TAM

• Total Addressable Market (TAM)

  • Overview

    • Total Addressable Market is the revenue a product or service would earn in a year if it reached every customer who could buy it. It is a ceiling, and it answers the question an investor asks about a business before any other: if this works completely, how big can it get?
    • A venture fund needs a few of its companies to return the whole fund, and no company can do that inside a market too small to hold the outcome, however well it executes. TAM is the first filter a pitch passes through.

  • Context

    • TAM sits at the top of a funnel with two narrower estimates (Total addressable market, Wikipedia):
      • Serviceable Available Market (SAM) — the part of TAM a company's product and distribution can reach today: its geographies, segments and channels.
      • Serviceable Obtainable Market (SOM) — the share of SAM the company can win against competitors within a planning horizon. It is a forecast of market share, and the only one of the three that is a revenue plan.
    • The TAM, SAM and SOM slide is a fixture of the pitch deck, and YC and most seed investors ask founders to show how the figure was built.

  • Mechanism

    • Top-down starts from an industry total in an analyst report and carves out the segment the product serves. It is fast and easy to inflate, since each cut is a judgment call and the starting figure was counted for some other purpose.
    • Bottom-up counts the customers who could buy and multiplies by what each would pay in a year. It is slower and more defensible, because each factor can be checked: how many businesses of this type exist, and what a comparable product charges them.
    • Value theory asks what the product is worth to the buyer and what share of that value the seller can capture. It is the method that works when the product creates a market that did not exist before.

  • Key principles

    • TAM is a ceiling. The revenue plan lives in SOM.
    • Bottom-up figures earn trust. An investor shown a top-down TAM assumes it was inflated.
    • A product can change its own market. Measuring the addressable market for a new kind of product with the old product's figures misses the demand the new product creates.

  • The Uber debate, 2014

    • In June 2014 Aswath Damodaran valued Uber at about $6 billion, against a funding round that had just priced it at $17 billion. He took the worldwide taxi and limousine market, about $100 billion, as Uber's TAM and gave Uber a tenth of it (A Disruptive Cab Ride to Riches: The Uber Payoff).
    • Bill Gurley, an Uber board member, answered that the taxi market measured demand under the old product's constraints. A cheaper, faster and more reliable ride expands the market: people take rides they would never have hailed a cab for, and some give up owning a car. He argued the potential market could be 25 times Damodaran's figure (How to Miss By a Mile: An Alternative Look at Uber's Potential Market Size).
    • The exchange is the standard example of a product changing its own market. Whether a TAM is a fact about the world or a claim about what the product will do to the world depends on how new the product is.

  • Misconceptions

    • A big TAM makes a good business. Large markets attract many entrants, and a share of a huge market is worth little when everyone is fighting for it. Bradford Cornell and Aswath Damodaran call this the big market delusion.
    • "We only need one percent of the market." A share is a claim about winning, and a top-down TAM says nothing about how the share would be won.