How to calculate Total Addressable Market (TAM) - Startups 101

Summary

This video discusses the common pitfalls startups face when calculating their Total Addressable Market (TAM). Steve Barse, a managing partner at Dream Adventures, emphasizes the importance of a bottom-up approach over the flawed top-down method. He highlights the need to accurately identify target customers and pricing, and to avoid using the size of the problem or the entire market as a proxy for TAM. Barse provides real-world examples to illustrate the correct way to calculate TAM, stressing the importance of documenting assumptions and using precise figures to avoid unrealistic market size estimations.

Takeaways

• 📝 TAM (Total Addressable Market) is the total market demand for a product or service, encompassing all potential revenue.
• 📉 Avoid top-down TAM calculations; they are often unrealistic. Use a bottom-up approach instead.
• ⚠️ Common mistakes include confusing the size of the problem with the TAM and using competitors' pricing without adjusting for your own pricing.
• 🔢 TAM calculation should be based on the number of target customers multiplied by your accurate price.
• 🌍 Clearly define the geographical regions when calculating the number of target customers.
• 💵 Ensure your pricing is accurate and based on tested and validated assumptions, not just competitors' prices.
• 📊 Document and show your work in TAM calculations, including assumptions and sources of data.
• 🔍 Narrow down your target market to specific segments to get a realistic TAM.
• 🎯 Investors often look for a minimum billion-dollar market to ensure sufficient room for growth and profitability.
• 🔄 The TAM calculation model works across various industries, including B2B, B2C, e-commerce, and social networks.

Q & A

What is TAM and how is it defined?

TAM, or Total Addressable Market, is the total market demand for a product or service, representing all revenue opportunities available.

Why should startups avoid a top-down approach when estimating TAM?

Startups should avoid a top-down approach because it often leads to unrealistic estimations by assuming a small percentage of a large market. Instead, a bottom-up approach, which documents assumptions and shows how the TAM comes together, is recommended.

What is the main mistake health tech companies make when calculating TAM?

Health tech companies often mistake the size of the problem (e.g., the opioid crisis) for their TAM. The size of the problem does not equate to the market size for their specific product or service.

What is a more accurate method for calculating TAM?

An accurate method for calculating TAM involves multiplying the number of target customers by the price of the product or service, ensuring both figures are realistic and well-documented.

How should a startup document their assumptions when presenting TAM calculations?

Startups should document their assumptions by providing footnotes on their slides, detailing where the number of customers and pricing data come from. This transparency helps validate the TAM calculation.

What factors should be considered when determining the number of target customers?

Factors include the specific market (e.g., US, Europe, global), the customer profile (e.g., small banks without a chief information security officer), and the geographical regions targeted.

Why is accurate pricing crucial in TAM calculations?

Accurate pricing is crucial because using incorrect pricing can significantly skew the TAM. Pricing should be based on tested and validated data, not assumptions or competitor prices.

What example illustrates a common mistake startups make with pricing in TAM calculations?

An example is a startup using a competitor's price of $5,000 per customer per month when they plan to charge only $500. This results in a TAM that is ten times larger than it should be.

What does the term 'narrowing of the TAM funnel' refer to?

Narrowing the TAM funnel refers to starting with a broad market size and refining it by focusing on specific target customers, geographical regions, and realistic pricing to determine the actual market size.

What minimum market size do venture capital investors typically look for in a startup's TAM?

Venture capital investors typically look for a minimum market size of one billion dollars. This ensures that the market is large enough to support substantial growth and returns on investment.

Outlines

00:00

📊 Calculating Market Size: Avoiding Common Pitfalls

This paragraph introduces the topic of market size estimation, emphasizing the importance of a bottom-up approach rather than a top-down one. It discusses the difference between TAM (Total Addressable Market) and SAM (Service Addressable Market), with a focus on TAM. The speaker, Steve Barse, highlights common mistakes startups make, such as equating market size with the size of the problem or the entire market, rather than the segment they target. Examples are provided to illustrate these points, and the importance of accurate pricing and customer base in calculating TAM is stressed.

