TAM and SAM (are not siblings)
The past few weeks have seen us discuss various segments that are important in the life of any business, startup or mature, as we explore Sramana Mitra’s virtual accelerator, One Million by One Million. To recap, this programme has the aim to assist one million startups to grow their revenues to one million Dollars each, leading to a trillion dollars in revenues worldwide, and creating ten million jobs in the process. We have briefly considered three aspects that the programme covers over the past three weeks and this week will delve into TAM, the Total Addressable Market, and SAM, the Served Available Market. This key aspect considers the size of the market opportunity as this will impact on financing and the go-to-market strategies.
What it is
Total addressable market (TAM), also called total available market, is a term that is typically used to reference the revenue opportunity available for a product or service. TAM helps to prioritize business opportunities by serving as a quick metric of the underlying potential of a given opportunity.
One approach is to estimate how much of the market any company can gain if there were no competitors. A more encompassing variation is to estimate the market size that could theoretically be served with a specific product or service. TAM can be defined as a global total even if a specific company could not reach some or most of it or, more commonly, as a market that one specific company could serve within realistic expansion scenarios. This focuses strategic marketing and sales efforts and addresses actual customer needs.
The inclusion of constraints such as competition and distribution challenges then modifies the strategy to frame it with realistic boundaries, reducing the market down to the serviceable available market (SAM), the percentage of the market that can actually be served, either by that company or all providers out of the TAM.Customers can be purchasers who intend to resell the product or end users who intend to use or consume the product.
Calculating the Total Addressable Market (TAM) Size for the Beachhead Market
The beachhead market and End User Profile gives enough specificity to make a first-pass calculation of the Total Addressable Market (TAM) size for the beachhead market. The TAM for the beachhead market is the amount of annual revenue, expressed in revenue per year that the business would earn if it achieved 100% market share in the beachhead market.
The goal of this exercise is not to write down a big number to impress others, but to develop a conservative, defensible number. Entrepreneurs often tend to inflate the TAM with excessive optimism. However, a big number is not necessarily better.
The startup should be looking for a market that is big enough to get to critical mass, develop key capabilities and get to cash flow positive in the market. On the other hand, if the market is too big, the business will likely not have sufficient resources to compete and may get overwhelmed and either not succeed or have to raise money without much of a track record for potential investors to evaluate.
To calculate the TAM, first determine how many end users exist that fit the End User Profile, primarily using a bottom-up analysis based on primary market research, with limited top-down analysis to complement the primary research. Too much top-down analysis will lead one to focus on spreadsheets instead of real-world customers. Once the number of end users who fit the End User Profile has been established, determine how much annual revenue an individual end user is worth. Multiplying the revenue per end user by the number of end users will determine the TAM.
The best way to calculate the TAM is a bottom-up analysis, often termed “counting noses”. Primary market research should reveal how many end users have been identified that fit the End User Profile. Customers, trade associations, etc. can help to identify how many customers there are, as well as how many end users per customer. Referred to as “counting noses” because the research is very specific and detailed enough to know how much they could spend.
A top-down analysis starts by using secondary market research, such as market analysis reports, to determine how many end users meet different characteristics. This data is usually expressed with an inverted pyramid that has several horizontal levels, where the bottom-most level is the smallest and contains all end users who meet the End User Profile. A top-down analysis should be complementary to the bottom-up analysis. It is often much higher because it is not as specific as the bottom-up analysis.
A key factor to consider is not just size but also gross margin, speed, potential for dominant and sustainable market share, and strategic value. But size does matter and it is a common language used universally so it is well worth doing the calculation.
The best means to explain the concept of TAM is by using a real world example of Korean students based in the USA.
Koreans in the United States were particularly interested in staying in touch with things going on in their homeland. One of the main ways to do this was to watch Korean soap operas. The students noticed that many of them visited websites where they could see bootlegged and low-quality versions of these shows. With their background, technical skills and connections, they were confident that they could build a site that would produce much higher-quality video and do it legally. The analogy would be iTunes as compared to Napster or Kazaa.
So the team dutifully built their End User Profile as can be seen in the graphic below. They determined at that time that the number of Koreans residing in the United States was about 2.5 million people. Of this total, a sub-segment was in the correct age group that they were targeting, and of them only a smaller sub-segment was female and possibly fitting their target customer profile, bringing the potential market down to 1.2 million. They were also able to determine through research that the top three websites for Koreans to watch the bootlegged material (Joonmedia, Bada, and Dabdate) had 700K users in total. They figured that based on these numbers, there existed 400K end users in their beachhead market.
While this is a good start to calculating the TAM, it does not end with estimating the number of potential customers. The TAM is not the number of customers but rather revenue per year. The team therefore also needed to determine how much the 400,000 potential customers would pay in a year to establish the TAM.
The TAM is how much annual revenue there is available to the startup if it achieved 100% market share. This is only to calculate the first “beachhead” market. The preference is for a bottom-up analysis where primary market research identifies the number of potential customers and then extrapolate this to the broader market. Complementary to this but less compelling on its own is a top-down analysis, working with market analysis reports and extrapolating without direct interaction and validation from real customers.
It is important to understand the size of the market to be targeted early in the company’s lifecycle. This number will be modified over time but it is wise to be thinking about and keeping track of a particular number, namely the TAM.