- Total addressable market, or TAM, is the total market for your product or service: the revenue you’d generate if you achieved 100% market share.
- Business owners can choose from three options for calculating their business's TAM: the top-down TAM calculation, the bottom-up TAM calculation and the value theory TAM calculation.
- Business owners can use their TAM for other financial calculations and projections, as well as to make decisions about their business.
Total addressable market (TAM), sometimes referred to as the "total available market," is the total revenue you could generate from the sales of your product if 100% market share were achieved. In other words, it refers to the amount of money a business would make if it achieved total market saturation and represents the ideal revenue that would be generated if the market were cleared of all competitors.
Understanding TAM is important for business owners when they're making financial projections about the profitability of their business. This guide will outline why business owners should calculate their TAM, as well as the benefits that can stem from understanding that calculation.
Why calculate total addressable market?
Calculating your business's TAM is an important step in your decision-making process regarding your business model and is a core aspect of a well-rounded business plan.
Because TAM outlines how much revenue you could generate under ideal conditions — when you have 100% market share and no competitors — it simulates a “best-case” scenario that may help business owners make key decisions.
Understanding TAM can help business owners:
- Identify business potential and revenue opportunities, so business owners can gauge whether their product or service could become successful.
- Prioritize certain business opportunities and/or goals with the highest potential for growth.
- Determine the effort and funding needed to achieve optimal market share.
How to calculate total addressable market
The three common ways to calculate a business's TAM each offer benefits and drawbacks.
Top-down TAM calculation
The top-down TAM calculation utilizes market research conducted by third parties, with added refinements and adjustments as needed to adapt the research to a specific market.
While this method offers some advantages — for example, it may be less labor-intensive for the business owner than conducting market research from scratch — the resultant TAM may be less accurate. What’s more, a top-down TAM calculation may not take into account the unique ways your business might change the market, for example, by disrupting or replacing an existing service.
Business owners seeking financing and investors may find they need to conduct additional research to calculate a TAM that investors find reliable.
Bottom-up TAM calculation
A bottom-up TAM calculation is based on a business’s current pricing and usage data. Business owners conduct research to determine their total target base market size and then extrapolate their TAM based on their current sales data using the following formula:
TAM = (annual revenue per customer/contract) x (number of total possible customers/contracts).
This approach yields more accurate results than the top-down approach, because it utilizes the business’s own data and allows the business owner to account for any factors that might affect its success. It also provides an opportunity for the business owner to analyze and get to know their target market in-depth, allowing them to make more informed business decisions. While this method is the most research-intensive, when done well, it often yields the most useful results.
Value theory TAM calculation
A value theory TAM calculation utilizes informed estimates to calculate TAM. The business owner estimates how much value their product or service brings to customers and then compares and contrasts that value with the price.
By considering how much customers may be willing to pay for a product or service — or how much more they’d be willing to pay for X feature or Y premium service — then comparing that figure to the actual price, business owners gain a sense of the viability of their business model.
What to do with your total addressable market calculation
After determining your TAM, you may wish to conduct additional assessments, based on the calculation approach used.
Business owners who used the top-down approach, for example, will likely want to conduct additional research that is refined and more specific to their business endeavors. Additional research might include hiring consultants to conduct surveys or market analysis to obtain the most accurate TAM possible.
Those who opted for the bottom-up approach may want to delve deeper into their calculation. For example, business owners might calculate TAM for certain demographics, niche markets and other market segments.
Business owners who utilized the value theory approach may want to conduct additional market research to assess how their product or service’s value compares to that of their competitors, and whether there is customer demand for added value.
Finally, business owners may use the TAM calculation for their business to create financial forecasts, estimate their business’s value or make other key decisions about their business’s future.
Grow your knowledge, grow your business
Understanding key business practices can facilitate business growth and success. The TAM calculation can help you assess the viability of a product or service, as well as help you create financial forecasts and play a role in your ability to attract investors.
Determining a useful TAM calculation can also be helpful in benchmarking the business’s performance so the business owner has a gauge for how effectively they are penetrating the target market.
Finding trusted resources, such as financial professionals, can help you understand business calculations and make more informed decisions about the future of your business.