Understanding the total addressable market (TAM) for a new product or service is essential for planning revenue growth. However, many businesses focus on the overall market size rather than the realistic number of targetable customers at a competitive price.
This guide will cover the fundamentals of Total Addressable Market (TAM), including its definition, calculation, and value for sales and marketing teams.
What is SAM analysis?
A SAM analysis, or Strategic Applications Market analysis, is similar to a TAM Analysis in that it seeks to identify potential sub-markets of the TAM to account for varying price points, product features, or quality of services.
Unlike a TAM Analysis, SAM Analysis identifies which markets present the most opportunity for a business to gain maximum market share. These differences can also account for changing geographic and regional demand for a new product or service and premium versus value-based target segments or product users.
The two analyses can be used together to better understand the potential of a given market.
1. Top-down approach
The top-down approach of the TAM Analysis seeks to identify the total potential value of a market. This approach involves analyzing the size and state of the entire marketplace to determine its potential. After the total market size is known, it's then possible to assess a company's individual market share.
The top down approach of the TAM Analysis requires several pieces of data and involves performing a few calculations. To start, businesses need to research the estimated size of the entire target market, which can be determined through surveys and available research. They can then determine the portion of the total market your company currently holds by tracking current market share. Finally, businesses can calculate the total available market by subtracting the current market share from the total market size.
While many early stage companies prefer to use the top-down TAM analysis approach, the numbers are often too high and tend to focus on the total size of the market versus a realistic number of potential customers.
Example: An accounting software company may cite an industry report that estimates its total global market size to be $15 billion USD.
They’ll quickly estimate that if they can get just 1% of that market, they’ll have a $200 million USD sales opportunity. If their target price for the product is $600 per year, divide that into $200 million, and they’ve got 333,333 potential customers.
The challenge is if they haven’t done the work to figure out how many customers would be willing to pay for their product at that price point in a market in which they have yet to enter.
2. Bottom-up approach
Like the name indicates, the bottom-up approach of the TAM Analysis calculates a market's potential from the ground up.
This approach requires the detailed analysis of each potential customer to assess their individual value within the overall marketplace. The bottom-up approach is more time consuming than top-down, but it also provides more accurate insights into a market's potential.
Many investors and CFOs of existing businesses prefer the bottom-up approach because companies look at the total market potential for their specific segment and geographic target market, along with a realistic existing or prospective customer base number.
Example: Let’s use the same accounting software company from before, but this time they want to target small businesses in the U.S. Unfortunately, most small companies won’t be able to afford a $600 per year product when they launch.
The business conducts its research via in-person interviews and online surveys. From the study, they discover most small businesses are willing to pay for a “light” or basic version of their product that limits the number of account users to one. They can invoice up to five clients per month at $240 per year (or $20 per month), which is what competitors are currently charging.
The business determines it can charge $200 per year (or $16.67 per month) by lowering overhead costs to steal market share. They also find statistics that reveal there are 33 million small businesses in the U.S. Likewise, a competitor recently reported that they could attract 100,000 small business customers in the first year of business at a higher price point.
Using their competitive pricing strategy, the new accounting platform estimates it can also attract 100,000 customers out of a potential 33 million in one year.
That means the accounting software company should multiply 100,000 X $200 to get a TAM of $20 million USD for the first year, which is a significant market opportunity.
3. Value theory approach
The value theory approach to TAM Analysis opines that potential markets can be best understood through analyzing the value that customers place on a product or service.
This approach requires an understanding of customer needs and motivations as well as the potential of a product or service to solve existing problems. The value theory approach helps to develop further insights into potential markets, which can be used to inform business strategy.
Example: The same accounting software company mentioned earlier gets funding to launch its basic service and then discovers 25% of the customers surveyed would be willing to purchase this higher-valued option at $35 per month or $420 per year.
In response, they reduce the price to $31/month or $372/year to remain competitive. To calculate the TAM for this value-based opportunity, the SaaS accounting platform would divide the 100,000 potential customers by 25% to get 25,000 likely high-valued customers in the first year.
Multiply that by $372 for the annual price (or contract value) and their TAM for a higher-valued product is $9.3 million in the first year, which is a customer segment and product to consider offering in the near-term.
