How to calculate your total addressable market and make a great TAM slide for investors.
What is TAM ?
- TAM analyses in an attempt to identify gating factors on the growth of a startup over time.
- A TAM slide’s role in a pitch deck is to convince investors that the company is chasing an opportunity big enough to achieve venture-scale returns with the right execution.
Three Ways To Calculate TAM.
- Top-down, using industry research and reports.
- Bottom-up, using data from early selling efforts.
- Value theory, using conjecture about buyer willingness to pay.
TOP-DOWN
- This method uses industry research reports to estimate the size of your market, which usually appears in the form of “According to ABC company, this will be a $123 bn industry by 2030”.
- Now, your business decisions are in the hands of ABC’s understanding and analysis.
- But the question is if ABC does not understand the specifications of your product, how will it be able to estimate the company specific market??
- For example, when Amazon started as an online bookstore, would it be right to calculate its TAM based on the industry (i.e. existing physical bookstores)? Absolutely not. Because Amazon was a disruptive idea and would lead to significant fall in the existing physical bookstore industry. In fact it’s TAM would be much higher owing to the extent of crowd pulled due to disruption plus the ‘online’ convenience may attract many new people as well. This is where industry level TAM may not serve your purpose.
- So, the moral is, if your product causes a change in industry numbers, (whether disrupt it or add new users), you do not take the existing industry TAM.
BOTTOM UP
- How we price and how many units of that price we can sell.
- This is a much better option than Top down method, because it involves tangible, relatable data on current pricing/usage of the product and imagines a larger customer base.
- In this approach, you use your own company data to build your market boundary. This method relies on early sales data of your product, and hence the TAM obtained is specific to your product
- Let’s calculate the TAM for a startup that sells employee relationship management software. If it caters to white collar firms and prices its product at $30 per employee per month, then it might reasonably take the number of employees at such firms and multiply it by price to get TAM.
VALUE THEORY
- How much value we can add, and why we’ll be able to capture it.
- A value theory TAM relies on an estimate of the value provided to a set of users by the product, as well as a guess at how much of that value creation can be captured through pricing.
- To calculate TAM using value theory analysis, you estimate the value that your product or service provides to the users and the extent of the value you can capture through your pricing
- If a startup sells commodity product, even if it adds a ton of economic value, it will not be able to obtain a reasonable price due to price wars between competitor companies. This struggle between producers always benefits the customers.
- Value theory approach is best used to get a hint of TAM when you are adding features to your existing product, which will eventually lead to greater value generation for customers.
Author:
Vins Rafaliya
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