A total addressable market (TAM) is a measure that reflects revenue opportunities businesses can receive after selling a specific product or service. It helps companies identify market demand for their goods. TAM enables entrepreneurs to assess their revenue potential from a specific product and prioritize tasks.
In this article, we’ll reveal the difference between the total addressable market and market size and review how to estimate the metric.
Why is calculating the TAM important?
If you decide to run a business, the first thing you should do is estimate your total addressable market. A total addressable market is an indicator that helps starters enter a new market, and well-established companies calculate profit potential. Large brands estimate the measure to find out whether they still have some space to grow within the market and increase their revenue opportunities. This metric allows you to evaluate the potential scale of the market. When making estimations with TAM, it’s crucial to use accurate values.
Entrepreneurs capture TAM to identify the number of clients they can reach using their marketing efforts and sales channels. Companies assess their market share to determine the size of their target audience. You need to estimate the measure to have a realistic outline of your new business. It will help you reach your business goals faster.
Now that you know why TAM is essential, it’s time to make the difference between total addressable market and market size clear. After exploring the next section, you’ll be able to determine each for your business.
Total Addressable Market vs Market Size
Since there’s often a misinterpretation of these two concepts, we’ll review each term in detail. This section will help you find out their peculiarities and calculate the measures for your company.
Total addressable market is an indicator that shows the revenue potential a company can obtain after selling its product. Calculating TAM enables you to decide whether it’s worth entering the market with a specific product or not. The value reflects the market demand for specific goods and services. Once you estimate the metric, you can make well-informed business decisions.
TAM provides you with a clear understanding of your market share and the size of your target audience. As a result, you can receive information about your business growth and future profits. After identifying TAM, you’ll be able to determine whether you can release new items and have bigger revenue potential.
Market size is a term that reflects the potential market volume and sales revenue. It refers to the total number of prospects for a specific product during a certain timeframe (usually a year). If you want to run a business, you need to discover the market size to efficiently allocate resources, build an effective business and marketing strategy, and receive investments.
Now that you know the difference, let’s discover how to estimate TAM for your business.
How to calculate the total addressable market?
Whether starting a business or having an established brand, you should capture your TAM. In this section, we’ll unveil three main ways to do it.
- Top-down approach. The approach requires you to search for market reports, research studies, and industry data to determine your total addressable market. However, if you do it on your own, data might be limited and out of date. Consider hiring management consulting companies like Gartner and Forrester to find relevant and fresh industry data. They will conduct deep research and provide you with actionable insights. This information will help you make smart decisions and improve your company’s performance. Their information will allow you to define subsections of your industry aligned with the offer and main objectives. Yet industry data might be limited and contain old data.
- Bottom-up approach. To calculate TAM using a bottom-up approach, you need information about your previous sales and pricing. Firstly, multiply your average sales price by the number of current clients. Once you do it, you’ll receive your annual contract value (ACV). Secondly, multiply your annual contract value by the total number of consumers. Finally, you’ll obtain your TAM. Let’s say you sell an average of 75 T-shirts at $10 each to local shops. 75 multiplied by $10 equals an ACV of $750. The next step is multiplying your ACV of $750 by the total number of shops (150). Let’s calculate: $750 * 150 = $112,500. Your TAM is $112,500.
- Value theory. The theory relies on your product’s value and the willingness of consumers to purchase it for a higher price. You need to find out whether customers will pay a higher price for the superior quality of your product in the future. Say your competitors sell sports shoes for $40/ pair and you sell your super light and comfortable shoes for $50. Will your customers pay more for better quality? Once you estimate your TAM, it’s necessary to decide whether you’ll obtain the targeted profits or not. If you get the measure equaling $30-$200 million/year, you can try entering it and receiving revenue opportunities. However, if the market size is too small ($5 million per year) or too big ($1 billion per year), it’s not worth entering. If you join such a market, it might be challenging because of low revenue and high competition.
Congrats, now you know what TAM is and why it’s essential. Hope that our guide will help you calculate yours.
Last Updated: 23.03.2023