What is Total Addressable Market
Let’s say you’re a product innovator with a great idea for a startup. Or you’re a product manager working on a potential opportunity that your group can pursue. Through disciplined qualitative and quantitative research with potential customers, you’ve continued to validate your idea. You’re convinced that there are key pains and gains that you can address for your customers. You’ve also performed a segmentation and customer persona building exercise to really identify the profiles of potential customers.
You’re all excited to get this opportunity funded and move to the next stage of your product journey.
If you present the concept to any serious investor or executive management, one of the first few things you’ll have to address is the revenue potential. One way to do is to determine the total size and value of the opportunity. This is what is known as the target addressable market or TAM.
Why You Need to Calculate It and How Do You Really Understand it
While you may still be early in the product innovation journey, a thorough treatment of this is crucial, not just to raise funds or get resources approved, but even for you to determine the viability. While the idea may seem simple and logical, it is notoriously easy to miscalculate. Most product managers and innovators tend to overestimate the size of the opportunity. But it’s also possible to underestimate.
The best way to think about TAM is to consider it as the total possible demand for your goods (products/ services) from all your potential customers.
Let’s take the term apart and look at each of the components to make the meaning clearer.
- Market: This is the section of the industry where your potential customers are.
- Addressable: You need to understand the right customer profile/segmentation that makes up the market for YOUR product. You need to filter out the segments of people who will not be your customers (based on demographics, geographic, behavioral attributes)
- Total: For TAM calculation, assume that there are no other competitors, that you can potentially reach everyone, and that you can deliver to everyone.
Two Ways to Calculate TAM
Two commonly used methods to calculate TAM are top down and bottom-up approach.
Top-Down Analysis: You start with the high-level research (usually available through external research sources, Gartner, Statista, etc) on market size and “go down” and reduce the size through the right segmentation until you’ve reached the right level of TAM. This isn’t usually the best method, especially for serious initiatives, but can be used at times like the back of envelope type of calculation.
E.g. If you’re looking to launch an organic locally-sourced dog food in your state, you could start with the total size of the pet food industry and apply sub-segments of dog food, organic food type, and target geography.
Bottom-Up Analysis: This is the more diligent and thorough approach to determine TAM for your product opportunity. The idea is to project the total number of potential customers for your product (or service) and the value ($) from each customer (say annual contract value).
TAM= Total # of potential customers X $ Value of each customer
Unlike top-down analysis, where you can rely on externally available research, bottom-up analysis requires a much more detailed understanding of the profiles (and personas) achieved using a mix of surveys, business and market research, and segmentation. then finally extrapolating it to determine the TAM.
What Total Addressable Market is NOT
Lets us take a few examples. The best way to understand the concept is perhaps looking at how to incorrectly calculate TAM. Take a look at the following examples. Can you think of what is wrong with these calculations? (Some of these situations are made up for illustration and are simplistic examples)
| TAM calculation example | Issues with the calculation |
| An entrepreneur who has a new idea for a unique photo app forecasts the TAM as 0.1% of the mobile app spend | This uses a very high-level top-down analysis and also fails to do any true segmentation to determine what type of users will download and pay for the app, or what that they will pay. |
| An innovative auto insurance product manager marks the TAM as $311bn based on the following research: The market size, measured by revenue, of the Automobile Insurance industry is $311.0bn in 2021 | This one misleadingly uses the size of the entire PROBLEM (insurance industry) and not that of the PRODUCT and opportunity. |
| Home Fitness Equipment Market is valued at USD 11.16 Billion. Therefore, this number can be used as the TAM for a new disruptive product in the space. | The home fitness industry is made of up multiple market segments (cardio, resistance, etc) which are required to determine TAM. Also, this doesn’t account for the rapid growth of the TAM in the near future, post pandemic. |
| An online wine club in the US determines that its Total Addressable Market size is $55 billion based on the wine revenue projections in 2021 | This isn’t accurate because online wine market is very different from table drinking (e.g. at Restaurants). So we can’t base the TAM off of the entire industry. |
| A company building out a secure peer-to-peer money transfer app, projects its TAM as $310 billion based on the global p2p industry size research | The product mentions global app. However, for a more intelligent calculation, including geographical assumptions is key. E.g. China has very strict laws and therefore this app needs to most likely exclude that huge market from the number presented here. |
| A taxi hailing service believes it can target 30% of the market in the city of its operation, given two other incumbent companies and it used that to calculate its TAM. | TAM should not consider other competitors. It is supposed to be the TOTAL demand for your service/product |
| A US women’s apparel brand wants to launch a new fashion line or product. It plans to use the size of the women’s apparel industry ~ $166 billion for the TAM calculation | The apparel industry is extremely segmented (luxury, mass, etc), and therefore regardless of the actual product here, it is inaccurate to use the TAM for the total industry to make any reasonable projections |
Example of Total Addressable Market (TAM) Calculation
The above examples are almost all some sort of the top down analysis of TAM calculation, which isn’t the method you should follow for your product proposal or pitch deck. These are all based on “canned” market data available externally.
