When looking for investment opportunities, investors, especially when it comes to early-stage startups in the technology sectors, beyond other potential metrics, primarily look for how big the potential market might be through what’s known as the TAM, SAM, and SOM frameworks.
A venture capitalist is an investor that provides capital to start-ups that have high growth potential. In other words, for a potentially high return, the investor endows the company with equity for a stake within it.
It is important to highlight that not all investors and venture capitalists look for the same things or focus on the same aspects of a business.
Indeed, some investors focus on a longer-term strategic approach, while others might primarily look for growth opportunities that might make a good exit.
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In general, most investors look for interesting opportunities that would represent a good long-term investment.
How might those opportunities look like? It is crucial at this stage you get acquainted with the market you’ll be operating.
This means you’ll need to understand three key concepts: TAM, SAM, and SOM:
From there, you might want to understand the size of the Serviceable Addressable Market. And what your Serviceable Obtainable Market will be.
Once you have defined the SOM, you can make a five-year projection of the expected sales (assuming you don’t have revenues yet).
Based on that projection, you will be able to apply a 3-5X multiplier on the revenues based on the market and business model you identified.Â
Quick case study
Imagine you are evaluating how much your marketplace idea is worth.
You operate in a market where the TAM is $10 Billion.Â
That your SOM is 0.5% of that market in the year 5th.Â
This means at the year five; you will have a volume of transactions on your marketplace of about $10 million.Â
As a marketplace, you might make money through transactions fee.
Assuming a transaction fee of 3%, you will have a turnover of $300K in year 5th.Â
Considering that a marketplace business model is highly scalable and that the TAM is pretty big, you might want to apply a high multiple, let’s say 5X, on the revenues.Â
This means that in the 5th year, your company will be worth $1.5 million.Â
Keep in mind the example above is just a simple case study.
The estimates will depend on what assumptions you’ll start with from evaluating your company.
So how big is the TAM? How much of that market can you service in 3-5 years? How will you make money? And so on.
Also, the ability to convince the business angel might depend on how good you will be at communicating your idea, the so-called pitch.
And suppose you’re looking for a business angel, venture capitalist, or investor. In that case, that means you might need a strategic figure able to help you scale your business as quickly as possible.
Case Studies
TAM, SAM, SOM for a Virtual Reality Theme Park:
TAM: Let’s imagine the value of the global virtual reality entertainment market is $80 billion.
SAM: Let’s imagine the market for your VR theme park, targeting thrill-seekers in North America, is $5 billion.
SOM: Let’s imagine that in the first year, you aim to attract 2% of North American thrill-seekers, which would be $100 million.
TAM, SAM, SOM for a Flying Car Rental Service:
TAM: Let’s imagine the value of the global personal transportation market is $3 trillion.
SAM: Let’s imagine the market for your flying car rental service, targeting early adopters in major European cities, is $500 million.
SOM: Let’s imagine that in the first year, you aim to serve 0.5% of early adopters in European cities, which would be $2.5 million.
TAM, SAM, SOM for a Space Tourism Company:
TAM: Let’s imagine the value of the interstellar tourism market is $1 trillion in the distant future.
SAM: Let’s imagine the market for your space tourism trips, targeting adventure enthusiasts worldwide, is $10 billion.
SOM: Let’s imagine that over the first decade, you aim to attract 0.1% of adventure enthusiasts, which would be $1 billion.
TAM, SAM, SOM for an AI-Powered Personal Assistant Robot:
TAM: Let’s imagine the value of the global AI assistant market is $150 billion.
SAM: Let’s imagine the market for your AI-powered personal assistant robot, targeting busy professionals in the Asia-Pacific region, is $5 billion.
SOM: Let’s imagine that in the first year, you aim to assist 1% of busy professionals in Asia-Pacific, which would be $50 million.
TAM, SAM, SOM for an Underwater Luxury Hotel:
TAM: Let’s imagine the value of the global luxury travel market is $2.6 trillion.
SAM: Let’s imagine the market for your underwater luxury hotel, targeting high-net-worth individuals who seek unique experiences, is $100 million.
SOM: Let’s imagine that in the first year, you aim to attract 0.1% of high-net-worth individuals, which would be $100 million.
TAM, SAM, SOM for a Time-Travel Adventure Game:
TAM: Let’s imagine the value of the global gaming industry is $159 billion.
SAM: Let’s imagine the market for your time-travel adventure game, targeting gamers of all ages worldwide, is $5 billion.
SOM: Let’s imagine that in the first year, you aim to engage 2% of gamers worldwide, which would be $100 million.
TAM, SAM, SOM for an AI-Enhanced Healthcare Platform:
TAM: Let’s imagine the value of the global healthcare technology market will be $450 billion.
SAM: Let’s imagine the market for your AI-enhanced healthcare platform, targeting healthcare providers in the United States, will be $20 billion.
SOM: Let’s imagine that in the first year, you aim to capture 2% of the U.S. healthcare provider market, which would be $400 million.
TAM, SAM, SOM for a Sustainable Energy Startup:
TAM: Let’s imagine the value of the global renewable energy market will be $3.5 trillion in the next decade.
SAM: Let’s imagine the market for your innovative sustainable energy solution, targeting commercial and industrial clients in Europe, will be $500 billion.