05:01

📝 Documenting Assumptions in Market Size Estimation

The second paragraph delves into the necessity of documenting assumptions when calculating TAM, using a product like Slidebean for presentation. It emphasizes the need to show the work behind the numbers, with footnotes explaining the source of customer numbers and pricing. The paragraph provides a real-world example of a cybersecurity company to demonstrate how to narrow down the market focus to a more realistic TAM, adjusting for the specific target customers and accurate pricing. The example illustrates the process of refining the market size from a broad perspective to a more precise and realistic calculation.

10:02

🤑 The Importance of Accurate Pricing and Customer Identification in TAM

This paragraph continues the discussion on TAM, focusing on the critical nature of accurate pricing and identifying the true target customers. It points out that many startups fail to correctly estimate the number of customers and pricing, leading to unrealistic TAM calculations. The speaker uses the example of Slidebean to illustrate how a company should identify its target market and price its offerings accurately. The paragraph also touches on the expectations of venture capital investors, who typically seek companies entering billion-dollar markets, ensuring there is ample room for growth and revenue potential.

Keywords

💡Total Addressable Market (TAM)

TAM represents the total market demand for a product or service, calculated as the total revenue opportunity available if a product or service were to achieve 100% market share. It is a core concept in the video as it outlines the importance of accurately estimating market size for startups. For example, the video discusses how TAM should be calculated from a bottom-up approach, rather than a top-down one, to avoid overestimation.

💡Bottom-Up Approach

The bottom-up approach involves estimating the total addressable market by calculating the potential sales based on the number of possible customers and the price they would pay. The video emphasizes this method over the top-down approach, showing its importance in creating realistic market estimates. It provides an example of calculating TAM by determining the number of small and medium-sized banks needing cybersecurity solutions and multiplying it by the expected revenue per bank.

💡Top-Down Approach

The top-down approach estimates market size by starting with a broad industry figure and narrowing it down to a specific segment. The video advises against this method for calculating TAM, as it can lead to unrealistic estimates, illustrated by the example of assuming capturing 1% of a multi-billion-dollar market without considering specific market dynamics and competition.

💡Serviceable Addressable Market (SAM)

SAM is a subset of TAM that represents the segment of the market targeted by a company's products or services within a certain area or demographic. Although the video mentions SAM, it focuses on TAM, highlighting that while SAM is important, many startups misinterpret it by assuming they can capture a large portion of the overall market without a clear strategy.

💡Pricing

Pricing is a critical component of TAM calculation, referring to the amount a customer is willing to pay for a product or service. The video stresses the importance of using accurate and tested pricing in TAM calculations, giving an example of a startup incorrectly using a competitor's higher price, leading to an inflated market size estimation.

💡Assumptions

Assumptions are the underlying premises that form the basis of TAM calculations, such as the number of potential customers and pricing. The video underscores the necessity of documenting and justifying these assumptions to avoid unrealistic market size estimates. It recommends footnoting assumptions in presentations to show transparency and reliability in the TAM calculation process.

💡Geography

Geography refers to the regional focus of the market being addressed. The video illustrates how geographical considerations impact TAM calculations, using the example of a cybersecurity startup focusing on banks in North America, South America, and Europe, but not including Asia or Africa due to limited data.

💡Market Size

Market size is the total potential sales or revenue available in a particular market. The video clarifies that market size should reflect the specific segment a startup can realistically capture, not the entire industry size, by using the example of the cybersecurity market being a $250 billion industry but narrowing down to realistic targets.

💡Go-to-Market Strategy

Go-to-market strategy outlines how a company plans to sell its product or service to its target customers. The video connects this strategy to TAM by explaining that understanding and refining the target customer and geographical focus helps create a more accurate market size estimation. It highlights the importance of aligning the go-to-market strategy with realistic customer segments and pricing.

💡Documentation

Documentation involves recording the sources and methods used to calculate TAM. The video advocates for thorough documentation of assumptions, data sources, and calculation methods to enhance credibility and transparency, comparing it to showing work in math class to ensure clarity and correctness.

Highlights

Introduction to calculating market size with insights from Steve Barse of Dream Adventures.

Explanation of TAM (Total Addressable Market) as the total market demand for a product or service.

SAM (Service Addressable Market) is a segment of TAM targeted by your products or services in a specific area.

Common mistake: using a top-down approach to estimate TAM instead of a bottom-up approach.

TAM is not the size of the problem or the size of the entire market; it's the size of your market.

Important to document assumptions and show how TAM is calculated using a bottom-up approach.

