A total addressable market or TAM is the available market for a product or service. That is a metric usually leveraged by startups to understand the business potential of an industry. Typically, a large addressable market is appealing to venture capitalists willing to back startups with extensive growth potential.
TAM, SAM, and SOM in a nutshell
When launching or running a business, at the question “who’s your target?” it often happens to hear answers like “everyone can use my product or service.”
This implies a complete misunderstanding of the market. This can be bad for several reasons.
First, it might make it harder to prioritize and focus on a few key partners who might help the business snowball and scale. For instance, when PayPal launched as pointed out by Reed Hoffman in Blitzscaling the company had to shift its focus four times in a short period.
When they identified their power users on eBay, they focused and prioritized on that niche market. Thus, PayPal first dominated that niche and then move forward.
Second, if you need external resources, such as lending and financing being able to present the total addressable market (TAM) is a crucial element to make the value proposition for those investing in your business compelling enough.
For that matter, a few crucial questions, such as who needs your service, how much can I charge for it, and what players are already in that market helps to find a few elements to compute the TAM.
To evaluate a business opportunity, you need to look into three metrics:
- TAM or total addressable market
- SAM or serviceable addressable market
- SOM or serviceable obtainable market
Let’s start with a practical and straightforward example. Imagine the scenario you’re opening a barbershop in Rome. Now your TAM might be any man in the world with a beard. However, of those how many can you reach and service?
It would also be great to say that your total serviceable addressable market is those men’s beards. However, this is not realistic. Instead, to be realistic, you might start from the neighborhood where your barbershop will be located.
This means that on a population of a hypothetical thousand people in the neighborhood, only 50% are men and of those men, only 50% have a beard.
This means your total serviceable market is now only two-hundred-fifty men (a thousand divided by two, twice). Yet, you’re not the only barbershop in the neighborhood. It seems like another person had your same idea, and her barbershop serves already half of those men’s beards.
This means that your potential share of the market might be 50% of the serviceable market, or a hundred and twenty-five people. This is your SOM.
Although this is a simplified example, that is a good starting point to understand the difference between TAM, SAM, and SOM. You don’t need to perform complicated analyses to start understanding those concepts. All you need is to start thinking in realistic terms who’s that you’re trying to serve!
Defining the total addressable market is important especially for companies attracting investors. In short, in many cases, investors don’t look for the potential growth of the company itself. But rather, to the potential growth of the company in a growing market and industry.
Thus, guessing the potential market size, especially in growing or rising industries is a critical point for most investors.
For instance, this is how Pinterest defined its total addressable market in its S-1:
The global advertising market is projected to grow to $826 billion in 2022 from $693 billion in 2018, representing a 5% compound annual growth rate (“CAGR”), according to IDC. The digital advertising market alone is projected to grow to $423 billion in 2022 from $272 billion in 2018, representing a 12% CAGR, according to IDC. In 2018, the consumer packaged goods (“CPG”) and retail industries accounted for $64 billion of this digital advertising spend, and the travel, technology (includes computing, consumer electronics and telecom), automotive, media & entertainment and financial services industries accounted for an additional $144 billion. The United States continues to represent the largest digital advertising market in the world. The U.S. digital advertising market is projected to grow to $166 billion in 2022 from $104 billion in 2018, representing a 12% CAGR, according to IDC.
Then the company defined its total addressable market and its market opportunity by highlighting the various advertising formats the company delivers (online brand advertising, and performance-based advertising).
Resources for your business:
- What Is a Business Model? 53 Successful Types of Business Models You Need to Know
- Blitzscaling Business Model Innovation Canvas In A Nutshell
- What Is a Value Proposition? Value Proposition Canvas Explained
- What Is a Lean Startup Canvas? Lean Startup Canvas Explained
- How to Write a One-Page Business Plan
- What Is Business Development? The Complete Guide To Business Development
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