Total Addressable Market (TAM) Reloaded
We’ve discussed market size in previous articles, but the TAM is so important that it deserves its own post. There are 4 levels of defining your market opportunity, which start with the Total Market. [However, in formal market sizing, the Total Addressable Market (TAM) represents the true “total market potential,” followed by the Serviceable Available Market (SAM) and the Serviceable Obtainable Market (SOM).
The TAM, considers your total available market, or the full universe of people who could logically purchase your product or service. It represents your maximum revenue opportunity if you achieved 100% market share, before narrowing down to SAM and SOM. The TAM provides more of a realistic view of your revenue opportunity than selling to everyone in the world and 100% of them buying from you.
The reason why the TAM is so beneficial to understanding your market better, is it enables you to prioritize specific business opportunities to ensure you are investing properly to meet the market your business needs. It provides a realistic ceiling for revenue potential before layering in geographic, operational, or competitive constraints. Here is a snippet of our previous article on the TAM, which you can read here (“The 4 Levels of Determining Market Opportunity”).
TAM = Total number of potential customers x Price (or annual revenue per customer)
Example: You want to sell your lipstick brand in retail locations that sale beauty products within the U.S. You calculate that there are 160 million women in the U.S. and you believe you can theoretically sale at least one product to 100% of them. You will still sale your lipstick for $20 per unit. Your Total Available Market is (160 million U.S. women x 100%) x $20 per unit = $3.2 billion.
Now in order to calculate the TAM, there are actually 3 different approaches one can take. Each method offers a different lens depending on whether you have historical sales data, competitive benchmarks, or only high‑level industry information.
The three methods are Top Down which takes more of a holistic view from the height of your industry down to your specific product segment, Bottom Up which starts with your customers and scales up, and the last is Value Theory which offers a competitive analysis view.
Top – Down Approach
Top Down offers a macro-level view of assessing factors from the top of the economy down to your business.
The Top Down approach is great for new and existing businesses by starting with the population, applying demographic, geographic, and economic assumptions to create a holistic view without irrelevant segments.
Top Down TAM typically evaluates the total industry size, then narrows based on competitive landscape, penetration assumptions, and your ability to reach the market.
In this approach, macro economy is a high-level view of the economic health of the environment your business operates in. Research your country’s GDP, unemployment, growth rate, and inflation. The second factor is the competitiveness of your market. Here, consider which players have the greatest market share and their overall annual revenue. Look at employee size and even where they are headquartered or have developed satellite offices. Then, dig deeper for the third factor, market penetration. Market penetration is a measure of how much a product or service is being used by consumers. Identifying the top tier of the market for your specific industry will also help in calculating market penetration of your competitors. If you are able to calculate your own market penetration, meaning you are currently in business and generating sales, this will be an extremely helpful metric as you consider your TAM. Lastly, you will need to consider addressability, or how your customer segment is reached.
Many business owners will tout their top-down TAM numbers, such as stating, “we develop women’s shoes a $180 billion industry”. Claiming the entire industry value as your TAM without adjusting for product fit or realistic reach is the most common misuse of the Top‑Down approach. While the women’s shoe industry may actually be a $180 billion industry, your products will not serve the industry as a whole. This is one of the downsides to the Top Down approach; if your product or service does not tip the industry scale enough your numbers will be bloated outside of reasonable performance possibilities. When Uber came on the scene, they disrupted the taxi, car service and public transportation industries by creating the rideshare sector. In this example, total disruption of three already large industries makes way for a larger TAM. Otherwise, another approach may be best for a more pinpointed value.
Bottom-up Approach
Bottom Up focuses on a subset of a more localized scenario and extrapolates the results to the wider market. This method is great for existing businesses or businesses that can leverage relevant market research to gather a granular view of audience segments to help inform the greater population.
If you are a new business and do not yet have customers or customer data to lean on, consider these factors against your closest competitors’ customers.
Bottom‑up TAM starts with your actual or projected customer base, then scales upward using addressability, market factors, and company‑specific data.
Bottom Up includes more relevant data with the inclusion of customer research based on the propensity to buy. This approach starts with addressability and then factors in market factors which include the economic, demographic, and locational factors of a market. The last factor, company specifics and known market specifics, are unique to each business. These are typically well-known characteristics of your market and/or industry.
This approach yields more of the perspective of “I will sale my product/service for $X and we will sale Y number of units in Z time frame”. To continue the Uber example from above, in a bottom up approach, Uber may have considered the number of people who travel into San Francisco for brief trips, those within the San Francisco area who worked a range of less than 10 miles from work without a means of owned transportation, groups who go out downtown at least two times per week and may be weary of parking fees. Then, they would factor in their known market specifics, such as the number of people who purchase car services regularly, for example. This would have offered multiple views of segmented groups who may purchase Uber rides (i.e. San Francisco travelers without a car during their stay, short-distance semi-professional commuters, responsible party enthusiasts, and San Francisco execs who are willing to try new car services) offering an improved view of realistic market potential. While the top down approach offers the high-level view of the industry, the bottom up approach presents more of a breadth of potential market fit.
Value Theory Approach
Lastly, the Value Theory approach considers the positive external factors derived from a product or service offering versus competitive options.
This method estimates TAM based on the incremental value your product creates compared to existing alternatives.
It is beneficial for new businesses preparing to enter a market or those who anticipate disrupting the way their market currently operates (i.e. Uber for the car service/taxi industry or iTunes to the music streaming industry).
By determining the threshold with which your customer base is willing to pay switching costs or a premium for a new product or service in their already comfortable lifestyle, the value theory approach helps you identify how much value you will bring into the market and how you plan to capture it.
So, how do you pick one? Should you use all three? The answer to those questions isn’t as simple as it may seem. Determining which approach you should take is based on the amount of information you have at your disposal to best calculate your TAM.
If you’re an existing business with years of historical sales information, know your customer well and are seeking a new perspective of how to further penetrate your market then a Bottoms-Up approach may be best. For a new or existing business who is looking to segment their audience or determine new ways to address their target market and want a holistic view of the population available to them, a Tops-Down Approach may be more suitable. Then, there are those businesses who are preparing to disrupt their industry or do not have a great deal of historical data to use who would benefit most from a Values Theory Approach.
No matter which approach you choose, calculating a TAM ensures you have a grounded view of your market size, your revenue ceiling, and the strategic opportunities available to your business.