TAM calculation involves the number of customers times the price of your product or service.

Ensure pricing is accurate and tested; do not use competitors' prices if they differ from yours.

Document assumptions and sources of data used in TAM calculations on your presentation slides.

Example of calculating TAM for a cybersecurity company by narrowing down to specific target customers.

Importance of considering the geographical focus when calculating the number of customers for TAM.

Pricing should be based on accurate, tested values and specific units of measure.

Investors often look for companies entering a billion-dollar market to ensure sufficient growth potential.

Same TAM calculation model can be applied across various industries and business models.

Final reminder: TAM should reflect your specific target market, not just the overall industry size.

Transcripts

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/youtube one of the most common

questions we get is how to calculate a

market size slide after so many years of

this I believe I can come up with a

decent market size estimation certainly

much better than it used to but in order

to explain this in the best possible way

we've invited Steve Barse one of the

managing partners at dream adventures

and also an angel investor to tell us

all about it

hi let's start with some basic

definitions so what's Tam or total

addressable market what is it it's the

total market demand meaning all revenue

for a product or a service now sometimes

people also talk about Sam which is the

service addressable market which is the

segment of the Tam targeted by your

products or services within a certain

area like a geographic region now I'm

not a big fan of things like Sam and

Psalm so in this episode we're just

gonna focus on Tam we'll talk a little

bit about how go to market strategy can

impact Tam but we're gonna focus on Tam

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so what's the first big mistake that we