Step 1: Identify target markets and pricing
Start by identifying the sectors (e.g., finance, healthcare, technology, or education) that'll be most interested in the product. Then, determine the market size of that sector in targeted geographic regions, and what those businesses currently spend on similar products and services?
Businesses must also determine precisely who their target customers are and in which markets the product or service is launching. Are they global, national, or regional customers?
Step 2: Analyze current market conditions
Once businesses know the target market, they must research the external market conditions or factors that may impact their willingness to spend on a new product or service.
How is the current economy impacting their spending habits? Are many of those businesses actively hiring new employees, or are they going through a period of layoffs? How quickly is the target market sector growing? What is the overall annual revenue within the target market?
Step 3: Determine customer needs and pricing
Take the time to understand all of the target customer’s needs and think through the pricing model. It’s helpful to either speak with or send out a survey to prospective customers to determine what features and benefits they need as a baseline to purchase a product or service.
Test different pricing options and models and source all of the research and document customer insights or assumptions when presenting pricing calculations to secure funds from investors or financial decision-makers.
Step 4: Develop marketing strategies
In addition to developing a TAM analysis, businesses must put together slides or documents to show how their sales and marketing strategies will deliver on the projected annual revenue from the total addressable market.
The more granular the strategy, the more believable it'll be because the business has spent the time to think through and plan the entire strategy.
TAM analysis FAQs
TAM analysis not only impacts the financial aspect of launching a product and service, but also the business’s sales, marketing, product, and technology departments.
How is TAM used by sales and marketing teams?
The TAM Analysis is used by sales and marketing teams to identify potential markets and understand their size. This analysis aids in strategic decision making, allowing sales and marketing teams to prioritize resources, develop strategies, and target the most profitable markets.
How effective is TAM data?
TAM Analysis is an effective tool for identifying potential markets and understanding their size. This data-driven approach considers the total potential value of a marketplace, providing insight into the best opportunities for growth.
TAM data is used to set realistic KPIs, including sales and revenue goals, as well as measuring the efficacy of marketing efforts.
What are the limitations of using TAM analysis?
Consumer behaviors are often unpredictable, vary from one customer to the next, and can shift due to ever-evolving market conditions. Therefore, any efforts to predict consumer purchase behaviors when calculating TAM are often subjective and incomplete. Likewise, data from third-party sources may be outdated, making it challenging to have accurate numbers when calculating TAM.
As a result, TAM analysis should be used as a simplified way of estimating or predicting a business’s total addressable market, and calculated results should not be perceived as an absolute number.
How is TAM used by product and developer teams?
The TAM Analysis can be used by product and developer teams to aid in the development of products and services.
In this context, the TAM Analysis can help teams identify the most effective customer segments, understand potential requirements, and develop strategies to improve user satisfaction. TAM Analysis is an invaluable tool for product and developer teams, providing data-driven insights to drive product success.
How long is TAM data valid?
The effectiveness and relevance of TAM data is dependent on the dynamics of the marketplace.
The TAM Analysis should be conducted regularly to keep up with market changes and make sure the data is up-to-date.
Generally, the validity of TAM data is between one to four years, with regular updates or refreshes as needed.
What should businesses do when the TAM is lower than anticipated?
Without a significant TAM, it'll be difficult for business leaders to convince venture capitalists or CFOs that a new product or service is worth the investment. If there is still a strong case to build a new business, product, or service beyond what the TAM analysis reveals, there are a few options to consider:
- Bootstrap the business without investors (e.g., ask friends and family or fund through credit cards), or raise less funds and launch a scaled down version of the product to test and prove there is a significant customer base out there.
- Research and show that other competitors are also entering the market – especially if it’s a new market or innovative technology product or service for which demand will grow significantly in time. VCs are often interested in businesses that can disrupt or change an entire market.
- Consider factoring in other customer segments or target industries to the calculation that the product might be able to serve in the near future. Or, consider adding an enterprise version of the product, as well as the basic option into the calculation.
- Demonstrate how a product or service will help to scale (or compliment) other parts of an existing business after its launch. For example, will the business benefit from bundling the new product or service with other core offerings to give it a competitive edge?