What Is Total Addressable Market? (TAM)

Let’s say you’re launching a new product. You need to understand how big the market is in order to determine whether it’s worth the investment. What if you could find the number that answers your question — and helps you paint an accurate yet exciting picture for investors? This number exists in the form of total addressable market (TAM). Finding it can guide your strategic plans, help you prioritize opportunities, and keep all your teams on the same page.

What you’ll learn:

What is total addressable market (TAM)?

The total addressable market, or TAM, refers to the total number of customers who could possibly use your product or service. TAM can also represent the total potential revenue from that market. This is why TAM is expressed as either the number of customers or as potential revenue. Companies use TAM to illustrate the broadest scope of their business opportunity.

The importance of finding your TAM

Your TAM indicates the size of an opportunity for revenue or new customers. Finding it can help your teams prioritize their efforts, guide how you invest resources, and measure actual success against your potential for growth. This makes TAM a valuable tool in sizing up new features and products. It can help you decipher which ones are more likely to generate higher revenue and are ripe for opportunity-based marketing. In addition, TAM can attract prospective investors because it shows your full revenue potential, with research and calculations to back up the opportunity.

(Back to top)

TAM, SAM, and SOM: What’s the difference?

SAM stands for serviceable addressable market. SOM represents your serviceable obtainable market. Each exists within your TAM and offers a more realistic near-term target. By definition, TAM casts a wide net, so capturing all of that market typically isn’t attainable — at least not right away. That’s why businesses sometimes narrow down their TAM using SAM and SOM. These metrics help leaders take a “shoot for the stars” target down to Earth, where they can begin to execute with the tools they have (no spacesuits required).

Serviceable addressable market (SAM) — While TAM represents the full market potential, SAM represents only the portions you could serve now. To find this more realistic number, SAM accounts for constraints like geography.

Serviceable obtainable market (SOM) — While SAM outlines the entire market your business is able to address, SOM narrows that down further by focusing on the portion of the market you can capture with your current business model. This metric takes into account your supply limits, production capability, and competitors.

Example: TAM → SAM → SOM

Let’s say you manufacture baseball bats. You’re not yet ready to chase international sales, so you find your TAM for the U.S. and discover there are 20 million customers who would buy one $60 bat per year. While 20 million people could hypothetically purchase your bats, yielding $1.2 billion, your current distribution network can only reach 5 million. This means your SAM is 5 million customers, representing $300 million.

Now, to find your SOM, you account for further constraints based on the market and your business. Your biggest competitor, for instance, has a firm hold on at least 60% of the market. This leaves 2 million customers (or $120 million in revenue) for you. But finding your SOM must also include your business model. Due to supply constraints, your manufacturing facility can only produce 200,000 bats per year. That number is your SOM — the market you can realistically capture and service with your current business state. However, because you found your SAM, you know there’s a market for all those bats and then some. Knowing your SAM and TAM helps you plan realistic growth targets, so you can confidently expand your distribution and increase production.

(Back to top)

Thanks, you’re subscribed!

How to calculate TAM

Your TAM includes every opportunity for your business, including future growth. Begin by identifying your target customers and determining the market size. Once you’ve uncovered the number of potential users for your product or service, calculate the potential revenue if you were to capture the entire market.

TAM = Total number of potential customers x average revenue per user

TAM calculation examples

Let’s go through a few examples of how various businesses can calculate their TAM.

Example 1: Software company

Based on market research, this company finds that its niche software could serve up to 30,000 clients in North America. Because their average account value is $5,000 per year, they calculate their TAM revenue by multiplying 30,000 potential clients by $5,000, arriving at $150 million per year.

Example 2: Small-time lemonade stand

Imagine a 10-year-old who wants to open a lemonade stand for three hours on a Saturday afternoon. There are 65 houses in the neighborhood, each with an average of four people. Now, let’s say that because the entrepreneur has done this before, they also expect drive-by traffic at an average of four vehicles per hour, with an average of three people in each car.