see startup after startup make about tam

and that is they take a top-down

approach they say it's a huge market and

if I just get 1% of the market

its enormous and all right so to that is

no absolutely not

you cannot do a top-down estimate of Tam

you're gonna have to go bottom-up you're

gonna have to document your assumptions

and show how your Tam comes together so

little further what is Tam not these are

some other big mistakes that we see

startups make all the time

your Tam is not the size of the problem

so we see a lot with health tech

companies we work with well if you look

at the size of the opioid crisis the

United States it's a hundred billion

dollar a year problem that's the size of

the problem not the Tam so another big

problem that we see is people talk about

Tam but they talk about the size of the

entire market and you don't even exist

yet so it's not the size of the entire

market it's the size of your market so

let's give some examples of that how big

is the market when you're trying to

calculate Tam so we see a lot of urban

tech and prop tech companies and they'll

say the cad and bim a market building

information management it's a

multi-billion dollar market right but

your product doesn't even exist yet or

they'll say the cybersecurity market is

enormous if you look at the Tam it's a

250 billion dollar market that's billion

with a B if we just get 1% of that will

be a 2.5 billion dollar a year cyber

security company yeah that's great but

you can't do Tam top-down so let me give

you some other examples of what we see

people make mistakes like imagine you

were making ski goggles and people say

if you look at the size the total dress

in the market of the US ski and

snowboard industry its 3.3 billion

dollars a year in 2020 you make a ski

goggle that's not your total addressable

market that ski resorts total

addressable market or you say well we're

making a cup holder that fits in Priuses

and toyota sells six billion dollars of

Priuses every single year that's not

your Tam that's Toyota's Tam so you're

gonna have to do a bottoms-up

calculation none of this top-down none

of this 1% of so that Tam calculation

that we're gonna start to get into is

gonna be the number of customers times

your price it's simple but there's a few

big traps in that simplicity and

mistakes that we see

startups after startup make this week

alone I've probably talked to a dozen

startups and out of 12 startups 11 out

of 12 made these classic mistakes

besides the top-down mistakes so let's

go into that and break down and give you

some examples so when you say the number

of customers it's times the number of

customers the first question we'll want

to understand is well where are your

customers are you talking about the US

market the European market the global

market you're gonna have to cite your

data but when you calculate the number

of customers what is that total number

what is the market that you're

addressing the next question is going to

be around price remember we're saying

that 10 is the number of customers times

the price and the question is how do you

know that your price is accurate now if

you're a little later stage startup and

you're raising your Series A or Series B

maybe you've been doing some selling and

you have accurate pricing we see a lot

of early-stage startups and their

pricing is highly inaccurate so if

you're trying to calculate your total

addressable market number of customers

times the price and one of those twos

numbers is way off the number of

customers is way off or the price is way

off your total addressable market is

unrealistic so big point around pricing

have you tested and dearest your pricing

because otherwise this is an assumption

let me give me an example of a mistake I

saw a start-up make the other day they

did their Tam they showed the number of

customers times the price and I said

wait $5,000 per customer per month where

did you get that price problem and they

said well that's what a competitor

charges today and I said well is that

what you're gonna charge no no we're

gonna charge a tenth of that well then

your Tam is gonna be a tenth the size

you can't use a competitor's price you

have to use your price customers times

the accurate price that's bendy rest

it's not an assumption you're gonna get

towards Tam

the other thing we're gonna talk about

again and again is when you're showing

that Tam and if you're building on a

slide using a product like slide bean

you're gonna need to document your

assumptions on your slide like your high

school math teacher used to say show

your work so we like to see it dream it

and it's great to use a product like

slide bean to show this as well when you

show your Tam calculation put footnotes

on the bottom of the slide as to where

that number of customers came from where

that pricing comes from and document it

and show your work so let's talk through

two real-world examples and show you how

this works let's do a cybersecurity

company first we meet with a lot of

cyber security companies hands are

waving all the time at how big the

market is so let's say I was meeting

with an early stage founder and startup

and they said look we've got a Swiss

Army knife type cybersecurity product it

crushes nearly every cybersecurity

problem major problem that a company

would have so the markets huge cyber

security is a trillion-dollar problem

and the market size is 250 billion

dollars annually that's billion with a B

well there's an example number one where

the startup just told me the size of the

problem I don't need to know the size

the problem I need to know their town

and they're about to go down that

top-down approach where it's a 250

billion dollar market but they barely

exist in it so how would you break that

down so what we're building is almost

like a Swiss Army knife type of

cybersecurity product that crushes

nearly every problem a company would

typically have the markets huge

cybersecurity is a trillion dollar of

global problem and the market size is

250 billion dollars a year annually so I

might drill into that startup and say

every company and they'd say well not

every company it's really tuned for

financial institutions so you start

drilling down on that weight all

financial institutions you mean credit

card companies banks insurance companies

mortgage companies and we see this again

and again and the cybersecurity startup

comes back and says well we don't really

it doesn't really address this for

insurance companies and credit card and

mortgage it's really fine-tuned for bank

specific issues cybersecurity problems

that happen at banks so I might come

back and say wait big banks like JP

Morgan Citibank chase HSBC they could

come back and say something well no

actually it's really good for banks that

don't have a see so you know a chief

information security officer it's really

fine-tune and grape for banks that have

like a VP of IT or CIO but they don't

have a dedicated security function with

an IT that's really where our value

propositions shines so startup comes

back and says something like we're like

a security team in a box for small to

mid-size banks that's our sweet spot

that's where our Swiss Army knife

cybersecurity solution really works we

keep digging into that more wait US

banks South America Mexico is this a

regional issue is this a global issue

and we've done things like this and

dream it you hear people come back well

we know it

really works for North America South

