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What is TAM Analysis?
How to Calculate the Total Addressable Market Using Examples
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 TAM analysis?
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.
LinkedIn Learning has a course that teaches how to determine the market size for a product or service.
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