Calculating Your Company’s Total Addressable Market (TAM): A Step-by-Step Guide

• Manjusha Karkera
• Calculating Your Company’s Total Addressable Market (TAM): A Step-by-Step Guide
• Published: January 3, 2023

Contributors: Manjusha Karkera
Published: January 3, 2023

Summary

Check out a detailed methodology for calculating a company’s Total Addressable Market (TAM), we focus on the importance of understanding the market potential for growth and investment decisions. We also focus on different approaches including top-down, bottom-up, and value theory methods, each offering unique insights based on market size, segmentation, and product value. This resource is crucial for businesses aiming to accurately gauge their market opportunities and strategize accordingly.

Introduction to Total Addressable Market (TAM)

The entire number of people (or businesses, schools, etc.) globally is the starting point of the total addressable market calculation. From there, it is narrowed down based on geography and demographics until it reaches the target market.

Total Addressable Market calculation or TAM is the total revenue opportunity that is obtainable for the products and services if the company achieves 100% market share. It’s a fantastic metric to gauge a company’s growth potential. The total addressable market captures the market demand for a particular product and defines the available opportunity. 

TAM helps businesses and companies determine the level of hard work and funding one should put into a new business line. In modern times, markets are evolving at an escalated speed, making TAM the most important and valuable metric. It makes businesses and companies aware of the blurred lines between their needs.

A step-by-step guide to calculating Total Addressable Market (TAM)

How to calculate total addressable market is one of the most crucial aspects to understand; a particular market’s entire revenue potential is represented by the total addressable market (TAM). Market sizing remains crucial in determining the company’s potential growth, start-ups, or established companies. The total addressable market (TAM) can be given as follows:

TAM = Average revenue * Total number of customers for the targeted market segment.

To calculate TRM, there are namely three primary collection methods and one secondary method:

Top-Down Method:

The top-down approach is the inverted pyramid and is usually represented in three steps, as mentioned below:

1. Defining the Macro Economy – This identifies a known-size large population that contains the target market.
2. Defining Market Segment – This means narrowing the large population so that the focus remains on a specific market segment.
3. Defining Addressability – This means separating the potential customers of the selected market segment.

To cut it down into simpler words, the top-down analysis can be an elimination process that takes in a large number of known population that contains the target market and then narrows it down to specific market segments. The addressable market calculations in this approach are based on existing work by market research firms. 

Bottom-Up Method:

The bottom-up approach is based on pricing data and preceding sales. This method is more accurate and uses first-party data to provide a more precise data estimation of market growth and revenue. 

Through this method, a business or a company can state why they selected particular customer segments over the rest. The addressable market is more reliable and accurate as the company relies on exact and relevant data. The data generated through this approach is in-house and real-world experience based and hence is more acceptable than the top-down method. 

Value Theory

The value theory method estimates the value provided to users using the product or service and how much the users are willing to pay for the product or service in the future. The value-theory approach is best applied when there is no actual market data to base things on and when the product is novel. 

Through this approach, businesses tend to be more careful about what customers find relatable and how much they are willing to pay for that value. This approach enters the market when a company introduces new products or services or cross-sells particular products to existing customers.

Importance of Total Addressable Market (TAM)

To estimate the total scale of the market, the total addressable market (TAM) is one of the essential metrics. TAM helps break down the manageable levels when a business or a company is releasing a brand new product or service, planning to cross-sell an existing product or service, or releasing a new customer segment. It gets easier for companies to validate assumptions based on growth or revenue with a sense of how many people could purchase the product. Companies need to understand TAM more accurately to make informed decisions based on revenue and time spent.

Wrapping up Total Addressable Market 

Total Addressable Market (TAM) helps companies determine how sales and marketing efforts might be allocated differently based on specific goals. A thorough analysis of the total addressable market is also one of the finest techniques to draw in potential investors. One can use TAM analysis as guidance to market the product and to gain knowledge on where to put the most effort on.

FAQs

How is the total addressable market calculated?

