Total Addressable Market | Introduction, Importance, and Working

Total Addressable Market (TAM) in product management is a crucial metric that helps product managers gauge the potential of their product within a specific market. In this article, we will explore the Importance, interpretation, and calculation of TAM, distinguish it from SAM (Serviceable Addressable Market) and SOM (Serviceable Obtainable Market), explore its real-life applications, and finally, discuss the limitations of TAM with a practical example.

What is the Total Addressable Market(TAM)?

The Total Addressable Market, often abbreviated as TAM, represents the entire revenue opportunity available for a specific product or service within a particular market. In other words, it is the total demand for a product, assuming there are no limitations, and every potential customer is willing to purchase it. Understanding TAM is fundamental for product mangers because it helps them identify the market’s size and potential, guiding their strategic decisions and resource allocation.

How to Calculate Total Addressable Market(TAM)

Calculating TAM involves several steps:

1. Define the market: Begin by identifying the market or industry in which your product operates.
2. Segment the market: Break down the market into segments, such as geographic regions, customer demographics, or industry verticals.
3. Estimate the market size: Determine the number of potential customers within each segment and the price they are willing to pay for your product.
4. Sum up the segments: Calculate the revenue potential within each segment and add them together to get the overall TAM.

For example, if you are launching a new software product for small businesses, you would estimate the total number of small businesses in your target market and multiply it by the expected price per customer to determine your TAM.

There are 3 approaches to calculate TAM, that are described below:

1. Top-Down Approach

With the top-down strategy, you begin with a large market size and then focus in on a single target segment. For instance, you may start with the estimation of the worldwide market for mobile applications and then hone it to concentrate on a specific market segment, such as fitness apps.

2. Bottom-Up Approach

Using a bottom-up method, you may estimate your target market’s total addressable market (TAM) by taking into account certain features including the total number of possible consumers and their purchasing patterns. For example, you might determine the TAM for a neighbourhood bakery by looking at your city’s population, the proportion of people who purchase baked products, and the average amount each client spends.

3. Value Theory Approach

This approach takes into account the whole value that your product or service provides as well as the price that buyers are prepared to pay. It often involves figuring out what problems your solution solves and how much value it adds. For example, a business software provider may calculate total addressable market (TAM) by taking into account the cost reductions and productivity boosts that their programme offers to new customers.

How to Interpret TAM

Interpreting TAM is crucial for product managers. It serves as a guideline for decision-making, helping them understand the potential market size, assess growth opportunities, and evaluate whether the market can support their product. A large TAM can indicate significant potential, but it’s essential to remember that not all of it may be accessible. TAM should be viewed as the upper limit, and other metrics like SAM and SOM are used to refine expectations.

Total Addressable Market Importance

TAM is vital for several reasons:

1. Strategic Planning: It guides product managers in setting realistic goals and strategies by providing insights into the market’s size and potential.
2. Resource Allocation: Understanding TAM helps allocate resources effectively, ensuring a product’s success without overcommitting.
3. Investor Relations: Investors often ask about TAM to assess a product’s growth potential and marketing opportunity.
4. Competitive Analysis: TAM aids in assessing competition and market saturation.

Differences between TAM, SAM and SOM

To better understand TAM, it’s essential to differentiate it from SAM and SOM:

1. Total Addressable Market (TAM)

Total Addressable Market (TAM) is the revenue potential with 100% market share under the assumption of no competition.

For example, TAM would include the total income that a company could make from selling oxygen to every living thing in the universe if it were the only producer of oxygen in the universe as a whole.

2. Serviceable Addressable Market (SAM)

SAM is a subset of TAM and represents the portion of the market that your product can realistically target. It factors in limitations such as geographic reach, product relevance, and market conditions.

Consider that, because of technological and logistical restrictions, this company can only supply its oxygen to planets inside the Milky Way galaxy. In this example, SAM would represent the part of the universe’s living beings within the Milky Way galaxy who could be able to purchase their oxygen. SAM focuses on a certain geographic area or market sector.

3. Serviceable Obtainable Market (SOM)

SOM is an even smaller subset of SAM, considering factors like competition and market penetration. It represents the part of the market your product can realistically capture based on your resources and capabilities.

Let’s add some competition to this to improve it. Assume that other firms are supplying oxygen inside the Milky Way, and our company has limited production capacity. SOM would reflect the company’s true market share inside the Milky Way galaxy, taking into account its manufacturing capability and competitors. It’s a conservative estimate of the company’s market share in the Milky Way oxygen market.

Application of TAM

TAM finds application in various aspects of product management, including:

• Market Sizing: TAM helps define the market’s overall size and potential, aiding in target market selection.
• Pricing Strategy: Understanding the market size allows for informed pricing decisions to maximize revenue.
• Business Planning: It serves as a foundation for business plans and revenue projections, aiding in securing investments.
• Product Development: TAM guides product development by identifying market demand and opportunities.
• Marketing and Sales: It helps tailor marketing and sales strategies to specific market segments.

Working Example

Let’s consider a practical example to illustrate the concept of TAM. imagine a company developing a new mobile app for fitness enthusiasts. They identify the market as “fitness apps” and segment it into users interested in weight loss, muscle gain, and general fitness. In each segment, they estimate the potential customer base and the price they are willing to pay for the app:

• Weight Loss: 10 million potential customers willing to pay $10/month.
• Muscle Gain: 5 million potential customers willing to pay $15/month.
• General Fitness: 15 million potential customers willing to pay $8/month.

To calculate the TAM, the company sums up the revenue potential in each segment: (10 million x $10/month) + (5 million x $15/month) + (15 million x $8?month) = $100 million + $75 million + $120 million = $295 million.

This $295 million represents the TAM for their fitness app in the broader fitness app market.

Flaw of TAM with an Example

While TAM is a valuable concept, it has limitations. For instance, it assumes that every potential customer is a viable target, which is rarely the case. To illustrate this flaw, consider the fitness app company. Despite estimating a TAM of $295 million, it doesn’t account for factors like competition, user preferences, and market saturation. In reality, only a fraction of the TAM is accessible due to these constraints.

Conclusion

Total Addressable Market (TAM) is an indispensable concept in product management. It provides a foundational understanding of market potential, guides strategic decisions, and aids in resource allocation. However, it should be viewed as an upper limit, with SAM and SOM used to refine expectations based on practical constraints. Calculating and interpreting TAM is a crucial skill for product managers, helping them make informed decisions that can lead to product success. It is important to recognize its limitations, as it doesn’t reflect the practical realities of the market. In summary, TAM is a valuable tool, but it should be used in conjunction with other metrics for a more comprehensive market analysis.