Total Addressable Market is essential as you need to know how big the potential market is, imagine.
Here we will explain the total addressable market in this article. Additionally, we will also demonstrate how to calculate the Total Addressable Market. Let’s dive in.
Total Addressable Market
Total Addressable Market, in short TAM, is also sometimes referred to as Total Available Market. Either way, it is the same thing. It is about how big the total market that you are attacking is. It means the total market opportunity, not what you expect to get, despite how big the opportunity is. Very few companies get a 100% market share, that never happens unless it is a monopoly.
Let's take a look at why this is important. When you build a startup, you will spend a lot of time and money on it. Before you start investing too much of your valuable time, you should check if the market is big enough. This means how big the Total Addressable Market is.
Should you get to a point where you will be raising money? - This is the question that investors will most certainly ask for a TAM. Investors need to know if it is possible to build a big business to make a good return on their investment. Never solve a big problem in a small market, it will never pay off.
Figuring out TAM:
There are two ways of figuring out what the TAM is. You can either do a Top-Down analysis or a Bottom-Up analysis. Either way is effective. In this article, we will discuss both with real-world examples.
#1 Top-Down Analysis:
Let’s start with the Top-Down Analysis. Top-Down is when you have some market data and want to slice that down to get an actual total addressable market for your product.
Let’s use Vivino as an example. Our business model is building a marketplace for wine online. The question is - what is the Total Addressable Market for selling wine online?
Globally, retail wine sales total $300 billion, according to one data point. That is not the number we’re looking for as we’re only looking for online sales and also we’re looking for retail sales. This means no on-premise sales like bars and restaurants.
Let’s start by taking out the on-premise sales data. Our research shows that on-premise sales are 25% of all sales. So now, we’re down to $225 billion being the retail sales.
The next thing to figure out is how many online sales are versus brick-and-mortar shops. In the end, we looked into some more research and found that the percentage of wine sales is around 15%.
This gives us a Total Addressable Market of around $34 billion for online wine. Now the TAM number is not a permanent state. The market could grow or shrink, and parts of the math could also change.
For instance, we believe that 15% of online sales will multiply over the next few years. Should that number double the total addressable market? Will it change to $68 billion? Moreover, the next question is obviously how big a part of the TAM can you grab, which you can figure out.
#2 Bottom-down Analysis:
The other way to figure out TAM is to do a bottom-up analysis. When we do a TAM, we often have no market data. Maybe it is a new product, and there isn’t a market yet. For that reason, we have to use whatever estimates we can figure out.
Now, let’s do an example. We will use a very niche product called Cue Pilot. Cue Pilot is a super-specialized product used for directing the most prominent live shows in the world, especially big live TV shows like the Eurovision Song Contest.
The current product is being sold to television producers throughout the world. Since the product initially comes from Denmark, the bulk of the existing customers are in The Nordics.
Now we want to find the global TAM for this product. The way of doing a bottom-up analysis is to find out how many potential customers there are in each market and how much they would spend each. As the product is already out there, we know the average cost per year is $40,000.
The next thing is to find out how many potential customers there are. They know the Nordics well, and the estimate is that there are around 30 potential customers there. The next thing is to go through all the other regions of the world and estimate the potential customers in each region.
Open a spreadsheet and start adding countries and regions. This is not a science. Instead it is about making the best possible estimate. However, this might not be a perfect estimation. In the case of Cue Pilot, we found that there were 719 potential clients for Cue Pilot.
The next thing is to multiply the potential clients with the average spend per year of $40,000. This gives us a Total Addressable Market of almost $29 million.
Knowing the Target Addressable Market or TAM also gives you an idea of what kind of company you should build. This gives you an idea of the potential customer base. It may be a good idea to raise millions of dollars and build a significant business if there is a chance you can get a piece of a multi-billion dollar company.
However, if the TAM is only $50 million, then you probably shouldn't raise a lot of money as the potential just isn't big enough.
After seeing the TAM, you may also realize that you need a broader product that appeals to more people. With the Cue Pilot, they could change the product to be used in other types of shows.
Therefore, it becomes an appeal to get more clients, which would change the total addressable market a lot. In addition, it is also possible to increase the price in some cases. Thereby, you can increase the total addressable market.
This is not about getting to a negative or positive conclusion. It could also mean pricing adjustments needed to make the potential business big enough.
This is all about the total addressable market. Don’t forget to do your exercise of figuring out the TAM for your startup.