The short answer is hell yes! But before we go further into how calculating the total addressable market can improve your marketing ROI, let’s first answer the question, “What is TAM?”
The TAM, a.k.a. total addressable market, a.k.a. total available market- is a market research exercise that allows companies and startups to precisely “size-up” their potential annual revenue growth for their offering, whether it be a specific product or a service.
Often the Head of Marketing or a marketing analyst will calculate TAM when seeking potential investors, or to get buy-in from higher-ups. This is because TAM pinpoints the amount of effort that is needed for the company to be successful (capture reasonable market share and be profitable), how many potential customers they could have, and the potential for success based on the size of the TAM.
Other times, Sales or Marketing teams run a TAM analysis to see if it’s worth selling/marketing a new product to new markets. Let’s take a second to unpack this a little more in the next section.
The Marketing Value Behind Calculating Total Addressable Market
TAM is a theoretical framework that indicates the total market that might exist for an offering if there were free access and no operational limitations for the provider of that offering. It has become increasingly important in today’s rapidly evolving marketing landscape for many reasons such as:
- It gives a whole-picture understanding of the overall revenue opportunity
- It provides a goal post for analyzing product-market fit
- It accurately identifies competitors
- It gives stakeholders a roadmap for the future
- It pacifies investors who require a degree of certainty before releasing funds
Take, for example, Uber’s TAM experiment. In 2014, NYU professor Aswath Damodaran and investor Bill Gurley debated about the valuation of Uber.
When doing industry research, Damodaran calculated Uber’s TAM based on its potential as a taxi/limo service. However, that’s only one specific market. Gurley challenged that approach, stating that Uber was actually a transportation business, and therefore, had a much larger target demographic than initially calculated.
The moral of the story here is that not only is that calculating TAM is a critical exercise for any company that intends to seek venture capital and other business opportunities, but it also gives a clear indication of the companies growth track- if done correctly. TAM calculation is hard, takes time, and needs to be agreed upon by the folks who are going to use the data for a specific purpose.
How to Calculate the Total Addressable Market
This next section is going to sound like you’re in a Marketing lecture at your favorite university or college. Meaning this may be a little technical, but it’s important to understand.
Technically speaking, TAM is the average revenue multiplied by the entire number of customers for each targeted market segment. This exercise will look different for every company, but in order to get this right, you need to know your customer segment(s).
One business may only need to evaluate how many companies have a specific type of software tool, while others may focus on the number of employees in a specific industry or geography. Others may focus on a specific title or department size. These are just examples of something that can be very broad or super-specific- it all depends again on the use of the market sizing exercise.
Once you know what/who you’re looking for, there are three methodologies for calculating TAM:
The Top-down Approach
This macro method assesses the factors that exist at the top of the economy and calculates the total number of potential customers from that perspective.
For example, if there are 10,000 companies that could utilize your service, your service costs approximately $200 per month, and your margin is 20%, then your equation would look like this:
10,000 (companies) * $200 (per month cost) * 0.20 (margin) * 12 (months) = $4,800,000 TAM
The Bottom-Up approach takes a subset of a local market and uses it to infer the greater, total market size. To do this, you would multiply the annual contract value (ACV) of your service or product and the total number of accounts in your industry.
For example, if your company offers an SEO tool that costs $50 per month, then that would cost your vendor $600 annually. If there are 10,000 companies that they market their tool to, then your equation would look like this:
$50 (per month) * 12 (months per year) * 10,000 (companies) = $6,000,000 TAM.
The Value Theory
The Value Theory approach scrutinizes positive outcomes that occur as a result of the products and services being offered against competitive alternatives to calculate the total value.
To utilize this theory, you must be able to estimate the value that your product provides to your users and how you can capture that value in your pricing. You must assess how much your customer would be willing to pay for the value they’re receiving and how many customers would choose your value over a competitor.
Regardless of the method you choose, to provide the complete picture of TAM, you also have to take into account the serviceable available market or SAM, and the serviceable obtainable market or SOM.
TAM, SAM, And SOM – What’s The Difference And Why Does It Matter?
As you know, TAM is the total available market. The serviceable available market or SAM is the subset of the TAM that your company should plan to target with its offering.
After the TAM is calculated, and the SAM is extrapolated from that, the final objective is to obtain the serviceable obtainable market or SOM from the SAM. The image below from Info Tanks Media provides a clear depiction of the process we’re describing.
For example, if your total addressable market is 10,000 companies, yet only 75% of that group fit your target persona, your SAM is 7,500 companies. Furthermore, if only 50% of that subset is obtainable for your company, then your SOM is 3,750.
The reason why the SAM and SOM are important is that it provides the most accurate idea of the total market demand that will be targeted at the end of the day. Without these additions to the TAM exercise, you are left with an unrealistic calculation of growth opportunities.
Tools To Help You Calculate TAM
There are a number of data enrichment tools that can help you calculate TAM, SAM, and SOM that we’ve used when performing this exercise for ourselves and our clients. Here are just a few that we recommend:
- LinkedIn Sales Navigator
- North American Industry Classification System (NAICS)
- Better Business Bureau
The Impact of TAM on Marketing ROI
Earlier we discussed the benefit of calculating TAM, but what about businesses who might want to skip this exercise?
We’ve worked with a few clients in the past who have not wanted to make the financial investment in calculating their total addressable market. While we always advise against this, they don’t always take heed of our advice, and their marketing bottom line suffers.
The client usually decides to attempt to calculate their target market themselves. At best, they don’t get a full picture of the actual market. At worst, they target the wrong audience entirely. Going down this path can cost more in lost marketing revenue than the investment of calculating TAM in the first place.
If you’re ready to invest in your company’s future and would like an expert hand to help you get there, Interrupt Media can help.
We’re a boutique B2B digital marketing agency and have helped many clients to take this step and maximize their serviceable obtainable market share as well as the return on investment for their market strategy.