Total Addressable Market: Learn How to Calculate the TAM

The smartphone market size today is valued at hundreds of billions of dollars. Three years ago, it was valued at $457 billion and is expected to grow by 73.35 percent in the next half a decade.

Knowing the market size of any niche helps in understanding new players to identify opportunities and threats and for established players to assess their market position and potential growth.

Understanding the total amount of money you could potentially make by selling your product or service to everyone who might be interested in buying it is important.

To capitalize on this growth and make informed business decisions, understanding the total addressable market is essential.

Total Addressable Market is a crucial metric for any business. It represents the maximum revenue a product or service can generate by reaching every potential customer in a given market. To put it simply, it’s the total size of the pie a company can potentially capture.

What is a Total Addressable Market?

Total Addressable Market, or its casual shorthand, TAM, is the highest or peak revenue opportunity available for a product or service. It is the maximum potential market for a product or service if we ignore the competition.

Understanding TAM is crucial for businesses as it helps in evaluating the business size of the market, prioritizing business opportunities, and determining the necessary resources and investment for a new product or service.

Learn How to Calculate the TAM

There are particularly three ways to calculate TAM:

1. Top-Down Approach

This approach is based on the elimination method.

First, a large target audience is considered and gradually narrowed down to a specific market.

The filtering is done from top to bottom, that’s why it’s known as the top-down method or “inverted pyramid” method.

Example & Calculation of Top-Down Approach

Let’s take an example of electric vehicles to assess the concept better.

The top of this will be any means of transportation, like cars, motorcycles, bicycles, and public transport.

Now, segment it to the passenger vehicle market – electric vehicles (EVs) and internal combustion engine (ICE) vehicles.

The third step would be finding the ideal target market, primarily electric vehicles.

Lastly, determine the total number of electric vehicles sold all around the world. Calculate the average revenue per electric vehicle and multiply the total number of EVs by the average revenue. It is the estimated TAM for electric vehicles.

(Note: Data on product sales can be sourced from industry reports, government statistics, company financial reports, and market research firms. This information is essential for calculating market size and potential revenue.)

2. Bottom-Up Approach

The bottom-up approach is the inverse of the top-down approach. It begins with specific details and builds upward to a larger picture.

It starts by defining a specific group of potential customers, such as individual consumers or specific businesses, and then aggregates their needs, behaviors, and spending patterns to estimate total market demand.

Example & Calculation of Bottom-Up Approach

Unlike the top-down method, which starts with a broad market and gradually narrows down, the bottom-up approach begins with the smallest units. In the case of electric vehicles (EVs), this means focusing on individual models like the Tesla Model 3 or Nissan Leaf.

By collecting sales data for each model and determining its market share within its segment, one can estimate the total number of units sold.

Additionally, calculating the average revenue per unit for each model, considering factors like discounts and options, provides a figure for total revenue. Summing up the sales and revenue of all EV models yields an estimate of the overall market size.

This bottom-up approach tends to be more data-intensive and time-consuming compared to top-down, but it often provides a more accurate picture due to its granular focus.

3. Value Theory

Value Theory TAM is a method for estimating the total addressable market (TAM) based on the perceived value of your product or service to customers. It’s particularly useful for innovative products or services where traditional TAM calculation methods (top-down and bottom-up) might be less accurate.

Example & Calculation of Value Theory Approach

To calculate Value Theory TAM:

Identify the Value Proposition. Clearly define the problem your product or service solves and the value it brings to customers.

Estimate Potential Beneficiaries. Determine the total number of potential customers who could benefit from your product or service.

Estimate the maximum amount customers would be willing to pay for the value your product provides.

Multiply the number of potential beneficiaries by the maximum willingness to pay.

TAM = Number of Potential Beneficiaries * Maximum Willingness to Pay

For example, let’s say you’re developing a new AI-powered tool that dramatically improves customer service response times.

Value Proposition: Faster, more accurate customer service responses.

Potential Beneficiaries: All businesses with customer service departments.

Maximum Willingness to Pay: Based on potential time savings and increased customer satisfaction, you estimate businesses would be willing to pay up to 10% of their annual customer service budget for your tool.

To calculate TAM, you would estimate the total number of businesses with customer service departments and multiply it by 10% of their combined annual customer service budgets.

Differences between TAM, SAM, and SOM

TAM, SAM, and SOM are three different terms that represent various market segments. Let’s understand them:

TAM represents the entire potential market for a product or service. It’s the maximum revenue a company could generate if it captured every single customer in the market. TAM is essentially the ceiling for a business’s potential.

SAM is a subset of TAM. It focuses on the specific segment of the market that a company can realistically reach with its product or service, considering factors like geographic location, product features, and target customer segments. SAM is a more practical estimate of the market size.

SOM is an even smaller subset of the market. It represents the portion of the SAM that a company can realistically capture with its current resources, sales force, and market position. SOM is the most conservative estimate and focuses on achievable goals.

In short,

TAM is like the entire gold rush era, encompassing all the potential gold-bearing land.

SAM is a specific gold-rich region like California or Alaska in that era.

SOM is the actual amount of gold a particular mining company extracts from a specific mine within that region.

Conclusion

Understanding the Total Addressable Market (TAM) is a cornerstone of a successful business strategy.

By accurately estimating the maximum potential revenue for a product or service, businesses can make informed decisions about resource allocation, investment, and market positioning.

Also, we have other Resources to look at: What is Consultative Selling 7 Sales Promotion Techniques to Maximize Conversion Rates  What is Sales Enablement? Best Inbound Sales Strategies: Processes and Examples Sales vs Business Development vs Marketing Sales Funnel vs Sales Pipeline What is SaaS? Software as a Service Best 15 Business Metrics for Maximum Profitability 12 Disruptive Innovation Examples: The Art of Creating Game-Changing Products