Total Available Market: How Much is Good Enough?
Entrepreneurs and investors are always after big market opportunities- they care about those sectors that are touted to grow at a fast pace in the coming times. But how do you know if a market is indeed big and worth going after? The answer lies in determining TAM, i.e., the Total Available Market.
In layman terms, TAM is the representation of the money that you’ll make if your business achieves 100% market share of your beachhead market.
Calculating your TAM
To estimate your TAM, you need to focus on two primary aspects, namely:
i) The total number of end-users based on your primary market research, i.e., a bottom-up analysis. This essentially means that you estimate the potential number of end-users, given your sample size during the market research.
It’s also worth supporting this with a top-down analysis, i.e., referring to market research reports available in the public domain and then estimating the available market pertaining to you.
ii) Judge the amount of revenue you can make per user. This number can again be based on your own research or after studying the industry landscape and competitors.
By multiplying both these numbers, you get the TAM. It is expressed as the potential size of the market in monetary terms.
To put it as a simple formula,
TAM = (Total number of end-users) x (Average expected revenue per user)
Many times, you’ll see entrepreneurs trying to impress their colleagues, investors and others by overstating TAM but that’s misleading for others as well as the entrepreneur himself. Given the fact that information is abundantly available, the focus should be on building a justifiable and defensible TAM that you can go after.
While on one hand lies the market opportunity, on the other hand, is the growth, which is represented by the Compounded Annual Growth Rate (CAGR).
Using information from the TAM going forward, you can check how the market opportunity increases to calculate the CAGR.
Words of Caution
A bottom-up analysis required you to do all the hard work as you find the right associations and find multiple sources to gauge a user estimate, which is why it should remain your primary source of information. A top-down analysis is a moon-shot driven by research reports you can not trust in isolation. So, it should be complemented by bottom-up analysis.
But again, do not overdo your analysis and get into the analysis paralysis trap because customers don’t reside in excel sheets.
In terms of determining how much you can make out of every user, you’ll have to use the magic wand of assumptions (no surprise here). It’s best to ask a few customers how much they are willing to pay if they value what you’re creating, which reinforces the value of primary market research.
You will understand and learn a lot more about your market size as you continue building your startup, so keep evolving and adjusting your numbers.
So How Much TAM is Good Enough?
There’s no one size fits all kind of an answer here. One should not go overboard with a large number which can’t be justified later to potential investors or co-founders. It’s also not worth going after a small number because scalability becomes a challenge.
Generally speaking, a TAM of less than $5 Million a year is not big enough of a beachhead market. Any number over $1 Billion is too good to be true or it’ll have too many flags (very competitive, large players etc.).
But we always have exceptions. In the case of some IT products, where the overhead costs are low (number of employees, etc.) and margins are high (say 90%), a TAM of even $5 million is considered decent.
Though it’s highly subjective, anything between $20 Million to $100 million a year is a good target market to go after. It’s worth noting here that what you’ll later come up with as an addressable or obtainable market will just be a subset of this. For your business to flourish, all these numbers need to be “good enough” specific to your industry.
Bottomline
TAM should be used with precaution because let’s face it, it’s nearly impossible for any player to get 100% of the market. You won’t be able to reach a stage where your revenue is the same as your TAM.
Use your TAM in accordance with your addressable market and obtainable market to get a clearer idea of how big your numbers can be.
The key idea behind TAM is to think whether your target market is worth the effort and not estimate how big the company can be. Spend a reasonable amount of time on it but be realistic and do not go overboard.
