Source: How to calculate your TAM
Further Reading: 8 successful startups early TAM decks
In investing, thinking about the TAM (Total Addressable Market) of the company is important to understand the growth options for the company. Founders/management teams who provide a well thought of TAM display how they think about the market they are serving, the extent of their product-market fit, and their product roadmap to capture the TAM.
Now, there are three distinct ways to calculate TAM:
- Top-down, using industry research and reports
- This is by far the most common but also the least useful
- The approach relies on accepting the TAM numbers from industry reports without factoring in how the company’s products cater to the market
- Another problem with this approach is that it does not incorporate how a product can shrink/expand the market. Think Uber
- Bottom-up, using data from existing users/customers
- This is a better approach as it helps the investors understand the current customers/users and prospective users/customers
- This would then help tie down the product roadmap with addressing the potential market
- Value theory, using conjecture about buyer willingness to pay
- This approach is like a dark art because it is less objective and more subjective
- The important word here is conjecture, because we are guessing on three elements;
- How much value the product creates for the customers/users
- How much are they willing to pay for the value
- How much of the value creation will accrue to the company
Of course, TAMs and plans change in the real world BUT having a well thought through TAM is helpful in guiding the decisions.