Here’s how you can think of a bottom-up analysis method to determine the TAM for the last example above (of the women’s apparel fashion brand. If the brand is/wants to be a serious player, it has to perform detailed active research to determine the markets, segmentation of customer profiles. See the following image for a view on market segmentation for fashion brands.
Let’s assume the new product is an ultra-luxury handbag expected to be priced at $2000. Now that we understand the market segment we are entering, we need to apply our research to understand the income, demographic, behavioral characteristics of the women that would be potential customers for this to determine the total demand.
Clearly, this is a not mass-produced product for cost-conscious or value-driven shoppers. This is geared towards the personal status focused shoppers. You can conduct an online quant survey, social media campaign, or other research methods to find out what will be your potential customer profile(s). Let’s say you’ve determined that women between the ages of 27-50 in Tier 1 cities, with a net worth of $500k, are the ones most likely to be your customers. You can then use the population density data to extrapolate the demand and hence the TAM for your product. Let’s say that number is 1 million women. The TAM then will be 1 million X $2000
Other Things to Remember in TAM calculation:
- While a large part of the sections above discussed how to calculate the size of the customer segments, it is just as important to know what the customers will pay for it. Price is the other component of the calculation. You can’t just use an existing competitor’s price to provide that answer.
- TAM is the first level of determination of the viability of a product or service. Other measures like SAM (Serviceable Addressable Market) and SOM (Serviceable Obtainable Market), Penetrated Market (PM) are further used to elaborate on the business model and plan. These discuss your reach, capabilities, and scope. I’ll cover these in future blogs.
- It is impossible to be exact about the TAM calculation. The goal is to apply as much science and due diligence as possible. The bottom-up analysis forces you to do that and is more robust. In a business presentation, document as many underlying assumptions you’ve made as possible.
- Successful products can change and expand the original “market” and create new demand by changing customer behavior.
- Markets do grow, therefore growth in TAM is also an important factor to consider.
How do you approach TAM calculation and why do you think it is important ?
4 comments
Kim
January 11, 2021 at 11:22 am
We’ve done TAM based on market research, our target market, population, demographics, %ages, etc. making assumptions based on how much of the addressable market you want to capture, which helps with financial projections and expected growth in your story, pitch deck. Many investors want to see the research done, your analytical thinking and explanation as to why and having these assumptions, estimates documented. Instead of a number out your you know what. This project is at that stage of getting your feet wet and visually seeing whats out there as a TAM and coming to an agreement with the logical way of thinking it all through and that things make sense on paper in number and visually to a 5 year old and grandma in a story, pitch deck. This project is at the stage of validating that this is a viable product, solution and there is an opportunity, need.
The algorithm, solution that will be what sells this, if and how it progresses based on what is all gathered after the upcoming exercises then yes, that will be the data that people will salivate over to make this attractive to investors and a bigger pool of users for traction, sales, potential strategic partners. Will this be IP? An API? Something that can be white labeled? This may pivot, may wound up reverse engineering, etc. Would love to see what can be put out here for demo so that we can see, as well as a beta test for users. I like the forward thinking.
Vinay Dalal
January 13, 2021 at 2:04 am
Nice drafted post, Vipin.
TAM, in its most nascent form, is an estimate. And I have seen a general tendency among product owners to over-estimate this item. TAM is often the foundation for many revenue projections, so there is incentive in keeping it high. This tendency is so widespread among presenters (seeking funding) that I have seen an almost cynical rejection from (investment) evaluators. The evaluators usually begin their analysis by ripping apart the TAM figures.
However, good product owners take it as an opportunity. If TAM calculations are done properly and logically, then it can be an instant trust-binder with the evaluator.
Professionally done TAM analysis is a great indicator of product owner’s diligence (in my opinion).
Vipin Makhija
February 2, 2021 at 1:52 am
@k4dwin Great points Kim. I’ve seen it done, understood, and calculated so incorrectly so many times. There may not be ONE right way to make this projection, but as you point out, it is the analysis and logical thinking behind it that is more crucial.
Vipin Makhija
February 2, 2021 at 1:55 am
@vinayvd Great to hear from you Vinay. You hit the bull’s eye with the comment about the rejection from the investors. So easy to get carried away with bloated numbers.