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What is TAM and how do you calculate it?

October 31, 2022
What is TAM and how do you calculate it?

Starting a business involves more than just coming up with an idea and selling a product or service. Considering things like financials, operations, and your target market are all necessary parts of the planning process. Most importantly, however, you have to think about how your business will evolve over a period of time. But what is the best way to do this?

Total addressable market (TAM) is a metric that provides useful data on the potential growth of your business. In calculating TAM, owners gain critical insights into business value and future performance. It also helps inform things such as future marketing efforts, fiscal decision-making, and personnel placement. More importantly, TAM may partly inform your tailored positioning in the market if you are looking to sell. Total addressable market accounts for the unique drivers that help a buyer recognize your business’ value. 

What is the Total Addressable Market? 

TAM projects your business’ financial viability and indicates the overall demand for what you are selling or providing by providing an in-depth analysis of your potential customer reach. Because no business starts with an absolute prediction of how well it will do, TAM gives you a better idea of what the future could look like. 

Before you can calculate TAM, it’s important to define it. Here are some questions to help narrow down the scope:

1. Who is your target audience? What are their demographics, preferences, needs, and wants? 

2. What do the historical trends look like for your product or service? 

3. What do your potential competitors look like? What are their marketing strategies, target markets, and other business practices? 

4. Are there new companies emerging in the market? At what rate does the market experience growth? 

How do you calculate TAM? 

Evaluating your business’ market value can be a challenge, given all the values, tangible and intangible, that need to be considered when selling your business. Calculating TAM follows three different frameworks: top-down, bottom-up, and value theory. Any of the three approaches allows potential investors or other key stakeholders to understand the value of your business. 

Top-Down TAM 

The top-down approach starts by looking at the big picture. The methodology turns directly to market research to calculate your total addressable market. The top-down approach requires an understanding of the macro-economy, as it analyzes the entirety of the market to determine where your business fits amongst your competition. Once the market as a whole is analyzed, the top-down approach narrows your scope to evaluate your business niche to a section of the market you can realistically target. 

By thinking big, you will gather more information about how your idea will compete against various other companies – including compatible products. For example, you buy your gas from a different company than your car manufacturer. One cannot function without the other, so their marketing strategies and target audiences may overlap. Including this in your analysis can give you a better view of how your product or service meshes with other industries. 

The pros to top-down TAM: 

1. The data you are collecting and analyzing is typically readily available, making it the best option if you are looking to get a quick baseline for your addressable market.

2. This approach works well for large, established markets where there is already plenty of data available.

Bottom-Up TAM

The bottom-up method is significantly more granular. You’ll consider several factors: geography, channels, market segments, value proposition, and product mix. With this approach, you will work to find waypoints that are extrapolated up to the whole population. Three steps are required for this methodology. First, you must identify your ideal customer profile. Narrow this down as specific as possible. Next, figure out how many customers will fit this profile. Finally, multiply the total number of potential customers by your average price per product/service. 

The pros to bottom-up TAM:

1. This approach is typically more accurate, as it is based on a proven, singular data point which is magnified to determine the whole TAM population.

2. It’s especially useful for new markets and markets where your product is likely to make a disruptive impact.

Value Theory

A value theory TAM analysis provides a more speculative look at the future growth of a business because it is based on projections rather than actual pricing. An estimated value is created based on what you think your potential customers will be attracted to and their budget. Similar to a top-down and bottom-up approach, the amount of potential customers that may purchase the product is also factored into the calculation.

Why is it important to care about TAM? 

While TAM reveals the revenue opportunity, it also has several other advantages. First, as a business owner, TAM can help you forge an informed roadmap for future products and pathways. Next, in performing a TAM exercise, business owners develop a better understanding of their market and the potential of their competition. In addition, a well-investigated TAM can help inform your marketing strategy and decisions. 

Moreover, TAM allows business owners to demonstrate their company’s potential to investors and potential buyers. It allows your M&A advisors to tailor the position of your company when they bring it to potential buyers. When the business is positioned for what’s in it for a specific buyer, they start to focus on their own need versus yours, resulting in a sound and rational argument for them to pay a premium. These value drivers need to grab the buyer’s attention, without being too obvious. TAM can demonstrate the potential return and insight into potential market growth later down the road. In other words, an accurate TAM calculation equips your M&A advisors with the data they need to position your potential value to buyers. 

How Persient Can Help

If you are looking for a San Diego investment banking firm, Persient San Diego is here to help. With our services, you can project the success of a business for yourself and potential buyers. Schedule an initial conversation about selling your business and what it takes to get top value

Investment banking services and securities offered through Independent Investment Bankers Corp., a registered broker-dealer, Member FINRA / SIPC. Persient LLC and Independent Investment Bankers Corp. are not affiliated entities. FINRA Broker Check.

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