3 Ways to Define Your Total Addressable Market

3 Ways to Define Your Total Addressable Market (TAM) for Startup Founders and Investors

Every startup has potential.

But, as a founder, you must ensure that the market is large enough to support your goals. 

Gaining a clear, data-driven understanding of the size of the market(s) you’re targeting is essential. Knowing the Total Addressable Market (TAM) is a key metric for investors and founders to set sales and revenue targets.

When a startup achieves successful growth, the TAM contributes to the value of a company — if looking ahead toward a potential exit (sale or IPO) in three to five years. 

Below, we give you a practical step-by-step guide with three ways to calculate your TAM. We also explain the benefits of producing a realistic total addressable market assessment. 

What Is a Total Addressable Market? 

A business’s total addressable market (sometimes known as a total achievable market) represents the total revenue opportunity if you achieve a 100% market share. 

Of course, no company achieves 100% of the TAM pie. You need to factor in elements like competitors, demographics, economic cycles, sector-specific seasonality, and psychographics.

You should also consider whether your product or service addresses the needs of your ideal customer profile (ICP). 

Founders must understand how much of this market they can realistically reach with the resources and runway time available to them.

Calculating this number involves working out your Serviceable Available Market (SAM) and Serviceable Obtainable Market (SOM). 

Why is a B2B TAM analysis crucial for growth projections? 

Understanding your TAM is key, especially for Software as a Service (SaaS) and Business to Business (B2B) companies.

Three reasons to know your TAM: 

  1. Investors want to know the percentage of the overall market you intend to pursue. For pre-revenue startups, this figure will feed directly into growth projections and valuations when raising investment. Once you’re generating revenue, TAM projections become more accurate and dependable because they are grounded in customer data, the average value of customer accounts, and revenue figures. You can confidently say, “We acquired 1,000 customers this year, and the average revenue value is X, but we know there are X thousand more potential customers in our target market so our TAM is Y.” 
  1. Founders must know the overall size of the market and any potential revenue from capturing a percentage of that market. What if you’re focusing on the wrong market, one that doesn’t present enough revenue opportunities? What if there’s another market with lower barriers to entry and a higher potential demand for your product or service?  Calculating your TAM gives you a clear idea of your startup’s revenue potential. Founders can use TAM to set ambitious (yet reachable) financial targets. TAM also gives founders more leverage when negotiating with investors. 
  1. Employees need a reason to stay motivated. Founders should show their team the size of the market opportunity and the research and reasoning that’s gone into those figures. Make your revenue goals realistic — instead of plucking them out of thin air and hoping for the best. Alongside a TAM calculation, you need a clear fix on your startup’s SAM and SOM; both will further reinforce and influence your revenue goals, outreach activities, and sales and marketing strategies. 

Why do investors need to understand a startup’s TAM?

Investors are vital stakeholders for startups. They provide founders with the funding and support they need to grow from pre-revenue to exit. 

  • Calculating your TAM shows that you’ve done your homework. Your numbers demonstrate that your revenue projections and growth targets are influenced by data-driven reasoning rather than wishful thinking.
  • Knowing your TAM proves that you understand your ideal customer profile (ICP) and their lifetime value (CLTV). 
  • TAM calculations give investors an idea of the potential return on investment your startup could generate for them — when growth is large enough to consider an exit event. 
  • TAM plays a role at the exit stage when you have a clear, proven indicator of your company’s financial health and value.
  • TAM is a useful calculation for entrepreneurs because it shows how much larger a business could grow with the right resources behind it. 

Now, let’s cover three ways to calculate your startup’s total addressable market (TAM). 

3 ways to calculate your total addressable market (TAM)

1. Top-down market size calculation 

A top-down approach uses publicly available data to which you apply demographic, geographic, revenue, and other relevant filters to produce an accurate TAM calculation. 

This data is easy to come by — generally through market research firms like Gartner and Forrester or government agencies including the U.S. Small Business Administration (SBA). 

Here’s an example: 

Imagine you’re a software startup with a product designed for accountants. Let’s say there are 10,000 accountancy firms in the US, but only 35% of those are large enough and have the budget to afford your software and services at the intended price point: 

10,000 x 35% = 3,500 potential customers. 

Because this information comes from third-party, public sources, it may not be as accurate as other methods of data collection. It also doesn’t account for competitors, price sensitivities, or disruptive competitors that might have greater funding.

2. Bottom-up market size calculation

A bottom-up approach is the reverse of the top-down process outlined above. 

Unlike the top-down method, a bottom-up approach is typically more accurate because it involves in-house primary research. Bottom-up calculations are effective when you already have customers and can extrapolate from a small subset of data to estimate the TAM. 

Let’s return to the previous example: 

You have 100 customers and the annual contract value is $5,000. This means you’re generating $500,000 in annual recurring revenue (ARR). 

Based on primary research, such as speaking to customers, you know there are actually 5,000 accountants who would benefit from your software and could afford to pay (as more research shows the top-down approach underestimates the market size). 

Now the TAM is: 

5,000 x $5,000 = $25,000,000 in total potential revenue (if 100% of market share is achieved). 

A bottom-up TAM calculation is calculated as follows:

Total Number of Potential Accounts X Annual Contract Value = TAM. 

3. Value-theory market size calculation

The value-theory approach estimates the TAM based on what customers are willing to pay. What you charge depends on the value your product or service creates for a business. 

For example, if your product produces $100,000 worth of annual savings for clients, it’s not unreasonable to charge $10,000 a year for it (refer to the SaaS business that sells its software to US accountants). 

Once you understand this, you can apply a top-down approach to calculate the number of potential customers and the total addressable market.

This method is especially useful for a business with unique products. Those products could be used to create a whole new market (e.g. HubSpot, Canva) or to reshape an old market. 

Key takeaways

As you’ve seen, understanding your total addressable market (TAM) is a powerful data-backed model used to demonstrate the potential size of the market(s) you are targeting.

Investors, stakeholders, employees, and potential buyers need to know this figure — and the research behind it. 

The three ways to calculate TAM: 

  1. Top-down: using public sources and filtering this information through demographic, geographic, revenue, and market-cap based data points. 
  2. Bottom-up: using in-house research; especially when you have customers and can extrapolate this data to produce larger, more accurate market estimates. 
  3. Value theory: working out the value your product/service generates, what you can charge, and the number of potential customers willing to pay. 

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Dom Wells

Dominic Wells is the CEO and Founder of Onfolio. Dom is responsible for developing and implementing Onfolio’s long term business strategy. He is a serial entrepreneur with more than a decade of experience investing in and building digital businesses. Dom has grown Onfolio from a startup to a NASDAQ listed company. For Onfolio’s investors, Dom has built a diverse and profitable portfolio of online businesses that deliver consistent returns. Dom is passionate about entrepreneurship and regularly speaks on digital business strategy, online business investment and profitable growth opportunities. For Dom, diversification and exceptional talent are the keys to sustainable growth.

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