Understanding Total Addressable Market

by Joshua Botello

So you are looking to start your own business but aren't sure how big the market is, then look no further. There is a deceptively easy way to validate that business concept. The Total Addressable Market or TAM is a helpful figure to evaluate your business idea. TAM is actually really easy to calculate:

Total Addressable Market Value in $ = # of Customers x Price of your Product. 

Like said, it's really easy to calculate but there are different ways to approach it. There are two main ways to arrive at this number: Top-down or bottom-up approach. 

Top-down Approach

Let's start with the top-down approach. Many businesses opt for this approach because it's really easy. In certain cases, this calculation does work and is used for business plans. Let’s show you an example. Say you want to start up your own specialty soap e-commerce business. This chart came from one of our research tools that the University of La Verne SBDC uses called IBISWorld. We mainly use this for market research when consulting with clients. We can look and determined the soap and cleaning compound market is 36.9Bn dollars.




So at this point, if you think “if I just get this at least 1% of this market,” you’re a millionaire, right? Well, it’s not that easy. With the Top-Down approach in most instances, it's going to be incomplete. This approach doesn’t account for a bunch of things like customer segment, location, or price. Many startups looking for venture funding run into this issue.

They assume a market value is their TAM, but not all of these people are their customer type or in their location or at the right price point, and using our example it's no different. Let me explain.

The market example shows all the soap and cleaning market but not specialty soaps, where our product is. In fact, only 42.1% covers household soaps that would include our products. This is called narrowing of the TAM. With this narrowing, we arrive at 15.5Bn. We could narrow it further but you get the idea. Let's take a look at the bottom-up method.

Bottom-Up Approach

Just as the Top-down method starts with the larger market and narrows to a true TAM the bottom-up method starts at a granular level. Remember TAM is Customer x Price. So you need to first define your customer. Who are they? Are they Men, Women, Mothers? Do they have 1 or more children? Where are they located? If you are doing an e-commerce business they could be all over the US but you need to start somewhere.

The other component is price. How much are you going to charge? Do you know what your target market can afford? And how do you find out? Well if you are just starting out, try your product at a farmers market, put together a focus group, and survey. Through this research, you will get data on who your customer is and what price they are willing to pay.

Now that you have a good customer profile and solid price that $36.9Bn or even $15.5bn is now a more realistic $5M business. Now you can take this information and create a more solid business plan that will attract investors or a business loan.

Conclusion

Calculating your Total Addressable Market is the best tool to evaluate a business idea and see if there truly is a market for it. Remember TAM is simply Customer x Price but you need to calculate it carefully and thoroughly. Don't just assume anyone who COULD use your product is your target market. You also need to make sure your pricing is accurate for your TAM through research and testing.

But what do you think? Have you ever Calculated TAM before? What other market research have you done? Let me know down in the comments below.

Funded in part through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, conclusions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.