Total addressable market (TAM) helps you estimate your growth potential. It also enables you to understand the total amount of demand in your available market, calculate your revenue opportunity, and even consider the level of competition you’ll face.
But what is total addressable market exactly, and how do you calculate it? Keep reading to find out.
Key Takeaways
- Total addressable market (TAM) is a market size forecasting method used by businesses and startups to estimate the total demand for their products or services.
- The two most common methods of calculating TAM are the “top-down” and “bottom-up” approaches, which rely on third-party data sets or in-house research.
- A value theory approach, where one estimates the value a product can provide customers, is an alternative way to calculate this metric.
- There are some pitfalls and mistakes to watch out for when estimating TAM; examples include overestimating TAM or focusing on irrelevant data.
- All stakeholders — including businesses and investors — can benefit from an accurate understanding of TAM, as it can help define goals and assess potential investments.
Total Addressable Market Definition
Total addressable market (TAM), occasionally called total available market, is a market sizing method that allows startups and businesses to estimate the total market demand for their products or services.
It’s a way to forecast annual revenue potential, understand the amount of effort your company must invest into a new business line, and help prioritize efforts to meet your bottom line.
However, TAM doesn’t consider market share, which is a calculation that underlines the portion of the target market your company owns.
Other key metrics to consider that put TAM into perspective include:
- Total serviceable available market (SAM): This indicates the market segments you can serve. The total serviceable available market (SAM, or serviceable addressable market) takes your products or services into account to identify your potential revenue.
- Total serviceable obtainable market (SOM): This metric further dissects your potential earnings and indicates how much of the market you can realistically capture. The total serviceable obtainable market will account for your business competitors as well.
How to Calculate Total Addressable Market
There are several ways to calculate the total addressable market, but the two most common are the top-down and bottom-up methods.
Let’s break them down:
Top-Down Analysis
The top-down approach is the easiest and quickest way to calculate your TAM. It requires taking macroeconomic data, usually from a third party, and applying various filters until you reach a relevant market subset.
Let’s assume you have a local pet store and sell dog food. You know your city has a population of 1 million, and 20% are dog owners.
To calculate TAM, multiply 1 million by 20% and estimate a 200,000-person market size. These are the potential customers in your area who could purchase your products.
Pros
- Uses third-party data sets
- Data may be publicly available
Cons
- The acquired data may be inaccurate.
- The method doesn’t account for potential market disruptions
Data Sources for Top-Down Analysis
- Industry reports
- Market research firms
- Trade associations
- Government bodies
Bottom-Up Analysis
The bottom-up approach requires taking a smaller market subset and extrapolating from your data until you reach the number of potential customers. It’s the reverse of top-down TAM analysis and requires using your primary research when calculating TAM.
For instance, let’s assume you run a marketing campaign for customers to pre-order a new brand of dog food. You had 5,000 sign-ups.
Using the knowledge that most customers spend an average of $50 on every order, you can calculate TAM as 5,000 x $50, meaning a $250,000 potential profit for this specific market or this new dog food brand.
Pros
- In-house data is often more accurate
- TAM analysis is more likely to be relevant to your business
Cons
- This approach is best for local market estimates
- The bottom-up method doesn’t account for variables needed for global markets (population density, consumer habits, etc.)
Data Sources for Bottom-Up Analysis
- Customer surveys
- Sales data
- Market share analysis
- Marketing campaigns
Alternative Methods
A popular TAM calculation alternative is the value theory method. It requires estimating the value a product or service can offer customers and multiplying it by how many customers are likely to purchase it.
But the value theory approach involves more guesswork than data, which could lead to misconceptions.
For example, you can estimate the value of your new brand of dog food at $66, and 1,000 of your customers would agree. Your TAM analysis will reveal $66,000 in potential revenue.
This method is useful when calculating TAM for a new product or service and when you can still use knowledge previously gathered, such as how much value it can provide or your customer’s spending habits.
Today, companies can leave their total addressable market calculation needs to software. Several tools help businesses estimate their TAM, SAM, and SOM using large databases to achieve accurate results.
Key Factors to Consider While Estimating TAM
The total addressable market should be estimated while taking into account the following:
- Market segmentation: The total addressable market estimation is more relevant for a business when you use a specific segment of your potential customers, not the market at large.
- Growth trends: This metric helps place your total addressable market into context and allows you to see where your TAM is headed.
- Seasonal fluctuations: Industries that see a seasonal surge or decline in demand should use this knowledge to interpret their TAM. Otherwise, they could overestimate or underestimate a market.
- Economic indicators: The total addressable market doesn’t account for fluctuations in consumer confidence, interest rates, inflation, and other key economic indicators that influence buying decisions.
- Competitive landscape: TAM estimates showcase revenue potential, but the figure accounts for the total market size, not the specific portion of a company’s products or services control.
Common Pitfalls and Mistakes in TAM Estimation
Total addressable market estimates can help a business understand its target market and potential revenue. They can also lead to improper conclusions.
Here are some common mistakes when calculating TAM:
- Overestimating TAM: This fills companies with overconfidence as they can perceive a higher revenue opportunity than the market can offer.
- Focusing on irrelevant data: The total addressable market should rely on data sets or filters close to home that reflect the company’s genuine target market.
- Neglecting competition: Most businesses don’t operate in bubbles. Relying on a total addressable market estimation is harmful when a company doesn’t take into account how much of the TAM truly belongs to them.
- Forgetting growth potential: A market’s growth rate shows how much room a company has to work with. Calculating the total addressable market without considering the growth potential in your industry leads to overestimating how much revenue you can make.
Importance of TAM for Various Stakeholders
Calculating TAM, SAM, and SOM is beneficial for all key actors in a company.
For TAM specifically, two parties can benefit most from it:
For Businesses
Knowing the amount of TAM that applies to your market share helps you define your vision for the future and establish better goals for your organization.
It may reveal where to allocate certain funds and optimize spending, particularly concerning new business lines.
Calculating the TAM may also highlight whether you should invest in innovation and product development. If the TAM is high, then you can assume there is sufficient room in that market for you.
For Investors
TAM is a crucial metric that can help investors evaluate different opportunities and decide which ones can deliver the best returns.
Companies with a higher TAM may display higher potential and lower investment risk.
Moreover, by contextualizing the TAM with other metrics revealed during market research, such as the size or expected growth rate, investors can compare multiple companies in the same industry.
Final Thoughts
The total addressable market (TAM) is a crucial number for businesses. Though it reflects the revenue potential of the entire market, a well-calculated TAM tells you how much you can expect to earn.
With this knowledge, you can optimize spending, invest in innovation, enter or avoid new markets, and more.
If you haven’t already, use this guide to calculate your TAM and factor in this metric for your next business decision.
Barbara Lawson is a marketing writer with over ten years of experience teaching marketing at a university level. Her content is backed by extensive research, and her expertise in the field is invaluable. Living in the beautiful city of Burlington, Vermont, Barbara enjoys practicing yoga to stay centered and focused.