Startup School: Determining the Total Addressable Market for Your Startup
In our previous articles, we’ve spent some time defining your initial market and end user profile. It was important to do this first because it gives you enough specificity to make a first-pass calculation of the total addressable market (TAM). The TAM is the amount of annual revenue, expressed in dollars per year, your business would earn if you achieved 100 percent market share in that market (though you likely will not actually attain 100% market share). It gives you a sense of how big your market is.
Two Methods to Determine Total Addressable Market
To calculate the TAM, you should perform two different types of market analyses: bottom-up and top-down. This is used to determine how many of your end users exist in your initial market. Then, once you know how much each end user is worth per year, multiply the two numbers together to get your TAM.
In a bottom-up analysis, you use customer lists, trade associations, and other sources of customer information to help you identify how many customers there are, as well as how many end users each customer has.
A top-down analysis relies on secondary market research such as market analysis reports to determine how many end users meet your different characteristics.
A top-down analysis should be complementary to your bottom-up analysis for two reasons: First, in a top-down analysis, you will often overestimate the number of end users in the market. Second, too much top-down analysis will lead you to focus on spreadsheets, not customers.
Is Your Market Big Enough?
In the end, you are looking for a market that is big enough for you to get critical mass, develop key capabilities, and get to cash-flow positive in the market. However, if the market is too big, you will likely not have sufficient resources to compete. Generally, a TAM between $20 million per year and $100 million per year is a good place to start.