be diligent in order to ensure they select the right approach when calculating TAM, making concerted efforts to remain as objective as possible. This is because an overstated value may lead companies to enter into markets with less potential for growth than anticipated, which can cause significant issues later down the line.