What is TAM?
TAM refers to the revenue opportunity and demand for a product or service in a given market. Sometimes referred to as ‘total available market,’ a startup’s TAM is the answer to the question: “How many of these products could we sell, and how much money could we make, if we owned this entire market?”
Why TAM is worth calculating as a startup
TAM is worth calculating as a startup because startup founders can use it to map out the future of their company. After all, startup founders need to not only be able to explain where their company is going and why but also how it intends to get there and what to expect in terms of future sales and revenue.
The crucial information a TAM provides can help startup founders put a value on their company and estimate its profitability. This is why many of them find it useful to refer to their startup’s TAM when trying to secure venture capital funding or setting priorities for their team.
Why TAM is worth calculating as an established business
Startup founders aren’t the only business leaders who should be concerned with their TAM. Executives of established businesses should also spend the time calculating it. In fact, as things can change — often quite dramatically at that — established businesses should be prepared to measure their TAM over and over again.
Take DVD players, for example. When the first ones hit the market in 1997, only two companies produced them. Prices ranged from $599 to $750 (or about $984 to $1,231 in 2021 dollars). Compare this to now, where they can be purchased for as little as $30.
This change in price point alone suggests the product’s TAM has changed considerably over the years. Specifically, it changed from a small number of early adopters willing to pay a premium to a huge number of mass market consumers. The long-term play, which largely came to pass, was to replace everyone’s VCRs, which represents an enormous market.
But the competitive environment has changed considerably as well. Consequently, someone wishing to calculate the TAM for a DVD player today will be contending with the rapid transition away from physical media to streaming services. Just as VCR production stopped in 2016 after a nearly 50-year run, DVD players are likely to also reach a point where their TAM is too small to pursue.
Using TAM to inform pricing
The information a startup gathers from calculating its TAM can also help it to determine how much to charge for its products or services.
For example, if a startup’s product costs $1M to develop and market, but the TAM is 1,000 people who won’t pay $1,050 — assuming a profit margin of 5% built into the price — it’s going to find it challenging to attract investors.
However, keep in mind that there is more than one way to estimate a TAM. One method, value theory, is especially useful in pricing a new product based on the value it adds to customers’ lives.
If that $1M product is actually worth $10,000 to the same 1,000 people because of its amazing utility or exclusivity, then the startup could be looking at making $10M off that $1M investment.
How to measure TAM
There are three main ways to measure your startup’s TAM:
- Conducting and/or analyzing industry research
- Estimating the impact that your product’s value may have on consumer behavior
- Analyzing company data from your company’s early sales
Whichever method you choose to use, it’s a good idea to conduct market research first. Doing so is useful because the more a startup can learn about its market, the better it can quantify these populations to set realistic short- and long-term goals.
Imagine your product idea is an app for competitive triathletes to better track their training progress through biometrics with their smartphones. At minimum, you would need to know how many serious triathletes there are.
Even at this conceptual level, the process of determining the app’s TAM would help a startup to explore its options. For example, does the startup intend to appeal to triathletes worldwide? If so, would this justify the cost of developing a multilingual version?
TAM, SAM, and SOM
As much as every startup might dream of selling everything to everyone, this is simply unrealistic. While TAM describes the maximum possible market for a product, it may be helpful to also consider some other relevant measures of possible growth and success.
One of these is SAM (serviceable available market). This term describes the customers a company can realistically acquire based on its business model and product specifications.
For our hypothetical app for triathletes, imagine that the founders decide to launch with an English-only version. Their SAM within the TAM would shrink down to that market.
Within the SAM is another, smaller group, the SOM (serviceable obtainable market). The SOM describes a more acute assessment of the SAM, which is taken to identify the sector of the SAM that’s more realistic to capture.
Let’s refer to our example again. Some relevant questions to ask about the app’s SOM include:
- Of the English-speaking triathletes, how many are interested in a smartphone app?
- Of these triathletes, how many have already been acquired by competitors?
- Do they tend to be fiercely loyal to a preferred app, or do they regularly try out new ones?
Calculating TAM can help both startups and established businesses to better understand who their products and services should target. It can also help a company to determine its pricing model. As TAM represents a broad measure of a market, companies should also remember to calculate their SAM and SOM as well.