TAM, SAM, & SOM: the importance of market size metrics
Metric Stack 18: Total Addressable Market and more!
What sounds like the lyrics of a children’s song or acronym-hell is actually a trio of metrics that will bring clarity to the size of your business opportunity and strengthen your investment pitch if you’re seeking institutional funding. After all, angel investors and VCs state market size as one of their top three areas of focus when evaluating a startup pitch deck, according to Alejandro Cremades, author of “The Art of Startup Fundraising''.
Welcome to Metric Stack Edition 18! I’m Priyaanka Arora, your personal metric assistant and Content Researcher & Writer at Klipfolio. We’re joined by Lauren Thibodeau, Founder of SaaSCan - a startup that enables Canadian SaaS companies with Canadian-centric SaaS metric research - for an action packed edition of the Metric Stack Newsletter! This week, we’ll deep-dive into the key metrics that add substance to analyzing your market opportunity. Let’s get started:
What is Total Addressable Market (TAM)?
Total Addressable Market (TAM) is the total size of the available market for a product or service. In other words, TAM calculates your potential revenue if you owned 100% of the market, existing as a monopoly. Here’s the formula:
Total Addressable Market = Total Potential Customers * Annual Contract Value
True monopolies are rare. That’s why TAM, expressed in dollars, is just the first step. It serves as the broadest level of market sizing, being orders of magnitude larger than the actual market one company can realistically serve. TAM mainly provides starting-point context for the growth opportunity in any given space.
As Lauren explains,
SaaSCan recently did a study asking SaaS investors and lenders what metrics SaaS founders should focus on at different stages of growth, and why. At the startup stage, TAM is, not surprisingly, one of the top metrics investors called out. Startup founders are getting crystal clear on the problem they solve and exactly who their customer is. Informed by that clarity, investors advise them to deeply understand and be able to articulate the TAM for that market.
Why? We’ve already heard it’s unrealistic to think one company could capture an entire TAM. It’s because having a large TAM is a precursor to building a venture scale business, in other words the ability to reach $100 million in Annual Recurring Revenue one day.
A benchmark for Total Addressable Market
Given each market is so different, there isn’t a specific benchmark for TAM. There is, however, a general sentiment of how big the breadbox should be.
When SaaSCan asked early stage SaaS investors like Pranavi Cheemakurti of Forum Ventures, Kathryn Wortsman of Amplify Capital, Isaac Souweine of Real Ventures, and Jennifer Francis of Capital Angel Investors, their answers ranged from "over $1 Billion" to "over $2 Billion" to "$5 - $10 Billion".
Bigger really is better here. But TAM on its own isn’t enough.
As we’ve seen, TAM is the biggest scoping of market size, and requires additional metrics to segment it further. The first subset of TAM is Serviceable Addressable Market. Let’s take a look:
What is Serviceable Addressable Market (SAM)?
Serviceable Addressable Market (SAM) is the revenue opportunity of capturing 100% of your target market segment within the limits of your geography and target demographic. Though not as all-encompassing as TAM, SAM still represents the size of a market segment with virtually no competitors. Here’s the formula:
Serviceable Addressable Market = Total Target Segment Customers * Annual Contract Value
SAM is where you start to get specific in your market size calculation. The best way to illustrate this is an example: say you sell second-hand books online.
Your TAM would be voracious readers on a budget with access to fast internet that allows online transactions, both domestic and international. Your SAM would be your TAM filtered down to all internet-savvy mid-twenties to forty year olds in the English-speaking world who prefer physical books over digital books and who are close enough in proximity to your headquarters to avoid high shipping costs - they are on a budget after all!
In short, SAM narrows down TAM to the overall demand, intent, and ability to purchase your product or service. Yet this can be further refined to give us Serviceable Obtainable Market:
What is Serviceable Obtainable Market?
Serviceable Obtainable Market (SOM) is the realistic size of the market when taking into consideration all factors that cause friction, such as number of competitors, competitor market share, production capability, demographic and cultural barriers, geography, and more. Here’s the formula:
Serviceable Obtainable Market = Market Share * Current Year’s SAM
As you can see, SOM is a percentage of SAM at any given time. SOM gives you the most realistic picture of how much revenue you could generate based on your previous year’s market share. Remember, market share is calculated by dividing last year’s revenue by last year’s SAM. In general, startups can expect to have a market share between 1% and 2%, which seems low but can mean hundreds of thousands of dollars of revenue or more, depending on the industry.
How to calculate TAM, SAM, and SOM with an example
Recall your hypothetical online used-book store example. Your SOM would be the subset of your SAM who engage positively with your social media posts, support local businesses in your city, and prefer your range of sci-fi books over your competitors.
Let’s calculate the TAM, SAM, and SOM for this example:
Assume the TAM for online used-book retail is $5 billion, derived from a potential customer base of 100 million and an average order value of $50. Your SAM would be the product of the subset of 100 million potential customers making $50 purchases each. Assuming your target segment consists of 3 million people, your SAM would be $150 million.
Finally, assuming you could realistically capture 0.5% of your target segment, your SOM would be $750K, if 15K customers made purchases averaging $50 per order. And that’s your revenue potential!
TAM + SAM + SOM: a complete picture, but how to paint it?
Lauren explains:
A complete market analysis includes all three of these levels. You want to paint a masterpiece that is viewed as genuine and credible. So how can you do that? There are really three analysis approaches: top down, bottoms up, and value theory, as explained in Alex Graham’s article.
But I couldn’t agree more with the advice serial entrepreneur and investor Raymond Luk calls out in his eBook “Pitching a Leap of Faith - A Guide to Building a High Impact Pitch Deck.”
Do a bottom-up analysis so you can avoid:
Quoting high-level numbers that have nothing to do with your specific business
Showing data from a 3rd party source unless you’ve read the full report and are an expert at its findings
Not being able to react when investors poke holes in your market size analysis
A bottom-up analysis takes more time, but you will be much more confident in your market sizing masterpiece and able to back up each and every assumption credibly.
The bottom line
Lauren summarizes the importance of market size metrics:
TAM and market sizing are near the top of the list of metrics SaaS founders need to wrap their heads around at the product-market fit stage. Being able to back up your numbers from every angle will empower you with both credibility and confidence.
-Lauren Thibodeau
Lauren is the Founder and Chief Research Officer at SaaSCan, whose mission it is to empower Canadian SaaS startups and scaleups with Canadian-centric SaaS metric research. She consults as a Customer Success & Customer Experience advisor with companies from startup to enterprise, and serves as Board Director for iSisters Technology Mentoring. Lauren lives in Ottawa with her husband and three kids.
Coming November 2nd: the Metric Stack Podcast
If you love the Metric Stack newsletter, you’ll love the Metric Stack podcast! Klipfolio co-founder and CEO Allan Wille and SaaSCan Founder and metrics enthusiast Lauren Thibodeau talk to founders, leaders, marketers, and more to uncover how they succeed with data. Whether you’re struggling with data, hesitant to take the leap or you’re a seasoned expert with years of experience, you’ll hear stories from people like you who have used data to grow and scale their business. Tune in for our first episode on November 2nd on your favourite podcast app.
Stay tuned for the next edition of Metric Stack Newsletter to get the latest scoop on all things metrics! Send feedback, comments, questions here: parora@klipfolio.com