America and Europe we don't have any

idea about Asia Africa okay so then

we're gonna sit there and say to a

start-up like that if they're trying to

calculate Tam and just first get a grip

on the customers so you're gonna need to

figure out how many medium and small

banks there are in North America South

America Europe Asia and Africa are gonna

be icing on the cake but the total

number of customers that you're gonna

focus on particularly ergo to market

strategy in calculating Tam is gonna be

those target customers that really fit

the criteria of what you're looking for

in the geographical regions you're

looking for so as you think about all

these things if you think about your

target customer the target geography

this is how you're gonna start to

calculate what the real number of

customers are for your particular Tam

now remember we said Tammuz number of

customers times the pricing so what's

the pricing so I might say to a start-up

so tell me what your pricing is well we

think it's gonna be around ten thousand

dollars well ten thousand dollars per

what unit of measure per month per user

per bank per branch can we see these

problems again and again what's that

unit of measure and a lot of this gets

back to willingness to pay or wtp what

is that customer willing to pay and what

is that unit of measure that you're

using one calculate pricing so now what

you're gonna do let's say they came back

well it's $10,000 per branch not just

per customer but these are banks and

banks have branches so they could come

back and say well it's $10,000 per

branch per month for small and

medium-sized banks in North America

South America and Europe okay

now you can come together and calculate

what your real Tam is the number of

customers times the pricing and think it

through and oh by the way if you

remember when we started with this

example it's a two hundred and fifty

billion dollar a year market all of a

sudden you're two hundred and fifty

billion dollars a year is two hundred

and fifty million dollars a year and you

might be thinking I was wondering why I

wasn't getting meetings with investors

when I'd send them my pitch deck because

they were laughing at your Tam slide

because your calculation is way way off

because you're not thinking

realistically about the customers are

going after the customers you're

targeting and what your real pricing is

by the way the example I just did of the

cyber security company a dream that we

call that narrowing of the TAM funnel

right

we start with this really big town but

the startup is unrealistic around who

the real target customers are and the

more you drill down the more you think

critically about who your true target

customers are the narrower and narrower

your funnel gets to what your real

market size is it's a common common

mistake we see so just make sure as you

think through what your Tam is you're

talking about your real target customer

we find also people are way off about

pricing this is for both pre seeds seed

and series 8 companies you need to nail

this because an investor wants to

understand how big a marketer you're

going into so realize we see most

startups are wrong about both things

number of customers and pricing and if

you're multiplying two wrong numbers

times each other you have a huge problem

on your hands your total addressable

market is ridiculous and not realistic

for it you're looking to do let's think

through slide bean right what would we

think about if we were talking to kiyah

and going through this same drill so I

would ask slide bean as a start-up or as

a company who's your target customer for

instance is it all startups like angel

and seed startups is it series a B C and

D level startups for instance are uber

and airbnb gonna use slide bean as

they're doing their mezzanine around

raising four billion dollars probably

not like a lot of great companies a lot

of great startups they know where to

focus slide bean focuses on early stage

it's perfect it's a perfect fit now I

might also ask who's your target

customer is it Pizza Shops is it laundry

or is it high tech startups because what

I want to try to do is start to narrow

that funnel and really make sure I

accurately understand who that target

customer is next question is gonna be

around pricing well we know what slide

being pricing is today but think early

on what's your pricing and how do you

know the next thing we think about is

geography is it all companies is it

globally or is it specific regions for a

company like sly bean it's probably

global but something to think about is

you think about that narrowing of the

funnel so now slide bean as a company

has been evolving over time and they

have a new service offering right so now

they'd have to do their Tam of both the

product and the service are they the

same target are they different targets

is the pricing different so now the Tam

in this situation you'd add up the Tam

of the product offering the Tam of the

service offering and that would be the

combined Tam and you do the math and you

do that all

bottoms up that's how we do sloppy by

the way as we talk about Tam let's also

hit upon what investors venture capital

investors are typically looking for

they're often looking for companies that

are going into a billion-dollar market

that billion dollar market minimum is

defined as your market it's gonna be

based on your pricing why is that they

want to make sure you have enough room

to maneuver the markets big enough if

you just get that 1% that means you're

doing 10 million dollars in annual

recurring revenue it's a big enough

market to support a venture back startup

so there's a lot of variations to

startups and what I want you to do is

that I want you to challenge your

thinking and challenge your assumptions

this model works again and again across

industries whether you're b2b b2c D to C

whatever markets you're going into it

works let's say you wanted to build a

new social network well what are the

total number of users you're targeting x

what you could do for advertising how

are you going to make money you need to

think those issues through are you gonna

be on pay-per-click or is it gonna be

cost per thousand CPM how are you

estimating it what's your premium you're

going to charge for all this so the same

model works how many customers what's

the revenue or what's the pricing per

customer or per whatever unit you're

selling let's say you wanted to do build

a new product or device same model works

you want to build a new e-commerce

company tam calculation works you want

to do dtc tam calculation this way works

you want to build a company to compete

against air B&B and VRBO same model

works

what's that target number of users

what's the pricing going to be okay so

that's it what's a great tan it's not

top-down it's not the size of the

problem and it's not the size of the

market today it's not what everybody

else is doing what all of your

competitors are gonna be doing it's

gonna be your Tam

what's your Tam it's the number of your

target customers times your price

remember to show your work site the data

and also talk about the geography that

you're estimating with it so Cayenne sly

bean thanks for having us on at dream it

we work with startups and secure tech

urban tech and health tech every single

day if you're interested in learning

more about us and seeing the content we

create please check out dream adventures

on YouTube thanks for watching

[Music]