TAM: Total Addressable Market

aka The Most Important Number You’ll Ever Bullshit As An Early Stage Startup

How can you look at this face and NOT trust what meows come out of it?

Dear Diary,

It’s been a minute since we chatted! Following my last entry, I’ve attended a college graduation while visiting family and (somehow) making progress on the startup. We certainly have a busy few weeks ahead with presentations and pitches for Aequa! However, while walking around college campuses and listening to commencement speeches, I heard a lot of rhetoric around the theme of “your future is yours to write” and “the potential is endless”. This is ambiguous, promising, and inspiring. Coming home, reminded of these themes, I dove right into calculating some numbers for our startup - the TAM, SAM, and SOM. These are three numbers about as ambiguous, promising, and inspiring as those commencement speeches last weekend! But honestly, last time I thought this hard about a TAM, it looked a lot more like this:

Did you know this type of gong is also known as a tam tam?

So what is a TAM? TAM stands for Total Addressable Market, which represents your product’s revenue opportunity at 100% market share as if no competition exists. So if you became this guy, how much money would you bring in on an annual basis?

Generally, the equation for a TAM is generalized as such:

TAM = Avg Revenue Per User (Annual) * Number of Potential Users

Now, when you’re working with a newer market (as some startups do), finding accurate data on the number of potential users is a task on its own. Sometimes you’ll have good data, but other times you’ll have little to no data you can rely on. So being able to justifiably come up with this number will take a little creativity and a lot of extrapolation. Fortunately, this is a number you can keep adjusting over time. Unfortunately, there are times where you have to present what you have, and that may not always be exactly where you want it. So what do you do in those moments? You present what you have, what you know, and what you assumed. And what matters most is this: that you can back up whatever number(s) you are presenting.

So if this number is all based on speculation, why does it matter so much? Well, some folks think it's a fool's errand. 🃏 However, there is value in going through the process. In calculating this number, you end up:

🧑‍ Researching your market and learning more about who is out there
🐎 Researching your direct and adjacent competition
👂 Learning more about the needs of the industry
💰 Understanding how you want to price your product (to start)
📈 Understand your business plan (strategy for selling your product)
📝 Listing out your assumptions in the space

All of these things are extremely powerful pieces of information to have at your disposal, and going through this process forces you to research these items that will inevitably come up in conversation. In addition, there are two other numbers that are also important and rely heavily on a properly-calculated TAM (or the TAM relies on them depending on if you construct it with a top down or bottom up approach): the SAM and the SOM.

The SAM, also known as the Serviceable Addressable Market, represents the part of the market you can actually service. While we all love to think that we can be a monopoly in the global market, that is very unrealistic. The SAM asks us to figure out what the market we can service actually is. This estimate still exists in the land of a monopoly, so it remains an unrealistic target.

The SOM, also known as the Service Obtainable Market, is an adjustment on the SAM that accounts for competition. This forces you to estimate how much of your market you can realistically obtain based on market demand and who would actually benefit from your product or service. This is the number that shorter-term goals for a startup are generally based on.

You can typically think of the SOM as a subset of the SAM which is a subset of the TAM.

So between the TAM, SAM, and SOM, you should have a solid idea of what is possible in a perfect world and what is possible in your world.

Now why do investors care about these numbers so much? It’s because they are focused on their potential return on their investments (ROIs). As investors, they are responsible for growing the money they have. In order to decide what they actually invest in, they need to look at the risk as well as the potential benefits. By explaining the TAM, SAM, and SOM for your company, you are not only demonstrating a knowledge of the market, but you are informing them of the potential opportunity, the realizable opportunity, and what you are capable of. Then, they can determine if an investment would yield an optimal enough of a return for their portfolio if you were to deliver on these figures. So at the end of the day, it’s about reducing their perceived amount of risk.

Do they know that these numbers are hard to predict? They sure do. Do they know it’s likely they won’t hold up? Of course. But to them, it’s important to understand as much about the market as possible before investing. This is why they will often challenge your estimates with questions after you give your presentation. Your number that you have calculated must be backed by data as much as possible and demonstrate the justifiability of your estimate to the investors so that you build trust.

Now, as I continue to iterate over and over again on my own numbers, I’m reminded that the value is in the journey, not the destination. As much as I hate the ambiguity this data forces me to represent, I understand that it is more about building trust and showing your process to make educated decisions - and that is something I can get behind. At the end of the day, you know you’re a badass and that what you’re doing matters. These numbers are just one way of showing everyone else how much of a badass you (and your company) really are.

Leila Kaneda
Co-Founder and CTO
she/her/hers