In college, I did an internship at a MarTech company that sold email marketing optimization software. With their software, brands could finally get some insight into the deliverability rate or inbox placement of their email program, which most email service providers like Constant Contact or MailChimp can’t.
The company’s biggest source of income was a channel partner program that allowed email service providers to sell my old company’s software to their own customers. And one day, at an all-hands meeting, our CEO showed us a slide that listed each and every email service we worked with and the number of clients they all had.
He told us this was our overall addressable market. Then he showed us a slide of how much of the market we had captured – it was a single digit percentage. Even though we had sales of $ 100 million a year, we were shocked at how little we had secured ourselves from the market. But it also helped us to recognize that we still had plenty of room to grow, which motivated us to gain as much as possible from the market.
Whether you’re starting a new business and measuring its industry’s profit potential, or forecasting a realistic sales growth target for your business, measuring your entire addressable market is a critical first step you need to take. To help you with this, we’ve put together a guide that will show you exactly what the overall addressable market is and how best to calculate it.
Total Addressable Market (TAM)
The total addressable market, or TAM, refers to the total market demand for a product or service. This is the largest amount of revenue a company could possibly generate from selling its product or service in a given market.
Unless there is a monopoly, most companies cannot capture the entire addressable market for their products or services. Even if a company has only one competitor, it would be extremely difficult for them to convince an entire market to just buy their product or service.
It is for this reason that most companies also measure their serviceable available market to see how many customers their marketing and sales channels can realistically reach. Additionally, they measure their market share to understand the size of their actual target market.
However, the overall addressable market is still useful as companies can use TAM to objectively gauge the growth potential of a given market.
How do you calculate TAM?
There are three ways to calculate your company’s total addressable market.
1. From top to bottom
The top-down approach uses industry data, market reports and research studies to identify the TAM. With this approach, you can use industry data from Gartner or Forrester to determine which subsections of your industry align with your goals and offering – and how large those subsections are.
However, there are limitations here. Data generated by industry groups may not always be kept up-to-date and may not reflect the niche elements of your market. You may want to hire a market research consultancy to conduct new research that focuses on your areas of need.
The bottom-up approach to TAM calculation is based on previous sales and price data. First, multiply your average sales price by your number of current customers. This gives your annual order value. Then multiply your ACV by the total number of customers. This gives your overall addressable market. Let’s see how that looks in an example.
For example, let’s say you sell dive fins to dive shops in the state of California. They could sell an average of 60 pairs of fins to dive shops in California for $ 35 / pair. 60 times $ 35 equals an ACV of $ 2,100. Then you would multiply your ACV ($ 2,100) by the total number of dive shops in California ($ 125) to get a total addressable market of $ 262,500.
3. Theory of Value
The value theory approach is based on how much value consumers are getting from your product / service and how much they are willing to pay for that product / service in the future.
Returning to our diving example, let’s say you make some type of fin that is lighter than your competitors and has patented technology that makes them easier to get off than anything else on the market. You would identify your theory of value by estimating how much dive shops would be willing to pay to transport your superior product. If regular fins sold for $ 35 per pair, would dive shops pay $ 40 or even $ 45 for a pair of your ultra-light fins?
Now that you’ve calculated your entire addressable market, it’s time to determine whether or not the industry is worth getting into.
An industry with a market size between $ 30 million and $ 200 million per year could be worth getting started. However, if the industry’s market size is under $ 5 million per year or over $ 1 billion per year, it is likely not.
In either situation, it would be difficult to convince investors to support your business – an industry with a market size of $ 5 million per year would likely be too niche, and an industry with a market size of over $ 1 billion would likely be too saturated.
Know your TAM before taking action
It’s always exciting to start a business or forecast sales growth for the next year. However, if you want to find a realistic path to success, the first thing you need to understand is what is actually possible. So let your overall addressable market become your North Star and take you on a journey that is rooted in reality, not hype.