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 not good 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 on and prioritized that niche market.
Thus, PayPal first dominated that niche and then moved 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 in 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 the same idea, and her barbershop serves already half of those men’s beards.
This means that your potential market share 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 about 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 company’s potential growth.
But rather to the company’s potential growth in a growing market and industry.
Thus, guessing the potential market size, especially in growing or rising industries, is critical 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).
Your TAM is the BHAG
No company will be able to reach its TAM in the short term.
And to be fair, no company should be trying to achieve that.
A company, if adequately reaching scale, ‘ll be able to get close to its TAM or even pass it (there are many assumptions in computing the TAM which might be underestimating it).
For instance, as the story goes, recounted in the book Measure What Matters, author and venture capitalist John Doerr asked Brin and Page, “how big do you think this could be?”
He was referring to Google. This was the fall of 1999.
John Doerr had thought that if everything worked, Google would have reached a market cap of $1 billion.
Yet, when Larry Page responded, “ten billion dollars,” Doerr replied, “you mean a market cap, right?”
Larry Page replied, “no, I don’t mean market cap; I mean revenue.”
At the time, assuming that sort of revenue generation meant reaching the size of companies like Microsoft or IBM, who were the dominant players.
While Doerr was impressed, he was also skeptical about it.
Yet, Google (Alphabet) today is an over trillion-dollar company, with $257.6 billion in revenues!
So both Doerr and Page, two incredibly smart people, were completely off about the TAM.
What does that mean?
Computing TAM is a great exercise to improve your business acumen, but it’s just that, an exercise.
Thus, it’ll be extremely hard to know, over time, how big an industry might get, let alone be able to tackle it all with limited resources.
Your SAM is your scale
Scaling up a business is a game for its own sake.
It’s not just about the product; it’s about the business model and whether that is able to sustain a product to reach its SAM.
So also here, before you can tackle the SAM, you want to start to creating options to scale.
How? From the SOM!
Your SOM is your niche
Any company with restrained resources, but in general, any startup trying to tackle a new market, should start with a niche, and better yet, a micro-niche.
From there, you want to start tackling your minimum viable audience.
When you tackle a small niche, you enable valuable feedback loops while trying to answer simple questions about the market and from there, create options to scale!
Related Market Development Frameworks
Stages of Digital Transformation
Platform Business Model Strategy
FourWeekMBA Business Toolbox
Other business resources: