Let's talk about TAM - Total Addressable Market. In recent years acronyms like SAM and SOM have been added to the list, making for alphabet soup, when all we really want to know is, how big could this startup be? But before I jump into calculation specifics, what does TAM (market size) really mean for your startup, and why is it what I would call a "goldilocks" variable?
I've always thought about TAM this way: take all the potential customers of your product, and multiply that count by a long-term price they might reasonably pay. With US-based technology startups, I generally use the entire US as the market area. Some companies might reasonably include international markets, if the same product can be sold (using the same go-to-market approach) with global customers paying a similar price.
How to think about TAM and market size
- For most startups, there are different product variations you could sell to different adjacent markets. Each has its own TAM, because early on you can realistically only chase one of them! Founders like to make pitch decks summing together all the different potential audiences and revenues, when the reality is, you should use this exercise to help choose a starting point for going to market.
- Think of market size as a fundamental ceiling to growth. If you are selling edtech to high school seniors, it's helpful to know that there are almost 4M US high school seniors each year. If you are selling to gas station owners, it's helpful to know there are roughly 145,000 gas stations in the US.
- Consider also the growth of your market. Continuing the prior examples, it's helpful to know that the number of high school seniors and number of gas stations are both shrinking in the US. This is not rocket science - your friend google can help (or maybe your friend ChatGPT can hallucinate you a better answer lol).
- In most markets, success for your startup means capturing a single digit percentage of the total audience. Success is not delivered by the market, but it can be taken away. An early potential audience for HiddenLevers was online brokers - but there are so few, how could we possibly scale in such a market?
- Price is a fundamental aspect of TAM analysis. Too many startups are fixated on growing to X scale, and then charging a real price for their product. This approach implies the need for an endless fountain of funding to get there - what about earning revenue along the way? Use a price (or revenue metric) that is realistic for your audience, or you're just lying to yourself.
Assume you can win 1% of your audience. If you do, does the revenue create a business worth having?
Done right, TAM analysis can effectively predict your long term prospects
At HiddenLevers, I did an early TAM analysis which influenced our strategic direction, and which proved surprisingly accurate in hindsight. Here's what I came up with:
- There are almost 400k individuals that claim the title of financial advisor in the US, but only about half of them make a living giving financial advice.
- HiddenLevers' original core product could support a price of perhaps $1000-1500/year per advisor. 200k advisors * $1000 = $200M TAM for the core product.
- Using the 1% rule, we figured there was just barely a meaningful business here, so we forged ahead. But a TAM below $1B really isn't healthy for a venture backed startup, so we focused on bootstrapping.
In the end, we captured several percent of our market, enough to create a healthy and profitable business en route to exit. And the $200M TAM of our core market fit solidly within the Goldilocks range described below.
The Goldilocks TAM and Bottom-Up Analysis
At one extreme you have (realistic) market TAMs over $10B - everyone wants this right? At the other extreme you have market TAMs sub 100M. Here's why the Goldilocks TAMs are somewhere in between:
- If the potential market is smaller than $100M per year, then capturing 1% of that leaves you with less than seven figures of revenue, too little to build more than a tiny small business, and too little to be a stepping stone to a next level. It goes without saying that you won't find investors for such a small niche.
- At the other extreme, over $10B, you're diving straight into the ocean with huge existing players and likely major-VC backed startups to boot. There can be so many competitors in these large markets that it's hard to differentiate. Do you have defensible IP? Even then you will find it difficult to get anyone's attention.
- The Goldilocks markets are in between. Between $100m and $1B you will find fertile ground for bootstrapping. VCs don't generally like to invest in markets this small, and there tends to be less noise here. Above $1B and below $10B is busy, but still too small to attract the attention of tech megacaps - Apple/Microsoft/Google/etc simply won't bother.
- A good market has to pass another test - the bottom-up test. Let's assume that attaining 1% of your target market can build a sustainable business. How many customers is that, and how realistic is it to go from 0 to that number? For that matter, how many customers are needed (price is important here) to get to MVR? Ideally you've got a Goldilocks situation where there's enough TAM, but not an overwhelming crowd of competition, and it's realistic to acquire enough customers to progress toward the 1% market share goal.
Don't use TAM analysis to tell VCs a story - use it to eliminate bad choices!
Here's my original TAM analysis from the early days at HiddenLevers. It enabled us to put blinders on and focus on our one core market, investment advisors, until we got real traction. I'm hoping this approach can help you do the same!
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