TAM, SAM, SOM: Four Takeaways from Doing the Market Research
Devil in Detail
Total Addressable Market (TAM), Serviceable Available Market (SAM), and Serviceable Obtainable Market (SOM) are three key metrics every startup operates in their pitch deck. However, many startups seem to simply display these as 3 figures:
- TAM - a ridiculously large sum (often tens or hundreds of billions of dollars);
- SAM - a very large figure (billions of dollars);
- SOM - just a large number (millions of dollars).
While the numbers themselves may have their raison d’être, what counts is if they are justified enough to make sense and appeal to investors.
During the calculations for our Amadeo startup, we uncovered a number of interesting cases and pitfalls, not obvious at a glance, until you delve into the details and start calculating on your own. Here are our four takeaways.
#1. TAM: ‘Addressable’, not ‘Available’
Various resources confuse the terms and refer to TAM as the Total Available Market, whereas, in fact, it is the Total Addressable Market.
The difference may seem insignificant: it only refers to the restrictions you put on your startup. The Total Available Market means where you can potentially be present. And the Total Addressable Market is where you can - and plan to - be present. However, this seemingly small addition can translate into tens and hundreds of billions of dollars.
Let’s look at some examples.
You are planning to open a coffee shop on 5th Avenue, New York City and work there as a barista. You do not plan to expand, build a chain, or open the same kind in San Francisco - because everything hinges on you personally and only in one place. That model means:
- The Total Available Market is the entire coffee shop market globally. No restrictions, as long as the market is there (unless coffee is banned at the state level). And for the calculation it won’t matter if your cafe is a misfit in Vietnam, where Vietnamese coffee is more popular. What matters is that you can potentially be there.
- The Total Addressable Market is the size of the New York coffee shop market. What is the point in complex calculations and false numbers, if New York City is your maximum capacity?
Let’s take an example from IT: a software application for short-term rentals worldwide (similar to Airbnb).
- The Total Available Market is the global market size for short-term rentals.
- The Total Addressable Market is the market size of short-term rentals in all countries except for high-crime locations, where renting property can affect your company reputation and your users’ safety. Though accessible, this market is in no way addressable.
#2. Prioritize bottom-up market analysis
Since you can calculate TAM, SAM, and SOM in two ways - top-down and bottom-up, many startups take advantage of the simpler and faster top-down market sizing. It certainly has its rationale, but is more applicable at the initial stage to determine the approximate order of numbers and understand if the idea of your startup is worth considering at all.
For instance, for a rental app, you may take the worldwide size of the short-term rental market from analytical reports (albeit reliable ones like Gartner or Frost & Sullivan) and claim your TAM to be 20% of this market. Easy, but looks more like shooting sparrows with a cannon.
The verdict: if you want your TAM, SAM, and SOM to be trusted, do your own calculations.
#3. No universal guidelines or formulas in market analysis
In our search, we also ran into a shortage of guidelines, instructions, and formulas to calculate TAM, SAM and SOM. It differs for every startup depending on the solutions, the market, or the business model they have. And rightly so. Everyone is unique.
However, several approaches to calculation may be applicable (partly or in full) to a wide range of startups, including yours.
Let’s take our rental app example.
The apartment rental market size can be calculated so:
- The number of apartments advertised for short-term rentals (here you set proper restrictions based on TAM, SAM, SOM) multiplied by the cost of your services.
- Gauge via the competition: calculate the number of your competitors’ housing (allow for your startup limitations) and multiply by the cost of your services. Competitor data is available in financial reports.
Then again, if you are making an application for a specific real estate agency, your market will be completely determined by the maximum number of their clients, multiplied by the cost of your services.
The cost of your services is also nuanced:
- local pricing, when the cost differs depending on the region (for example, Netflix);
- varying pricing for different user types, etc.
#4. SAM is more than just about geography
Here is another misconception: the Serviceable Available Market (SAM) is not just about geographic limitation as many resources wrongly claim.
Returning to the rental app example, at the moment your long-term plans are to launch in North America with only a mobile version. Then your SAM calculation should take into account both factors, not just North America.
Bottom line, or why you should care
TAM, SAM, SOM are the key metrics that allow you to understand where you are going and how you plan to develop - your startup roadmap and destination.
It is also an opportunity for an investor to understand the prospects of investing in your startup: SOM and SAM help to de-risk the investment while TAM enables you to assess the upside potential.
Let me give you an example. You come to pitch to an investor with a target return of 10x and ask for $250k in exchange for 20% of the startup equity. One of the primary things the investor looks at is your potential market. This is where your calculations come in handy. So, based on your market analysis:
- TAM = $4B
- SAM = $1B
- SOM = $5M for 2 years
- Expected EBITDA margin = 25%
- Expected Valuation at exit = 8x EBITDA
The investor calculates the payback:
when you reach your SOM ($5M), Investor return = Company worth x Startup equity / Investment fund = ($5M revenue x 25% margin x 8 valuation at exit) x 20% / $250k = 8x
Hence the investor understands the possibility and payback period of their investments and, based on this, draws a conclusion about the prospects of working with your startup.