The total addressable market (TAM) is quite simple and can be given as follows:

TAM = (Average Revenue Per User (ARPU) * Total potentials in the market)

Above mentioned is the basic formula. However, companies will require time and research before determining the above values.

What is a total addressable market example?

Let us consider a company that sells mobile phones.

The potential market size (total addressable market) here is the number of people buying mobile phones in a year, around 60 million.

If a company has 50% of the shares here, it can reach 30 million users of this product. And if two more companies have 20% of the share, they can reach around 15 million customers.

What is total addressable market (TAM)?

The term “total addressable market” (TAM) describes the largest possible market opportunity for a specific good or service. In other words, how big would the market be if 100% of people potentially found value in a product or solution bought or started using it?

As competitors and alternative solutions can also address TAM, it is not a measure of actual future customers or revenue; instead, it gives stakeholders an idea of the size of the overall pie before it is divided among the company, its various competitors, and those potential customers who decide to stay on the sidelines and not use or purchase anything at all.

How is TAM calculated?

TAM is equal to (ARPU * total market potential customers).

The total number of potential clients is frequently determined using external data sources, such as market analysts or official statistics. However, those sources rarely segment the market following how a specific business sees it.

What factors should be considered when calculating TAM?

The four ways to calculate TAM are the top-down strategy, bottom-up approach, value theory, and consulting external research. The top-down strategy involves identifying a subset of customers linked together by characteristics of how they use a good or service utilizing macroeconomic factors.

What is the significance of TAM in business planning?

It’s the most money a company can make from selling its goods or services in a particular market. The best way for firms to determine the objective growth potential of a particular market is to determine its total addressable market.

What are some limitations of using TAM as a metric?

A popular metric for determining how well new technologies are adopted and used is the Technology Acceptance Model (TAM). But there are certain restrictions when utilizing TAM as a statistic. These consist of the following:

1. Limited scope: TAM solely concentrates on individual-level characteristics, such as perceived usefulness and ease of use, influencing technology uptake and usage. Organizational or environmental issues that could affect the adoption of technology are not taken into consideration.

2. TAM is a static model that doesn’t consider attitude and behavior changes over time. It supposes that the variables affecting adoption and usage stay the same, which may not hold in actual circumstances.

3. Limited generalizability: TAM’s applicability to other categories of technologies may be constrained because it has primarily been used to investigate the adoption and usage of information technology.

4. Self-reported data: TAM relies on self-reported data, which may be skewed by sources of measurement error such as social desirability bias.

5. Lack of external validity: Research utilizing TAM frequently uses student populations or convenience samples, which may restrict the generalizability of results to other people.

Overall, TAM is a good tool for analyzing how new technologies are adopted and utilized. Still, it should be combined with other metrics and methods to create a complete picture of technology adoption and usage.

Other Startup KPI Metrics

Understanding and Maximizing Monthly Recurring Revenue

The ARR Advantage for Startups: Understanding and Calculating Annual Recurring Revenue

Using ACV to Measure the Success of Your Sales and Marketing Efforts

Total Contract Value – A Key Metric for Evaluating Business Performance

Why Customer Lifetime Value Is the Most Crucial Metric for Your Business

The Importance of Accurately Calculating Deferred Revenue

Maximizing User Retention: How to Calculate Daily Active Users

Compounded Monthly Growth Rate: Understanding and Calculating Compounded Monthly Growth Rates

Measuring Monthly Recurring Revenue: Expert Tips and Advice

Maximizing the Efficiency of Your Billing Process in Accounting

About the Author

Manjusha Karkera

Copywriter

Manjusha Karkera is an enthusiastic content marketer who has created numerous engaging and compelling writing pieces for various clients and companies over the years. She enjoys writing pithy content and copy on various sectors like fashion, beauty and wellness, sports, fitness, education, etc. Prior to Team upGrowth, she worked as a Marketing Communications Specialist. Her overall experience includes all forms of content writing and copywriting.