How to Calculate Your Total Addressable Market (TAM)?
Where does your company stand in your larger markets? If you don’t know, it might be time to calculate and track your total addressable market (TAM).
Total addressable market is a metric startups and existing companies of all sizes use to learn where they stand in a given market and how they stack up to competitors. Because TAM isn’t as cut-and-dry as other sales and revenue metrics (there are multiple ways to measure it, and it always requires some estimating), companies often fail to see its value and incorporate it into their strategies.
But those that know their TAM and use it well to drive strategy are better positioned to make smart decisions about marketing and sales timing and more capable of driving growth.
In this article, we’ll define total addressable market in more detail, consider some of its use cases, and walk through the three primary ways to calculate it.
- Total addressable market represents the entire revenue opportunity a company or product could capture if it had 100% market share.
- Serviceable available market and serviceable obtainable market are related metrics to help companies understand the portion of the market they can realistically acquire.
- The top-down method for calculating TAM uses third-party market research and makes an informed estimate based on total industry value.
- Bottom-up and value theory approaches are more accurate, using first-party data and starting with a real number of potential customers.
What is total addressable market?
Total addressable market (also referred to as total available market) represents the entire revenue opportunity available to a company or product — in other words, what you’d earn if you had 100% market share.
While it’s not generally possible to earn 100% market share in any market, TAM is a starting point from which you can build sales and revenue goals, craft a go-to-market strategy, create a value proposition, or understand your competitive position.
Total addressable market is often calculated alongside two other related metrics: serviceable available market (SAM) and serviceable obtainable market (SOM).
Serviceable available market is the portion of the market you could logically acquire based on your offerings and business model (i.e. the target customers and market segments fit with your business). Serviceable obtainable market is the portion of the market you could realistically acquire based on your go-to-market plan, budget, location, and other practical considerations.
Why do you need to know your TAM?
There are many situations where a company may want to know their total addressable market. It’s often discussed as a metric for startups, but existing organizations can and do use it as a valuable metric often. Let’s consider some of the most common and useful reasons to measure and track TAM:
- Pitch to investors – Perhaps the most commonly-cited use for TAM, startups use it to demonstrate revenue and growth potential to investors.
- Plan product launches – Existing companies calculate TAM to smartly plan product development and launch initiatives that will succeed.
- Create GTM strategies – TAM helps marketing teams target their messaging to the highest-potential segments of the market.
- Forecast sales and revenue – Understanding TAM can help companies drill down to accurately predict their own likely sales or revenue during a given time period.
In a more general sense, total addressable market is a good metric to know because it gives you context. When you know TAM (along with SAM and SOM) you have a clear understanding of how your company is positioned alongside competitors in the market, and how successful any given launch, initiative, or sales period will likely be.
How to Calculate Total Addressable Market
There are three primary ways companies calculate total addressable market: top-down, bottom-up, and value theory. There is no single right way to do it, but each strategy does have scenarios for which it’s better fit than the others.
The top-down approach to calculating TAM takes a high-level view of the market first, then drills down into what’s actually addressable. It uses industry research from successful third party organizations (like Gartner or Forrester) to learn about the industry, understand its players, and craft an idea of how big it is in total.
From there, companies can determine the total addressable market as well as what’s actually available and obtainable to them within it.
The top-down approach doesn’t have a single equation for calculating it, but typically it involves understanding the current players in the market and how much revenue they’re earning, as well as the number of customers still in need of a solution and the revenue potential they represent.
Top-down measurement is usually not 100% on the nose — it’s an estimate to give you a good idea of your opportunity, but not a hard number.
This is intentional. It’s considered the optimistic method for calculating TAM, focusing on opportunities without necessarily calculating real numbers and considering specific limitations. For this reason, the top-down method is popular for startups.
The bottom-up approach is a more accurate (and often realistic) option for calculating TAM. It looks at your own first-party data and that of other companies to understand real revenue revenue numbers (actual and predictive). In short, the bottom-up theory looks at the number of customers on the market for your solution and multiplies it by potential revenue per sale.
For example: Say you’re a local company selling Product X to companies in the southeast United States. There are 500 potential customers you could sell to. Your revenue per sale is $2500. You would use the bottom-up approach to calculate TAM as follows:
Total # of Potential Customers X Total Revenue/Sale = TAM
500 potential customers X $2500/sale = $1.25 million.
The visual below is helpful for understanding how the top-down and bottom-up approaches to calculating TAM consider the market in opposite ways.
Value theory is used for new companies and product launches. Like the bottom-up method, value theory uses the total number of potential customers in the market to make the calculation, but because there is no historical sales data, it has to estimate how much customers will be willing to pay based on perceived value. Factors like indirect competitors or average budget of target companies can help inform value theory estimates.
Over to You
Knowing your total addressable market is great — but it’s only a first step. Next, you need a smart, scalable sales prospecting strategy to generate leads and reach the right buyers.
RevBoss’s outbound email software and lead generation services are custom-built for startups, consultancies, marketing agencies, and other B2B organizations.
Schedule a quick call with us and find out how we can help you win more clients.