What is a Total Addressable Market?
A company’s total addressable market (TAM) – also referred to as total available market – refers to the total amount of revenue that could be generated if their product was sold to 100% of the customers within their market. It’s unlikely that a company would ever achieve this amount of revenue, but it serves as an important metric to measure market demand and is used to set long-term goals and objectives.
How to Measure Your Total Addressable Market
There are three different ways a company can measure their TAM.
1. Top-down Approach
A top-down approach requires a large amount of research and utilizing industry data and trends. Information is taken from third-party companies that specialize in measuring market reports and data to identify exactly how large your potential market is.
Once your market is identified, you can then determine what percentage you’re already working with, and how much has been left untapped. Then, you’re able to see what your TAM is.
However, utilizing industry reports and data can be tricky because it’s not always updated, and may not accurately reflect your precise market.
2. Bottom-up Approach
For the bottom-up approach a company must first use their previous sales data and pricing structure to determine their annual contract value (the amount of revenue they generate per year on each existing account). Then, you multiply your annual contract value by the total number of potential customers in your market.
For example: $100 per (1 annual) subscription x 5,000 potential customers = $500,000 TAM.
If the company from this example currently has 1,000 active subscriptions, they’re only engaged with 1/5 of their TAM.
3. Value Theory
The value theory approach is a bit different, as it focuses on the potential value customers place on your product. Start-ups and companies launching brand new products typically use the value theory approach when calculating their TAM.
If a competitor has a product selling for $150, but you’ve developed a similar option that has additional features to make it more appealing, you need to determine if potential customers would be willing to pay more for it. If it’s safe to assume the value is there, you can move ahead with your product.
You must determine the value of your product, the willingness of potential customers to pay for it, and how large of an audience you can engage with. These factors will all play a role in determining your TAM using the value theory approach.
Benefits of Knowing Your Total Addressable Market
It’s important that a company understands what their TAM is and is transparent when communicating it with staff members. Having staff plugged into this information will help with the following:
- Forecasting. When managers forecast future growth, they can use the company’s TAM to set up realistic guidelines.
- Setting goals and objectives. Like forecasting, setting realistic goals and objectives should be in line with your company’s TAM. If sales reps are expected to double or triple the number of sales they make in the next fiscal year, you need to make sure that’s doable.
- Motivation. Sometimes sales reps feel like they’ve hit a brick wall. Prospecting can feel repetitive, and it can be difficult to find new leads. However, if they know what the company’s TAM is, then they know there are still options to explore. Telling sales reps that only 25% of potential customers have been contacted will help motivate them to tap into new prospect pools.