Whether you’re looking to assess profit potential for a company pre-acquisition, evaluate group buy-in opportunities, or potentially expand your existing business—measuring total addressable market (TAM) can be a useful first step.
TAM identifies revenue potential and demand, and it can help determine a company's growth strategy. In this article, we’ll cover what TAM is and how to calculate it.
What is total addressable market?
Total addressable market is the result of 1) identifying all potential customers and 2) the possible revenue if your business served every one of those customers—assuming there was no competition.
Your portion of the TAM—also known as the serviceable obtainable market (SOM)—is your market share. Typically, the TAM is split among competitors. In markets where there are many competing businesses, a given company’s market share may be small. Meanwhile, greater market share can lead to scalability and increased profitability.
How to calculate the TAM
There are various ways to arrive at the TAM. We’ll focus on a top-down approach that identifies a large group of customers and then narrows it down to a smaller target audience. To use this method, you’ll need information from industry reports as well as statistics.
The formula is simple:
Identifying the number of potential customers may require significant research. This can be challenging—yet it is important to the formula and arriving at the most accurate estimate.
Essentially, you can determine the TAM by following these three steps:
Establish the larger audience that you’ll be looking into before narrowing it down into a more specific segment.
Find your ideal customers. Determine what percentage of your broad audience would be interested in your product or service. You want to try to identify the most specific audience possible.
Now multiply the number of potential customers by the average revenue per customer to get to the TAM.
Exploring a use case to illustrate TAM
Now, let’s examine a scenario where the TAM formula may be applied (Note: the figures used in this section are based on assumptions and are intended to illustrate an example only).
Assume there's a medical spa in a city with a population of 320,000 residents. This medical spa’s clients consist mostly of women between the ages of 35 and 55.
There are 90,000 women between the ages of 35 and 55 in the area.
The average medical spa treatment is $600, and the frequency of service is 2x per year. Therefore, the average revenue per customer is $1,200 per year.
Now let’s apply the formula:
Remember that the medical spa must acknowledge their competition. With two other spas in the community, a TAM of $108MM will be shared with these other providers.
While TAM can help you formulate your business strategy, it should only be one of multiple resources in your toolkit. For the purpose of business expansion, for example, you should also consider these other factors:
Profitability—It’s important to take time to determine whether expansion will positively impact your business’ bottom line and whether that impact will be substantial.
The wants and needs of potential clients—Taking a look at your current offerings, you must evaluate how well they’ll serve your target audience.
Your competition—It’s common to have various competing businesses in your market. Be sure to consider how your business can or should differentiate itself from these other companies in order to secure an edge with your client base.
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