Here’s how to calculate the lemonade stand’s TAM revenue for one Saturday afternoon, assuming every possible customer buys a $1 cup of lemonade:

• 65 houses x 4 people = 260 neighbors
• 4 vehicles x 3 people x 3 hours = 36 people from drive-by traffic
• 260 + 36 = 296 potential customers
• 296 customers x $1 serving of lemonade = $296

Example 3: A pizzeria

Let’s say a Manhattan pizzeria is looking to open multiple locations throughout New York City. To find this expanded TAM, the owner starts with population data. They learn that 1.7 million people live in the city, and research shows that New Yorkers eat an average of three pizzas per capita per year. The business charges an average of $20 per pie, so they use this calculation to find their TAM revenue:

• 1.7 million people x (3 pizzas x $20) = $102 million

The bottom-up approach for TAM calculation

This approach starts with a smaller target segment and then scales it to extrapolate the total possible market. The formula:

Total number of accounts in your industry x Annual contract value (ACV) of your company’s product or service

By using fewer estimations, you can deliver a more reliable number. However, your company must be mature enough to have sales analytics data on at least a pilot set of customers.

Value theory method

One thing to remember when calculating TAM revenue is how much customers are willing to pay. This is especially important when introducing an innovative or entirely new product to the market, and it’s where value theory comes into play. Once you determine what your typical buyer would be willing to spend based on the value your product adds, you can set a more informed price and multiply that by the total number of potential customers to estimate your revenue-based TAM.

(Back to top)

Common challenges in TAM calculation and how to overcome them

Finding your TAM isn’t an exact science. While it can include research-based numbers, it does involve some assumptions and artful estimations. Here are some common pitfalls and how to avoid them.

Overestimating TAM

One stumbling block is sizing a TAM too large. Building products to meet all the needs of all people is not only hard, but it’s also expensive. Be realistic about who you’re targeting so you can take a focused approach to creating a minimum viable product.

To avoid overestimating:

• Do your market research and use internal customer data when possible. Whenever possible, find market data from credible sources (e.g., the U.S. Census Bureau or published reports from analyst firms) to find total potential users. And use CRM data to find the average revenue per user.
• Narrow your target market to realistic user segments. Consider the actual demographics of customers likely to use your products or services. This could include geography, age, income level, gender, etc.

Failing to reevaluate TAM

It’s important to realize TAM can change. Ignoring new information and failing to adjust your TAM could cause you to miss key opportunities for improvement. Avoid this by reevaluating your TAM at least annually, if not quarterly.

Giving up if market research isn’t available

Sometimes, market research doesn’t exist, especially for new products. But that could mean you’ve landed on an exciting opportunity, especially for startups looking to define a new market and establish product-market fit. In this case, estimate numbers based on the available related information.

(Back to top)

How to use TAM in strategic planning

Calculating TAM can help you evaluate an opportunity to determine whether it’s worth pursuing. It can also serve as a starting point for identifying your initial target market. As you narrow your focus, you can better plan how to capture those initial target segments.

Here are ways TAM can inform strategic planning:

1. After calculating the TAM for any given opportunity, compare this potential with the cost of building your product or feature. This will help you decide whether you can expect a positive return on investment.
2. Determining your TAM, then narrowing it down to your SAM and your SOM, helps you identify opportunities ripe for growth by pinpointing which segments have yet to be captured. Use these insights to drive growth by planning how to attract those customers. For example, you might compete with a rival by focusing on lower pricing, introducing new products or features, or highlighting superior service.
3. When it’s time, expand your TAM. Here’s an example: One of the world’s most well-known social media companies expanded its TAM after it had proven its model by capturing most of its initial target market. While it had previously allowed only college students in the U.S. and UK to join, it eliminated the account requirement of a school-issued email address and opened its network to any user older than 13 with an email address.

(Back to top)

Grow your opportunities with TAM insights

Once you know the TAM for any given product, you can better understand your current market position and identify areas for growth. Use sales planning software to create a realistic plan for capturing market share. As you pursue growth, be mindful of market trends and reevaluate your TAM as needed to ensure you don’t miss valuable opportunities to scale in new directions.