SOM: Let’s imagine that in the first three years, you aim to serve 1% of the European commercial and industrial clients, which would be $5 billion.
TAM, SAM, SOM for an AI-Driven Personal Finance App:
TAM: Let’s imagine the value of the global personal finance software market will be $60 billion.
SAM: Let’s imagine the market for your AI-driven personal finance app, targeting millennials and young professionals in North America, will be $5 billion.
SOM: Let’s imagine that in the first year, you aim to acquire 4% of the North American millennial and young professional market, which would be $200 million.
TAM, SAM, SOM for an Eco-Friendly Transportation Service:
TAM: Let’s imagine the value of the global transportation industry will be $8 trillion in the next decade.
SAM: Let’s imagine the market for your eco-friendly urban transportation service, targeting environmentally conscious commuters in major Asian cities, will be $1 billion.
SOM: Let’s imagine that in the first two years, you aim to serve 2% of environmentally conscious commuters in Asian cities, which would be $20 million.
TAM, SAM, SOM for a Virtual Fitness Coach App:
TAM: Let’s imagine the value of the global fitness and wellness market will be $1.2 trillion.
SAM: Let’s imagine the market for your virtual fitness coach app, targeting fitness enthusiasts and health-conscious individuals in South America, will be $50 million.
SOM: Let’s imagine that in the first year, you aim to engage 3% of South American fitness enthusiasts, which would be $1.5 million.
TAM, SAM, SOM for an Advanced Agricultural Technology:
TAM: Let’s imagine the value of the global agriculture technology market will be $200 billion in the next decade.
SAM: Let’s imagine the market for your advanced agricultural technology, targeting large-scale farming operations in North America, will be $15 billion.
SOM: Let’s imagine that in the first five years, you aim to serve 10% of North American large-scale farming operations, which would be $1.5 billion.
Key Takeaways
Understanding Venture Capitalists: Venture capitalists invest in high-growth potential startups, providing capital in exchange for equity stakes in the company.
Investor Focus: Different investors have varying investment criteria and focus, with some looking for long-term strategic opportunities, while others seek growth opportunities for potential exits.
Key Concepts: TAM, SAM, and SOM: Investors assess the market size through the Total Addressable Market (TAM), Serviceable Addressable Market (SAM), and Serviceable Obtainable Market (SOM) frameworks.
Total Addressable Market (TAM): The TAM represents the total potential market size for a product or service, indicating the maximum revenue opportunity in a given market.
Serviceable Addressable Market (SAM): The SAM is a subset of the TAM, considering the specific market segments a company can effectively target and reach.
Serviceable Obtainable Market (SOM): The SOM is an even smaller portion of the SAM, representing the achievable market share a company can capture within a specific timeframe.
Projection and Valuation: Once the SOM is defined, projections for expected sales over a certain period are made to calculate the company’s potential valuation. Multiples are applied to projected revenues based on market and business model assessments.
Case Study: An example is given of a marketplace idea with a TAM of $10 billion and a projected SOM of 0.5% in the 5th year, leading to a company valuation of $1.5 million with a 5X revenue multiple.
Communication and Pitch: The ability to communicate the idea effectively in a pitch is crucial to attract investors and convince them of the business potential.
Strategic Figure: To scale the business rapidly, startups may seek strategic figures such as business angels, venture capitalists, or investors who can provide expertise and guidance.
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.
A microniche is a subset of potential customers within a niche. In the era of dominating digital super-platforms, identifying a microniche can kick off the strategy of digital businesses to prevent competition against large platforms. As the microniche becomes a niche, then a market, scale becomes an option.
In simple terms, market validation is the process of showing a concept to a prospective buyer and collecting feedback to determine whether it is worth persisting with. To that end, market validation requires the business to conduct multiple customer interviews before it has made a significant investment of time or money. A transitional business model is an example of market validation that helps the company secure the needed capital while having a market reality check. It helps shape the long-term vision and a scalable businessmodel.
Market orientation is an approach to business where the company focuses more on the behaviors, wants, and needs of customers in its market. A company will first target a niche market to prove a commercial use case. And from there, it will create options to scale.
In a tech-driven business world, companies can move toward market expansion by creating options to scale via niches. Thus leveraging transitional business models to scale further and take advantage of non-linear competition, where today’s niches become tomorrow’s legacy players.
Digital and tech business models can be classified according to four levels of transformation into digitally-enabled, digitally-enhanced, tech or platform business models, and business platforms/ecosystems.
A platform business model generates value by enabling interactions between people, groups, and users by leveraging network effects. Platform business models usually comprise two sides: supply and demand. Kicking off the interactions between those two sides is one of the crucial elements for a platform business model success.
Business scaling is the process of transformation of a business as the product is validated by wider and wider market segments. Business scaling is about creating traction for a product that fits a small market segment. As the product is validated it becomes critical to build a viable businessmodel. And as the product is offered at wider and wider market segments, it’s important to align product, business model, and organizational design, to enable wider and wider scale.
Developing a successful business strategy is about finding the proper niche, where to launch an initial version of your product to create a feedback loop and improve fast while making sure not to run out of money. And from there create options to scale to adjacent niches.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
In short, you might want to start by understanding the size of the Total Addressable Market.
