What is Total Addressable Market: How to Calculate & Perform TAM?

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Total Addressable Market

For a layman, the term total addressable market means the total money a new business can raise by selling the product and services they are going to sell. Total Addressable Market or TAM can also be explained as total demand for a particular good and service in the market.

Most people often confuse TAM with market share. Market share is the total revenue generated by a segment of goods and services, while Total Addressable Market is the total revenue that a particular organization can earn if they are able to capture or motivate their target audience to actually buy their goods and services.

Calculating Total Addressable Market

Before we delve deeper into what TAM and how it is calculated, it is also important that we understand why we need to use TAM. From the business point of view, you must answer the following questions before using any form of TAM analysis in your business activity:

  • Who are your current and potential customers and how will you classify them?
  • What sector are you entering? 
  • What type of products or services will you be providing?
  • Are there any other companies offering the same solutions?
  • What size are the companies that are willing to buy our services?
  • Is the market new? How big is the growth potential in the segment? 
  • How much revenue and growth are you expecting?

Calculating the total addressable market can be difficult if the competitors are not ready to share their sales figures or present a wrong figure altogether. There are three ways of calculating TAM, which is as follows:

  • The first method is top-down, under which the business analyses the largest market size estimate and reduces it using information and assumptions based on their business and market. 
  • The second method is Bottom-up, where the company analyses the data acquired from the early sales of the company and then estimates the market size.
  • The last method is called the Value theory, where the company analyses all the data available to them and evaluated how their products and their value will affect the buying habit and behavior of the customer.

Now that we have given you a gist of what the methods are, let’s read through to understand the methods in detail.

Top-down TAM Analysis

If we start from the highest point in the hierarchy, the total market calculations are used for forecasting the future performance of the company. This method is most popularly used by firms that do market research, like Gartner and Forrester and others, who use such methods to draw specific conclusions about the markets. Big research firms use data from phone or email surveys or third-party consultants to support their results.

Though this strategy is not as beneficial as other TAM methods. The only reason is that this method is not very successful is that the investors may find the numbers are not trustworthy. The Top-down analysis starts focuses on the widest lens of data available in the market and then moves to the smaller units.

This method focuses on global trends, macroeconomic factors and sector analysis and then takes individual factors into consideration. This analysis method can be very useful in conducting trend analysis and may help business in the long run.

Bottom-up TAM Analysis

The bottom-up analysis method uses the local market size to determine and analyze the data while moving upwards to a wider population. This method is more accurate as compared to the top-down TAM analysis method, hence it is more popular among new businesses. The data collected under the method are more accurate as it is the primary data collected from disparate geographies and cultures.

The only drawback of the bottom-up TAM(Total Addressable Market) analysis method is that it ignores factors like how long does it take for the products to reach the consumers, churn rates of customers and the market competition.

To accurately calculate the market revenue number you must extrapolate your data on your current pricing and usage and then multiply it with a number of the larger customer base of your target market.

The TAM analysis Value Theory

The value theory method for calculating TAM is based on too much hypothesis and guesswork and the data collected using this method tends to be a bit questionable, but it is still useful in calculating the revenue a business can generate in a given segment.

In order to calculate TAM uses this method, you must first gauge the value of the product and service that you will be selling to your target audience and if you are successful in capturing the same through your pricing.

The value theory method for estimating TAM is very useful if you are launching a new product or upgrading an old product with new features and that product will be creating its own category in the market.

But for this approach to have its desired use, you must make sure that the customers find your product useful to them and available and how much money they are willing to pay for that product and service.

Next, as much as you find it hard but you must predict how many customers will choose an alternative over your products and services. And this is really simple if you have the right tools.

Benefits of TAM

Now that we have offered you guidance on total addressable market (TAM) means, its benefits can be listed as follows:

Set realistic goals for your company: When you have a detailed understanding of your market, you know that if you don’t have a monopoly in the segment your revenues can never be 100%. When you have a clear knowledge of your market standing and how many shares your competitors have acquired, you can plan your strategies accordingly, thus, generating profitable revenue and sales.

Position yourself differently than competitors: When you know how much TAM(Total Addressable Market) your competitors have control over, you can easily create a niche and space for yourself in the market. Say for example, if you’re targeting small, medium and enterprise size businesses, but your competitor has already a stronghold on the enterprise market segment, then you can start targeting the small and medium companies before entering the enterprise company sector.

Guide your company’s growth trajectory: Once you have a clear idea of what you are targeting and how much revenue and sales you should make, and effective TAM analysis helps you increase the portion you want to capture from your target market. If you hit a growth plateau, then you can use the TAM(Total Addressable Market) to change your strategies and target a larger sector.

Importance of TAM

The Total Addressable Market is the first step that every business organization must take in order to set out and achieve their business opportunities. Without the knowledge of how to target your audience and how many people or companies are willing to purchase or invest in your products, it will be difficult to form assumptions about your potential growth, revenue, or sales.

When an organization launches a new product or decides to enter a new market, or even upgrade an existing product with new features, it is imperative that you understand how your revenue can impact these strategic moves.

Calculating the TAM can help in revealing future business opportunities and roadmap for product evolution. With the data collected from the TAM, your business can make more informed decisions about how and where to invest their money, which will provide maximum Return on Investment (ROI).

Calculating TAM can also prove helpful when you are deciding to enter a new market, undergoing major changes or pricing change. Understanding how the market share will change based on these factors can help you better understand your options for the total market opportunity and how your decisions may impact your revenue projections.

For a startup business, TAM provides one of the most important data points for investors, who is evaluating a company or product’s prospects in the market. TAM focuses on the market opportunity as compared to the size and provides various opportunities for the business to increase its sales and revenue.

Calculation of TAM forces a company or product to set out of its comfort zone and create a niche for itself and see where it falls behind as compared to its competition and make changes to come out on the top. 

Calculation of TAM does not mean that you have permanent data on which you make decisions for your company or product as long as it does not perish. The data calculated is for a short period of time and will change as the market changes.

Factors like demographic changes, changes in business trends, and new technological innovations, all these affect the TAM calculation. And if you are looking for a forecast based on these macroeconomic elements, you must ensure that all these data are revisited before making any big decision.

Conclusion

Do we hope that from all the above information you are able to understand what a total addressable market is? And how it can be helpful for you in figuring out your market size and sales opportunities. The process of calculating the TAM(Total Addressable Market) allows you to better understand the make-up of your market so that you can better target your audience in that segment and manage the competition effectively.

These analysis methods can help you market your product efficiently, and helps you make the right decision about where to put the most of your effort and how much return you can expect from these efforts. A carefully crafted TAM(Total Addressable Market) can also help you generate investment opportunities, as this data provides the knowledge that the investors need to understand the playing field and how much you are prepared to market your products effectively to your audience.

 

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