Total Addressable Market (TAM): The Ultimate Guide for Businesses

Entrepreneurs, small business owners, and startup founders have a lot to consider when expanding into a new market. At the top of the to-do list is demonstrating the revenue impact of entering a market they’re considering. But it can be challenging to estimate how much revenue one market may produce—and equally difficult to compare one market to another.

This is where total addressable market (TAM) comes into play. Using the information in this guide, you can gain a thorough understanding of TAM, why it’s important, how to calculate it, and how to use it to grow your business.

Total addressable market (TAM), sometimes called total available market, refers to the total potential demand for a product or service within a particular market. In other words, you first estimate the number of people who may become customers and then assume that they will all make a purchase.

For small to midsize business (SMB) owners, TAM gives you insight into which markets have the most revenue potential. It also makes it easier to do an apples-to-apples comparison of two markets you’re considering entering.

When using TAM, you have an objective metric that solves the problem of figuring out which market can make you more money. With this analysis in hand, you’re one step closer to choosing your next growth region.

TAM is important for businesses because it provides decision-makers with a way to quantify revenue potential—free from many of the natural biases people may feel when considering which markets to expand into.

For example, someone may want to expand into an area where they grew up or visited frequently. They argue that they know the area and understand what makes its residents tick. But, upon doing a TAM analysis, they may discover that the market has far less profit potential than others in the same general area. Even though it may take a little longer to understand the buying psyche of an unfamiliar market, the TAM numbers may justify a move in that direction.

TAM is also important when it comes to designing your marketing strategy. For instance, if your TAM reveals that an urban area may be more fruitful than a less-populated region, you can adjust your marketing strategy and budget accordingly.

To calculate TAM, you do the following multiplication:

Number of customers you may get, times average revenue per customer. For instance, suppose you estimate that there are 50,000 customers who may be interested in your offering. You put the average spend per customer at $100. Therefore, your TAM would be 50,000 x $100 = $5,000,000.

But there are a few different ways of approaching your TAM calculation. Here are the most common methods.

Top-down

With the top-down approach, you start with the overall market you’re considering and then narrow it down to pinpoint your target segment. For some businesses, it makes sense to use census data or industry reports to get started. Then, you whittle it down to a more specific market.

For example, let’s say you have a software company that builds customized e-commerce solutions for retailers. You could start by finding an industry report that gives you the total number of retailers in your target region.

You could then narrow down your analysis by eliminating the large enterprises that already have well-established e-commerce systems. You would then use the remaining businesses to do your TAM calculation.

Bottom-up

With the bottom-up approach, you begin with specific details of your target market. Then, you base your TAM calculation on what you discover.

For instance, a hardware store may start by looking at the number of people who purchase homes in a certain area, assuming that they may be interested in doing a little DIY work after the purchase. The business could then estimate the average spend per customer and use that to calculate the area’s TAM.

Value theory

Value theory uses the value a product or service brings to customers to figure out the TAM of a region.

For example, suppose you offer solar panel installation services. You could choose an area that has particularly high electricity rates. For instance, residents in one location may pay $0.25 per kilowatt-hour. Using value theory, you surmise that the TAM for that area would be higher than for another where people spend less per kilowatt-hour.

If that high-electric-rate area is similar to another region in almost every other way, including population, you would say it has a higher TAM.

External research

When you approach TAM using external research, you use the findings of a third party to figure out which area has a higher TAM. This could involve consulting industry experts or companies that perform market research and use their data to figure out an area’s TAM.

For some businesses, bringing external research into the picture can save a lot of time and energy. For instance, a business consulting company with a focus on tech could simply ask a market research firm to provide the total number of tech companies with less than 50 employees in three different areas. The area with the most businesses that fit the bill wins the TAM battle.

TAM’s cousins, SAM and SOM, can also be useful when analyzing markets. SAM stands for serviceable addressable market or segmented addressable market. SAM is different from TAM in that it also takes into consideration the amount of people it can reasonably serve. For instance, a pest control company may use SAM to limit the size of its market to people who live within 40 miles of its office.

SOM, or serviceable obtainable market, also accounts for the company’s resources and strategies to figure out the number of customers they can reasonably expect to capture. This is far more specific than TAM and would normally produce a far lower calculation.

For example, a company may have a limited marketing budget and can only afford $20,000 worth of geo-targeted social media ads over the course of a year. This could limit the number of people who are both serviceable and obtainable, while TAM would include all potential customers.

You can use TAM to grow your business by performing TAM calculations on multiple areas you’re considering expanding into. Each TAM calculation becomes a metric you incorporate into the decision-making process.

In addition, you can use your TAM figures to start calculating spending around:

• Advertising and other marketing

• Shipping expenses involved in getting your products to an area with a high TAM

• Recruiting and onboarding experienced professionals to staff an office in an area with impressive TAM numbers

To illustrate, let’s say you have a company that provides fulfillment centers to e-commerce companies. Even though it would cost more money to establish a fulfillment center close to an urban area, the TAM potential is undeniable compared to other regions you’ve considered.

The TAM is the decision-making tipping point, so it’s time to take action. You let the marketing team know what you have planned, and they start working on a strategy to earn more business customers that ship from that region.

You can also set up a recruitment process to identify managers and stock management associates who live relatively close to that region.

Your TAM analysis can also make it easier to get a head start when it comes to identifying warehouses or existing fulfillment centers to purchase or lease.

Getting started with these and other growth actions puts your business in a better position to hit the ground running as you expand into that region.

TAM can also make it easier to identify a target market because it can inspire important discussions about which customers you actually want to pursue.

For example, you may do a TAM analysis of a region and identify 450,000 potential customers. The next question would be, “How many of these should we focus on?” The answer may lie in demographic factors, such as age or income level. For some companies, TAM may spark conversations about the kinds of people who have a history of purchasing your type of product or service.

These kinds of TAM-driven discourses can speed up the process of figuring out which target market to invest your budget in so you can get started on designing a winning strategy.

With this guide to TAM, you’re ready to start comparing growth opportunities side-by-side. You also have the tools to quantify a specific area’s growth potential in discussions with other decision-makers.