From Barbie-themed ketchup to exploding owl butts, these PR campaign examples prove that with the right data, timing, an
Posted: Thu Dec 05, 2024 4:32 am
Total addressable market (TAM) is an estimation of how much you could earn if you could sell your product or service to every possible customer in your market.
The basic formula for calculating TAM is:
TAM = (Total australia mobile phone number Number of Potential Customers) × (Average Annual Revenue per Customer)
Understanding TAM helps you figure out the size of your market and the amount of money you could make if you captured all of it.
TAM is also a key metric for startup investors. It shows whether a business idea has a big enough opportunity. Investors often look for a TAM that is “just right” — not too big or too small. A TAM that’s too large might mean the market is crowded with tough competition, while a TAM that’s too small could mean limited room for growth.
In this guide, you’ll learn how to estimate TAM using three methods, where people often make mistakes, and how to refine your estimations to make them plausible to investors or stakeholders and actionable for your business.
3 methods of calculating TAM (with examples)
There are three approaches to calculating TAM. Depending on the available market data, your business model, and your stakeholders/investors, you should consider using the top-down, bottom-up, or value theory approach.
1. Top-down approach
The top-down approach starts with broad market data and narrows it down to estimate the market size for your specific product or service.
TAM: top-down approach.
This approach is useful when there’s reliable, broad industry data available.
How to use
Estimate the overall market size in which your product operates, usually obtained from industry reports or research.
Apply a percentage that represents the portion of the market your product can realistically capture.
Example
If the global smartphone market is valued at $500 billion, and you are launching a new smartphone accessory, you might estimate that your product could target 5% of the market, which gives you a TAM of $25 billion.
2. Bottom-up approach
The bottom-up approach builds the TAM by starting with specific, individual data related to your business and scaling it up.
TAM: bottom-up approach.
This method is great when you have detailed knowledge of your customer base and pricing. As far as I know, investors prefer this method, which offers the most accurate and actionable TAM estimation.
A few birds in the hand is worth billions in the TAM. Early-stage (pre-Series-B) startups shouldn’t worry too much about calculating a precise TAM. As long as it’s in the right ballpark for their thesis, investors care a lot more about the traction you can show with paying customers. That’s why bottom-up is far more convincing than hand-wavy top-down methods that only rely on finding a big enough pie to claim as your market.
Rob Cheng
Rob Cheng, Founder, Startup Marketing Advisor, Rob Cheng
How to use
Estimate how many potential customers there are in your target market. You can do this by using sources like industry reports, census data, or research from trusted organizations (more data sources at the end of the article).
Multiply this number by the average revenue you expect to earn from each customer (ARPU - Average Revenue Per User).
Tip
To calculate ARPU, consider the pricing of your product or service, how frequently customers will purchase, and the churn rate.
For example, if you charge $100 per month for a subscription service, your monthly churn rate is 5%; on average, a customer might stay subscribed for around 6-7 months, meaning your average revenue per customer would be around $600-700.
Example
Let’s say you have subscription-based software that helps small businesses manage their finances. You identify that 2 million small businesses could benefit from your software. If your ARPU is $600, your TAM would be 2 million customers × $600 = $1.2 billion.
3. Value theory approach
The value theory approach estimates TAM based on the value your product provides to customers and how much they might be willing to pay for it.
TAM: value-based approach.
This approach is especially useful if you’re introducing a product or service that disrupts existing markets; traditional market size calculations may not accurately reflect the potential.
How to use
Assess the value or cost savings that your product delivers to the customer.
Estimate how much customers would be willing to pay for that value and scale it across the entire market.
Example
Suppose you have developed a new energy-efficient lighting system that saves companies $10,000 per year in energy costs.
If 100,000 companies could use your lighting system, and each is willing to pay $5,000 for it (because they’ll save $10,000), your TAM would be 100,000 companies × $5,000 = $500 million.
There’s also a fourth option — a middle ground mentioned by quite a few people who offered their insights for this article.
The basic formula for calculating TAM is:
TAM = (Total australia mobile phone number Number of Potential Customers) × (Average Annual Revenue per Customer)
Understanding TAM helps you figure out the size of your market and the amount of money you could make if you captured all of it.
TAM is also a key metric for startup investors. It shows whether a business idea has a big enough opportunity. Investors often look for a TAM that is “just right” — not too big or too small. A TAM that’s too large might mean the market is crowded with tough competition, while a TAM that’s too small could mean limited room for growth.
In this guide, you’ll learn how to estimate TAM using three methods, where people often make mistakes, and how to refine your estimations to make them plausible to investors or stakeholders and actionable for your business.
3 methods of calculating TAM (with examples)
There are three approaches to calculating TAM. Depending on the available market data, your business model, and your stakeholders/investors, you should consider using the top-down, bottom-up, or value theory approach.
1. Top-down approach
The top-down approach starts with broad market data and narrows it down to estimate the market size for your specific product or service.
TAM: top-down approach.
This approach is useful when there’s reliable, broad industry data available.
How to use
Estimate the overall market size in which your product operates, usually obtained from industry reports or research.
Apply a percentage that represents the portion of the market your product can realistically capture.
Example
If the global smartphone market is valued at $500 billion, and you are launching a new smartphone accessory, you might estimate that your product could target 5% of the market, which gives you a TAM of $25 billion.
2. Bottom-up approach
The bottom-up approach builds the TAM by starting with specific, individual data related to your business and scaling it up.
TAM: bottom-up approach.
This method is great when you have detailed knowledge of your customer base and pricing. As far as I know, investors prefer this method, which offers the most accurate and actionable TAM estimation.
A few birds in the hand is worth billions in the TAM. Early-stage (pre-Series-B) startups shouldn’t worry too much about calculating a precise TAM. As long as it’s in the right ballpark for their thesis, investors care a lot more about the traction you can show with paying customers. That’s why bottom-up is far more convincing than hand-wavy top-down methods that only rely on finding a big enough pie to claim as your market.
Rob Cheng
Rob Cheng, Founder, Startup Marketing Advisor, Rob Cheng
How to use
Estimate how many potential customers there are in your target market. You can do this by using sources like industry reports, census data, or research from trusted organizations (more data sources at the end of the article).
Multiply this number by the average revenue you expect to earn from each customer (ARPU - Average Revenue Per User).
Tip
To calculate ARPU, consider the pricing of your product or service, how frequently customers will purchase, and the churn rate.
For example, if you charge $100 per month for a subscription service, your monthly churn rate is 5%; on average, a customer might stay subscribed for around 6-7 months, meaning your average revenue per customer would be around $600-700.
Example
Let’s say you have subscription-based software that helps small businesses manage their finances. You identify that 2 million small businesses could benefit from your software. If your ARPU is $600, your TAM would be 2 million customers × $600 = $1.2 billion.
3. Value theory approach
The value theory approach estimates TAM based on the value your product provides to customers and how much they might be willing to pay for it.
TAM: value-based approach.
This approach is especially useful if you’re introducing a product or service that disrupts existing markets; traditional market size calculations may not accurately reflect the potential.
How to use
Assess the value or cost savings that your product delivers to the customer.
Estimate how much customers would be willing to pay for that value and scale it across the entire market.
Example
Suppose you have developed a new energy-efficient lighting system that saves companies $10,000 per year in energy costs.
If 100,000 companies could use your lighting system, and each is willing to pay $5,000 for it (because they’ll save $10,000), your TAM would be 100,000 companies × $5,000 = $500 million.
There’s also a fourth option — a middle ground mentioned by quite a few people who offered their insights for this article.