Total Addressable Market: How to Measure TAM (2024)

Before you start your business, it’s often a good idea to know the overall market size and potential revenue opportunity for your product, service, or even an entirely new business idea. So, think about your Total Addressable Market (TAM).

TAM helps estimate the total demand and monetary value of your business idea by considering factors such as market size, annual contract value, and industry affiliations. This information is often collected from industry reports or data generated from your own line of business and helps estimate the maximum revenue achievable if all potential customers purchase your product or service. It also helps estimate your growth rate if your product is successful. Here are some ways to calculate TAM when evaluating potential business opportunities:

What is Total Addressable Market?

Total addressable market (TAM) refers to the entire revenue opportunity for a particular product or service. It’s basically an estimate of the total market size if all potential customers bought the product at a particular price. (Note that some people use the acronym TAM to refer to “total available market,” and this phrase is used interchangeably with “total addressable market.”)

Why is TAM important?

Whether you’re looking to develop a new market or focus on existing customers, a TAM provides a comprehensive overview of the revenue opportunity your product or service can generate. Potential investors are particularly interested in a TAM because it shows the potential for growth and market share.

Calculating TAM is important for several reasons.

• It helps in assessing the market potential. TAM provides an overview of the overall market size and indicates the maximum potential revenue that can be achieved.

• This allows you to make informed decisions. Understanding TAM allows a business to decide whether to invest in a particular product or service, taking into account its potential for growth and profitability.

• It helps you set realistic goals. TAMs are Growth Strategy Set achievable sales targets by understanding your market capacity.

• Provides benchmarking against competitors. By comparing the TAM estimate to the serviceable market (SAM), which is the portion of the TAM that a company can realistically reach, a company can assess its market share and growth potential.

TAM does not negate the need for companies to offer superior products to capture market share, but it is an important component of market research that helps companies decide how and whether to pursue business opportunities.

How to Calculate Total Addressable Market

There are multiple ways to calculate TAM, each with their own advantages and disadvantages. Below are three ways to calculate TAM:

Top-down approach

The top-down approach starts by looking at the entire market, then splitting it into subgroups to estimate the TAM, which is calculated as follows:

TAM = (Total Potential Customers) x (Average Revenue per User)

Here we use market size and penetration to calculate the total potential customers.

TAM = (Total Market Size) x (Market Penetration) x (Average Revenue Per User, or ARPU)

“Total market size” is the total population of the relevant market (e.g., the population of Miami), “market penetration” is the estimated percentage of the total market that will adopt a product or service, and “ARPU” is the amount of revenue expected to be generated by each customer.

The advantage of this approach is that it provides a quick, high-level view of the overall market opportunity, and the formula also leverages existing industry data.

However, this method can include unreliable assumptions about market penetration and may not accurately assess demand for niche markets or innovative products such as those offered by start-ups.

Bottom-up approach

The bottom-up approach evaluates a company’s total market size in terms of: Market Segments.

Here’s how to calculate TAM using a bottom-up approach:

1. Well-defined Target Market For example, a segment such as parents with children under the age of five.

2. Estimate the number of potential customers in that segment.

3. Determine your average revenue per customer. For most businesses, this means leveraging past sales reports on existing customers. This will give you your Annual Contract Value (ACV).

4. Multiply your ACV by the number of leads.

5. Repeat steps 1-4 for all relevant customer segments.

6. Add up the TAMs for all segments to get your total TAM.

The main advantage of bottom-up analysis is that it potentially provides a more detailed and accurate picture of a particular market segment.

However, this is a more labor-intensive and time-consuming method that starts with collecting detailed customer data. This approach can also miss unidentified potential customer segments or entire emerging markets.

Value Theory Approach

The value theory approach estimates TAM based on the following criteria: Value Proposition Here’s how to calculate the TAM for a product or service using a value theory approach:

1. Clearly define the value proposition of your product or service.

2. Identify the entire population or group that could benefit from your value proposition.

3. Estimate the maximum price that a customer would be willing to pay to solve the problem your product solves.

4. Calculate your TAM by multiplying your entire potential customer base by your maximum willingness to pay.

This approach is advantageous when considering innovative products or services that target new markets. Additionally, it considers the customer’s perspective and potential value perception when assessing TAM.

The downside to this approach is that it relies on assumptions about a customer’s willingness to pay. If you rely too heavily on this, it can be difficult to quantify true willingness to pay. Value Proposition of the product or service.

TAM vs. SAM vs. SOM

Total addressable market, serviceable available market, and serviceable obtainable market are three interrelated metrics used in business and marketing to estimate the market size and revenue potential of a product or service. They represent increasingly narrow segments of the overall market, and each has its own implications for strategic planning and resource allocation. Here’s a breakdown:

Total Addressable Market (TAM)

TAM represents the entire potential market for a product or service, encompassing all potential customers. This is a hypothetical scenario in which a company has no competitors and can reach all potential customers. In the real world, no company enjoys complete market share. Market DemandRegardless of the attractiveness of a company’s product, many companies begin their exploration of the market landscape by calculating their TAM. The TAM calculation process typically takes a top-down approach, considering the overall market size and potential adoption rate.

Serviceable Addressable Market (SAM)

SAM stands for “Serviceable Addressable Market,” but it can also stand for “Serviceable Available Market.” It is a subset of TAM and focuses on a specific segment of a market that a company can realistically target and serve. This includes factors such as geographic reach, product-market fit, marketing capabilities, and the competitive landscape. SAM is typically determined by considering a company’s resources, capabilities, and target audience. This allows the company to assess its position in the competitive landscape and estimate the market share it can capture.

Serviceable Market (SOM)

SOM represents the portion of the SAM that a company can realistically capture within a specific time period. It is the most achievable and measurable market segment that reflects a company’s current market share, sales goals, and competitive positioning. SOM is calculated by considering historical data, market potential, and competitive analysis. You may need to research companies that share a particular market and look at their average selling price per item.

Relationship between TAM, SAM, and SOM

You can visualize the relationship between TAM, SAM, and SOM by drawing concentric circles. SOM represents the innermost circle, SAM the middle circle, and TAM the outermost circle. Each circle represents a smaller, more attainable market segment. Your primary market research might start with a total addressable market calculation, but as you narrow it down towards your serviceable, addressable market, you’ll get a more realistic sense of your target audience, potential size, and revenue opportunity.