What is it and how can you calculate it

Whether you’re looking to start a new company or forecast realistic revenue growth, measuring your total addressable market is an important first step.

Total Addressable Market Count before the meeting

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To understand how much of a market you can secure—and how much revenue your business can generate—you’ll need the right formula.

In this post, you will learn what is Total Addressable Market and the best way to calculate it.

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Unless they are a monopoly, most companies cannot capture the total addressable market for their product or service. Even if a company has only one competitor, it will be extremely difficult for them to persuade the entire market to buy only their product or service.

That’s why most companies also use the other Metrics for Analyzing the Market,

Companies can measure their serviceable available market (SAM) to determine how many customers they can realistically reach. Additionally, they measure their share of the market (SOM) to understand the size of their actual target market.

However, TAM is still useful. Businesses can use total addressable market analysis to objectively estimate a specific market’s potential for growth.

how to calculate tam

To calculate the total addressable market, TAM is the total market demand for the product or service.  You can determine TAM by analyzing your industry, calculating a projection with past data, or determining the value of your product.

There are three ways to calculate your business’s total addressable market.

1. up-down

The top-down approach uses industry data, market reports and research studies to identify TAMs. In this approach, you can use industry data from Gartner or Forrester to identify which subdivisions of your industry align with your goals and offerings.

However, there are limits here. Data generated by industry groups may not always be kept up to date and may not reflect the specific elements of your market.

You may want to hire a market research consulting firm to conduct fresh research focused on your market.

2. Bottom-up

The bottom-up approach to TAM calculation is based on past sales and pricing data.

First, multiply your average sales price by the number of current customers you have. This will give you the annual contract value.

Then, multiply your ACV by the total number of customers. This will output your total addressable market. Let’s see how it looks in an example.

The total addressable market formula is the total number of customers multiplied by the annual contract value;  How to Calculate Total Addressable Market;  total addressable market formula

Let’s say that you sell scuba fins to dive shops in the state of California.

You can find dive shops in California selling 60 pairs of fins for an average of $35/pair.

Multiplying 60 by $35 equals an ACV of $2,100. Then, you multiply your ACV ($2,100) by the total number of divers in California (125) for a total addressable market of $262,500.

Total Addressable Market Analysis, Calculate TAM for New Scuba Fins.

3. Theory of Value

The value-principle approach is based on how much value consumers get from your product or service and how much they are willing to pay for that product or service in the future.

To return to our scuba example, let’s say you make a type of fin that is lighter than your competitors’. You’ll identify your pricing principle by estimating how much dive shops would be willing to pay to carry your top product.

If normal fins are selling for $35 per pair, will dive shops pay $40 or $45 for a pair of your ultra-lightweight fins?

After you’ve calculated your total addressable market, it’s time to determine whether it’s an industry worth entering.

industry with one market size Might be worth entering in the range of $30 million to $200 million per year. However, if the market size of the industry is less than $5 million per year or $1 billion per year, this is probably not the case.

In either case, persuading investors to back your company will be challenging. An industry with a market size of $5 million per year would be too niche and one with a market size of over $1 billion would likely be too saturated.

Know your TAM before you take action

Starting a business or anticipating next year’s revenue growth is always thrilling. But if you want to follow a realistic path toward success, you must first understand what is actually possible in the market.

Let your perfect market be your North Star and guide you through a journey that is rooted in reality, not hype.

Editor’s note: This post was originally published in November 2020 and has been updated for comprehensiveness.

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