Total Addressable Market (TAM)

What is total addressable market (TAM)?

It’s important to note that determining a product or service’s TAM is not a revenue projection. Rather, it’s a way for companies to understand the size of the current marketplace.

Even businesses operating in niche markets with just one or two competitors are unlikely to gain anything close to their maximum potential revenue. Nonetheless, it’s still a valuable way to understand the demand for a product or service before investing time and resources in developing it, as well as to make validated predictions about growth and revenue.

The benefits of knowing your total addressable market

Considering the TAM of any product or service is crucial before embarking on any new business opportunity. No entrepreneur or investor can afford to leap without looking. The TAM helps create a concrete understanding of the potential gains an investment may accrue in the future.

Taking the time to calculate the total addressable market shows the reality of a new venture and helps determine its validity. The excitement of feeling inspired by ideas or possibilities can lead to impulsive decisions, but these can be costly down the line if there’s no real basis (or market) to build on.

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You may discover there’s less opportunity to succeed in the current market than you expected or had been led to believe. This would prevent you from throwing money into a fruitless enterprise with little hope of significant ROI.

On the other hand, calculating the total addressable market can reveal that a product or service’s potential is far greater than imagined. Extra capital or resources may be required to make the most of it. As a result, data on the total addressable market can help secure funds from investors. 

How is the total addressable market calculated?

The total addressable market can be calculated in multiple ways:

Top-down

This process starts by taking the full number of people, businesses, or other targets in the world. Next, you apply geographic, demographic, and economic factors to rule out inaccessible prospects. This leads you to a viable scope of opportunity for the total addressable market from the top down.

Bottom-up

This method is based on a granular approach, beginning with a small calculation and expanding it to a broader range. You may analyze a small base of theoretical buyers or use real research, before applying this to a much bigger audience. 

Value theory

This is best for innovative products with no existing example to compare them to. It revolves around looking at the amount of extra value the goods bring and then identifying how much the buyer would be willing to pay for it before calculating the total addressable market.