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Total addressable market (TAM)

Why bother with the total addressable market?

Knowing the total addressable market (TAM — basically, your maximum revenue opportunity volume) provides an objective assessment of the market situation. It also allows us to

  • see opportunities for the future development of a given company, service or product,
  • determine the competition landscape,
  • choose appropriate lines of business,
  • plan production, finances and
  • develop a sales program for different regions.

TAM (total addressable market) indicates how many сlients are there in the target market and how much they need (not necessarily can buy), products/services in the same product/service category that you offer. The key question for determining your TAM is: who can needs your product or service and to what extent.

The total addressable market calculation logic

b2c business example

  • Need: bakery foods
  • Your product:  premade baked frozen products
  • Product category: bakery products
  • Target market (the market you are targeting): UK

TAM result in this case

  • Consumption rate: 200 grams/person/day of all baked goods
  • Population: 66 million people
  • Total: 9 000 tons/day

This article will be useful for the following segments:

  • startups
  • b2c
  • b2b
  • digital

What input data you need to calculate TAM?

As a brief introduction, let’s first take a look at the input data you might need. To calculate TAM, you must first collect the necessary information using market research. The following questions will help you solve this problem:

Factors & indicatorsDescription
PeriodMonth/quarter/half a year/year
Market RegionUSA, Western Europe, Asia, Far East, etc.? This will help work out further factors
CompetitionHow many other companies already play in this particular market or actively aim at it? Remember: in that case TAM revenue is going to be split between you.
Product group/typeE.g., are you going to sell cars? Or cars & parts? Or vehicles, parts & services? It is important to specify this accurately to define your addressable audience further.
Audience

Is it the entire population of 18+? What about gender? Women? Or anyone?

Consider:

  • Age
  • Gender
  • Income levels
  • Social/marital status (in a case with, say, baby strollers)

The more precise you are, the better your revenue estimation is.

MetricsThe main is — number of clients and total revenue/per year (in case you choose 12 month period for your calculations)
SourcesWhere can you get this data? Resort to official statistics or/and hire a market researcher. Better do both for better results.

Now with that in mind let’s move forward and take a look at general approaches one can use to work with that data and calculate TAM.

The three approaches to TAM calculations

There are three primary approaches to how to calculate the total addressable market: top-down, bottom-up and value theory.

Top-down approach

The method involves determining the size of the market based on the data of domestic sales of all market players for the billing period (if it is impossible to cover all players – it is enough to take only the large ones making up 80-90% of the market sales).

The formula for calculating the market capacity for the top-down approach is as follows:

Market capacity = Sum of sales of all companies on the market expressed in sales prices to the buyer (that is, not in shipping, but retail prices).

One can obtain information through surveys of large market players, as a result of publicly available data published by players in some markets.

So, this approach is somewhat okay, if you trust the data obtained, but vague enough to not risk your whole game. Unless you’re a huge company and you occupy a stable position in a particular market like oil refinement. I’d advise startups mostly to steer clear from it for their good.

Bottom-up approach

This method is, in my opinion, more preferable. It relies on robust data your company can provide to your partners or investors. It is based on what you can produce, how you can price it and whom you can cater it to, including the level of demand for your particular product. The bottom-up TAM is equal to the sum of all expected purchases of goods by the target audience volume over the billing period (more often, annually).

Calculation. If you want to estimate TAM using the “bottom-up” approach, then you’ll need input presented earlier in the article and a couple of formulas outlined below.

Your job here is:

  • to define your target audience and its volume
  • calculate TAM based on this data
TAMFormula
TAM in quantitative termsTAM volume over the period N (thousands pcs) =  target audience volume (outlined thousands of ppl) * rate of consumption of goods over the period N (pcs)

[the same goes for volumetric consumption when we talk about coffee shops, bars, or other commodity markets. Use ounces/liters/pounds instead of pieces]

TAM in monetary terms ($/€/etc)TAM volume over the period N ($/€/etc) = target audience volume (thousands of ppl) * rate of consumption of goods over the period N (pcs) * the average price of 1 unit of a product on the market ($/€/etc)

What’s great about this approach is that it not only clears things up for you giving you an objective perspective but it is also a reliable set of data for a pitch. Investors are more likely to trust companies (especially if we’re talking about startups) who can prove their point and showcase the potential success of their endeavor.

Real sales approach

Many research companies, such as Nielsen (formerly known as AC Nielsen) currently use this approach. The essence of it is in tracking actual sales of specific categories of goods through actual receipts of real buyers.

This approach only fits into large chain stores. A company signs a data supply agreement with a chain and its stores provide a representative sample. As a result, the data obtained can be extrapolated to the entire country.

In this approach, it is impossible to isolate a specific audience, but it is possible to realistically estimate: at what price and in what individual volume products sold over the billing period. This approach allows you to analyze information in all its dynamics.

And remember: TAM assessment should not be taken lightly. Apart from calculating numbers it is also a great way to model a meaningful roadmap for future business scaling.

TAM specific to B2B industries

Estimating TAM in the B2B segment is much easier than dealing with the consumer market. But that’s if you know which indicators to use and which direction to follow.

To figure out TAM, we need the following information:

  • a list of potential companies,
  • purchase frequency (of goods or services provided by target companies),
  • average order value.

To estimate b2b TAM, first examine the current customers of the company. You need to evaluate:

  • Whether current customers divided into specific groups that differ in the way they interact and requirement they have for the product?
  • How often during the year does each group of customers place an order?
  • What is the average cost of 1 order for each group of customers?

Know your boundaries

Correct TAM assessment requires that you know your market boundaries. To do this, you only need to make a list of the countries or cities in which you operate or plan to carry out your activities.

Working with the base of companies and assessing TAM

Calculation of the volume of the target market is a complicated process, and this stage is the longest and most ambitious. Without the help of sales managers who work in the target market, it becomes a process challenging to pull off.

Humble self promotion: prospects list building is a fundamental thing in b2b sales, thats why we have market research listed at GRIN Launcher as separate service. Basically, when we figure out target profiles for customers and do list building of say “CTOs in Bay Area of Warehouse companies with head count up to 500” thats a TAM metric for them that can be further extrapolated to same parameters by targeting a wider geo. Here is an article covering the topic in greater details: Scraping LinkedIn – scalable approach to prospecting & lead gen

 

How much it costs

Costs also depend on the company’s objectives and business specifics. Sometimes you can get by buying a finished report (as in top-down approach). For some markets there is barely any statistics at all, no ready-made studies, market players are incredibly reluctant to share any information, so this kind of research is the only way out.

To sum it up on Total Addressable Market

In b2b sales list building alone is so many potential pitfalls and miscalculations, that I don’t believe that it is possible to execute TAM calculation without outside help unless you have a relevant background.