Everyone wants to grow their business, it’s a part of being an entrepreneur, but with growth comes risk. Sometimes you feel you have found a solid prospect for your business, only to later find out that they were not as interested in your product as you initially thought. Or perhaps you missed a great opportunity because they did not appear to be interested in your business at a glance.
So how do we mitigate these risks? A Total Addressable Market understanding may be the answer. By having guidelines in place to identify which companies fall within your target market, you can save time and money chasing the leads that matter.
What is the Total Addressable Market?
Total Addressable Market (TAM) is the total number of companies in your target market. Also known as the total available market, TAM represents all the revenue opportunities available for a given product or service. It acts as a metric for identifying your business’s overall potential, eliminating the risk of chasing bad leads or dead ends. This metric often looks at patterns in current and potential customers, industries, location, business size, market growth, and budget. By analyzing the patterns in your existing customers, you can establish clear parameters that define which prospects are a part of your TAM. With these filters, you can narrow down your target market and get a good idea of just how many opportunities are out there and which ones are the best for your business.
Additionally, TAM allows companies to analyze their prospects without having to account for dozens of other factors. TAM metric looks at an environment with zero competition to estimate your company’s overall potential. Understanding this potential can tell you whether or not this is a worthwhile and profitable business line. If demand for your product is low without competition, it may be nonexistent with the competition. Alternatively, competition need not dissuade you from pursuing a business opportunity if TAM is high, after all, there is a demand for your product, you just need to convert leads.
Why is the Total Addressable Market Important?
As mentioned before, an understanding of TAM allows you to identify your company’s overall revenue opportunity, but that is not its only benefit.
TAM provides necessary industry insight that shows you where your business stands in the current industry and where you need to be. TAM understanding can help you plan out the future of your business, building a roadmap for how your services need to evolve to stay relevant. This information and planning are valuable in growing your business at the ground level, but also for investors, who will want accurate estimates for your growth.
At the end of the day, growing your business is about resource management, and understanding your TAM will help you allocate your resources accordingly. From budgeting to marketing, operations on the ground level will run more smoothly if everyone involved has a clear understanding of where to dedicate their energy. Marketing in particular can benefit since your TAM provides your marketing team with the exact target demographic for their campaigns.
After selecting a TAM calculation method and finding your market, you now can define your company’s goal and explain your potential to investors, employees, and key stakeholders. This big-picture view helps everyone in your company recognize the market they are attempting to service.
A solid TAM understanding is important for new and established businesses alike because it provides an estimate of the viable value proposition. A value proposition is a summary of why a customer would choose your product or service, and while communicating the benefits for current customers is important, TAM elevates the value proposition. Understanding the entire market for your product provides a fuller picture of what current customers need and what prospective customers may want. Additionally, TAM tells you what financial benefits and opportunities are available to you. With this knowledge, your company can better allocate funds to prioritize certain segments, products, and opportunities.
Beyond the Total Addressable Market: SAM and SOM
While the total addressable market is the total market demand for a service, it is not the only metric that businesses use to measure their potential. TAM, SAM, and SOM all represent various subsets of the target market.
Serviceable available market (SAM) refers to a portion of TAM that is served by a company’s products or services. A serviceable obtainable market (SOM) is an even smaller portion of SAM that can realistically be reached. Although there are many companies within an industry, not all of them are available buyers, since they are already being serviced by competitors. While TAM can help estimate total potential, SAM and SOM help estimate the most realistic potential for your business.
How do you calculate the Total Addressable Market?
There are three major methods for estimating the Total Addressable Market: top-down, bottom-up, and value-theory.
The top-down analysis focuses on an inverted pyramid structure, with a large population of a known segment at the top and the end-user represented at the bottom. Through secondary market research, you can determine how many users within the large population meet your business criteria. Each layer of the pyramid represents the overall market and is narrowed down based on the industry until you eventually arrive at a manageable market size that fits your company’s ideal customer profile.
The bottom-up analysis starts at the result: your existing sales. By taking your sales history and pricing data, you can multiply your average sales price by your number of current customers. This number is your annual contract value. From there, you can multiply your ACV by the total number of customers in your industry, giving you your total addressable market. It is important to remember in this metric that no two customers are going to be the same, and some customers will spend far more money than others on your product. This value calculation is an estimate and can be further refined by looking at the average size of prospective customers in your industry.
Value theory looks at the cost-benefit analysis of your product or service for your customers. How much value do your customers receive from your product? How much are they willing to pay in the future for that product? Do you provide enough value to warrant your prices? By asking these questions, you can determine if your product or service could succeed in a given market.
Value theory also looks at the cost-benefit analysis for your business, helping you determine if an industry is profitable enough to enter.
It may also be beneficial to use two or more methods when calculating your TAM. Since the criteria for each calculation method are different, they can provide you with slightly different markets as well. The companies that fall within your criteria for multiple calculation methods are probably a better fit for your business. Additionally, companies that fall outside your TAM for some calculations but inside your TAM for others may be better left alone until you have addressed your more viable leads.
Understanding the total addressable market can take your business to the next level, helping everyone from your average employee to your investors. These metrics give you estimates for your overall potential, your realistic potential, and your current earnings and can help you create an accurate roadmap for the future of your business. Research into your TAM mitigates risks and allows you to dedicate your resources where they will make the greatest impact.
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