Before launching a brand new company, expanding into a new vertical, or launching a new product or service, there’s one very important first step you’ll likely take: determining your market potential. After all, determining your market potential tells you what the market is worth, which helps you decide whether or not your new venture is worth the investment.
Determining market potential involves a few factors, but there’s one specific factor that’s often either misunderstood, miscalculated, or misused. That factor is your Total Addressable Market—frequently referred to as your TAM.
What Does Total Addressable Market (TAM) Mean?
TAM is a market sizing analysis that helps you define the total revenue potential of your current (or future) set of products and services. Measuring your TAM gives you the full picture of what your total available market and landscape looks like (simply put: how many clients or customers could you possibly sell to?).
Why is Defining Your Total Addressable Market (TAM) Important?
Defining your TAM helps you implement more effective, data-driven, and dynamic targeting built on data that you can take action on immediately. Your total addressable market is also a critical data point when trying to determine how much effort you can invest into a new business venture. With this data, you can better prioritize your product roadmap, marketing efforts, and future business goals.
What Are SAM and SOM? How Are TAM, SAM, and SOM Different?
As described above, your total addressable market is the total number of customers that could buy your product or service. If you were launching a new line of modern workwear essentials, your TAM would include any person that could ever possibly buy, say, a button-up blouse. However, just because someone could buy your product doesn’t mean you should invest valuable time and resources in marketing to them.
Let’s face it: most companies can’t possibly capture the entire addressable market for their products or services. There will always be at least one, if not many, competitor(s) trying to capture the same market share. Plus, you likely won't have the resources at your disposal needed to handle that volume of output.
For that reason, it’s unrealistic to set your TAM revenue potential as your actual revenue goal. That’s where SAM and SOM come into play.
What is SAM (Service Available Market)?
SAM stands for Service Available Market. SAM is a subset of your TAM that caters to different types of customers based on factors like:
● Geographic data
● Demographic data
● Differences in product/service pricing, quality, or functionality
To build off of our earlier example, your total addressable market for your new line of modern workwear essentials would include any person that could ever possibly buy workwear. Your SAM, however, would carve out a segment of that huge audience and factor in the fact that the majority of your clothing is for women, it’s priced above the norm, it’s made with mid-to-high-quality sustainable materials. You wouldn’t want to advertise to the segment of the market that solely buys low-quality, fast fashion apparel, so those consumers aren’t included in your SAM. Instead, your SAM would likely consist of higher-income consumers, most of whom are women, who likely live in a more urban area and care about the environment.
What is SOM (Serviceable Obtainable Market)?
SOM stands for Serviceable Obtainable Market. It’s an even smaller subset of your SAM and TAM that tells you much of your market you can realistically capture in the near- to mid-term. Your SOM layers in additional factors like your competitive dynamics and current resources to give you a better idea of how many customers you could realistically win.
Once you know your SAM, you can analyze the data and your own resources to figure out what bandwidth you have for targeting that market. You can determine which, and how many, geographic locations you’d like to launch in. You can measure how much market share your competitors hold and find out what market share you think you could potentially grab for yourself. Once you’ve defined those high-priority markets and profiles, you can calculate your SOM.
Referring back to the workwear example, you could determine that you want to open pop-up shops in three major hubs: New York City, Chicago, and Atlanta. You can then calculate the revenue potential of each hub and add them together for your initial SOM. Over time, your SOM could grow as you expand your business.
How to Calculate Total Addressable Market (TAM)
But before you can calculate your SAM or SOM, you need to figure out your total addressable market. There are a few common ways to calculate your total addressable market:
1. Top-Down Approach
The top-down approach to calculating your TAM uses third-party data, market reports, and consumer studies within your industry to calculate the size of your market potential.
Depending on the size of your industry, you may consult companies like Nielsen, Gartner, or Forrester to get accurate market size calculation data. The risk of using the top-down approach is that you’re relying on data that may be out of date, and likely does not fully reflect the nuances of your business. In some situations, it may be more effective to work with a firm that can help you generate up-to-date data that takes into consideration your unique business needs.
2. Bottom-Up Approach
The bottom-up TAM calculation is a fairly simple math equation.
Annual Contract Value (ACV) * number of customers for the entire segment of the targeted market
Your ACV is calculated by multiplying your average sales price by your number of current customers. Let’s look at an example:
You own a fragrance company that distributes your fragrance products to beauty supply stores in your state. Your product costs an average of $95/bottle, and you sell an average of 100 bottles to each store. 100 * $95 gives you an ACV of $9,500. You’d then multiply your ACV by the total number of beauty supply stores in your state (150) for a Total Addressable Market of $1,425,000.
3. Value-Theory Approach
The value-theory approach requires you to determine how much value a consumer does (or will) receive from your product and determine how much they’d be willing to pay for that product/service in the future. If you’re manufacturing a new product, you’d identify the value-theory by estimating how much your customer would be willing to pay for it.
Product price testing is a helpful, data-driven method to discern price sensitivity and determine the ideal price for a good or service. You can use price tests to calculate how much consumers are willing to pay for your product/service, and then use that data to more accurately calculate your TAM with the value-theory approach. After all, let’s say you’re wavering between charging $10 per unit or $15 per unit. To a consumer, it may not seem like a huge amount, but depending on which unit price you use during your calculations and the size of your target market, you could end up with wildly different TAM estimates.
Find Your TAM First—Then Focus On Your Opportunity
By defining and segmenting your market appropriately, you can better organize and prioritize your marketing and development efforts. Finding your TAM is an essential first step to estimating the potential scale of your business. It helps you assess the market potential for a new product or service, so you can decide if it's worth the investment in the first place. Once you find your TAM, the rest of your consumer targeting efforts can start to fall into place.
Unlock your full market potential
Determining your TAM, SAM, and SOM can help you determine who to market to, when the best time to scale is, and where you have opportunities for additional growth. Finding and aligning on the right data for these analyses can be more difficult than it seems, especially if you don’t have a clear framework.
Starlight Analytics has a team of seasoned product experts that power winning products across all major industries. We’ll equip you with high-quality, easily digestible insights and actionable takeaways that are practical and considerate of your business strategy. We can even help you uncover product whitespace and new market opportunities by identifying unmet customer needs and emerging conversations.
Together, we’ll review the output and work to prioritize which ideas have the potential to influence your product roadmap. Want to learn more? Click here to share more about your goals and get started.