To understand the potential of a project we have to analyze a single key variable, the market size.
Now, this is extremely important when it comes to investors.
Consider that the average VC (venture capitalist) firm speaks to around 1,200 companies before narrowing it down to a list of 10 – just 1% of their initial outreach.
How do they narrow down their choice from the thousands of great ideas they come across? It’s impossible to invest in them all, right?
They do so by looking at the potential upside a startup has. Is it likely to be confined to a smaller, local market? Or is there substantial evidence indicating they could go global?
Similarly, both VCs and angel investors are looking to de-risk their investment. They also want to know the minimum investment capital needed to discover whether or not this product has a good market fit.
So how do they do this?
Typically by assessing the TAM, SAM, and SOM. In this post, we are going to analyze and explain each of these concepts and how they can help you to secure funding for your new venture.
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What is TAM SAM SOM?
When thinking about TAM, SAM, and SOM, try to view them as total potential market, attainable market, and share of the market.
TAM – Total Addressable Market or Total Available Market
TAM (Total Addressable Market) is the total possible market for your company’s product or service.
It’s a great tool for investors as it allows them to estimate the maximum possible revenue a startup could generate in a given market and its potential scalability.
As TAM is a snapshot of the entire market’s potential, it’s almost impossible to expect a company to capture this figure. It would mean you were the only provider of this product or service (in the world) with zero competition.
You’d have to execute the perfect Blue Ocean Strategy to achieve TAM…
SAM – Serviceable Addressable Market
SAM (Serviceable Addressable Market) is the sub-market formed from the various geographical, regulatory, or pricing/quality market differences within a TAM.
It represents the proportion of the market you are potentially able to capture with your current product/service, business model, and sales and distribution channels.
SOM – Serviceable Obtainable Market
The SOM (Serviceable Obtainable Market) is the sub-sector of the market niche (SAM) that you are realistically able to target given the limitations of resources, presence of competition, and level of market awareness.
As a start-up, it’s highly unlikely you’ll be able to penetrate the entire market from the get-go, so a SOM serves a short-term goal – a yardstick which potential investors can use to monitor your company’s progress.
How to Calculate TAM, SAM, and SOM
To calculate the TAM, SAM, and SOM, there are two options for making your estimation:
A top-down estimate looks at larger, macro-economic trends within a market to narrow-down and determines what percentage a company could capture.
To do so, founders rely on outside market reports from industry analysts to make their estimations.
Areas of analysis would include customer trends, demographic data, the evolution of GDP, trade balance, prices of raw materials, surveys, industrial activity, energy consumption, etc. A typical top-down review would:
- Analyze the international market as a whole
- Analyze national economies
- Analyze each sub-sector of the national market
- Analyze all potential competitors within those sub-sectors
Using this data, an attempt is made to guess how much a company can carve out the TAM, SAM, and SOM pie.
As the name suggests, this estimation attempt is the complete reverse process from what we just looked at.
A bottom-up analysis starts with the core business figures (number of clients, amount of product sold, average price point) and uses this data to make assumptions about the larger market as a whole.
The formula is extremely simple:
For example, imagine you’ve founded a craft brewery. You sell your three different types of beer (an IPA, Stout, and traditional Pilsner) at an average of $700 a barrel to vendors.
Last year your 5 vendors bought 40 barrels between them, taking your annual revenue to $28,000.
Looking at the market, there are around 6000 vendors across the entire country. You could therefore calculate your TAM as:
6000/5 = 1200 (to calculate the overall number of vendors to potentially purchase 5 barrels annually)
1200 x $28,000 = $33,600,000
Unlike the top-down approach, this process analyzes tangible data from products or services currently being sold in the market and is therefore considered a more accurate depiction of market potential.
However, when presenting this data to investors it might be worthwhile to use both market size estimation methods. You could present them individually first, detailing the data used, and how you arrived at your conclusions, and then together as a median average.
This serves two purposes:
- It shows potential investors you’ve done your research, and documents how you arrived at your market assumptions
- It serves as a sort of ‘checks and balances’ against your results. If you find they differ markedly from one another, then perhaps you need to go back and reevaluate the data sets used.
TAM SAM SOM Examples
Now that we understand what TAM, SAM, and SOM are and the different methods available to us for calculating our market estimations, let’s have a look at a couple of different examples.
Local city restaurant business
A brand new Italian Pizza restaurant opens up in a bustling, up-and-coming neighborhood. The total average annual revenue from all restaurants (not just pizzerias) in the entire city is $500m.
This would represent the pizza restaurant’s TAM. Technically you could argue for extending TAM for the entire state however, it’s far more likely TAM is restricted to the city’s population
Out of this $500m, Italian restaurants accrue roughly 25% of the market revenue ($125m) This figure represents the SAM.
Now, there are 200 different Italian restaurants within the city. This would make the average SOM around $625,000.
However, this new Italian pizzeria is located in a bustling neighborhood in an affluent part of the city. Therefore the owner predicts that the restaurant could potentially earn around 3x the average SOM, at around $1,875,000.
Therefore, the TAM, SAM, SOM would look as follows:
This time we’re going to take a look at a mobile CRM application.
Now the global CRM industry is worth an estimated $60bn. As a SaaS company, the founders are less confined by geographic constraints and could theoretically reach a large proportion of this market.
So this will be their TAM.
The global mobile CRM industry (their particular niche) is estimated to be worth around $15bn.
This particular mobile CRM application is aimed at companies with around 40-50 field sales reps. If companies employ more than 50 field reps, then it’s likely their needs will be better served by a more complete, integrated, 360-degree business software platform.
If they employ less than 40 field reps, then their sales managers are unlikely to reap the full benefits of the system’s analytics and tracking features. Their needs could probably be catered for by a simple Excel or Google Sheet set up.
Now the number of companies that employ between 40-50 field reps represents about 5% of the overall SAM.
This leaves the founders with a SOM of $750m.
The concept of total addressable market is important for startups and existing businesses. It gives them an idea of the effort and funding required to make the venture work, helping them to prioritize specific products, customer segments, and business opportunities.
Where there are potential investors and buyers of the business, company executives can use TAM to provide a viable value proposition.