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

Contributors: Manjusha Karkera
Published: January 3, 2023

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Introduction to Total Addressable Market (TAM)

Total Addressable Market or TAM is referred to as the total amount of 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 entire market demand for a particular product and defines the total available opportunity for that product. 

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 easily lets businesses and companies become aware of the blurred lines between their markets.

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

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, be it start-ups or established companies. The total addressable market (TAM) can be given as follows:

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

In order 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 said to be an elimination process that takes in a large number of known size 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 said to be 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 highly precise 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 is based on estimating the value provided to a set of 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 a novel product. 

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 comes into the market when a company is introducing new products or services or cross-selling particular products to existing customers.

Importance of Total Addressable Market (TAM)

In order 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 in the process of 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 in order to make informed decisions based on revenue and time spent.

Wrapping up Total Addressable Market 

Total Addressable Market (TAM) helps companies effectively determine how sales and marketing efforts might be allocated in different ways based on specific goals. A well-thought total addressable market calculation is also one of the best ways to attract various potential investors. One can use TAM analysis as guidance to market the product and to gain knowledge on where to put the most efforts on.

FAQs

1. 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 spending some time and researching prior in hand before determining the above values.

2. 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, which would be around 60 million.

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

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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
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.

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