Total Addressable Market (TAM): What Is It and How Can You Calculate It?

Imagine walking into a crowded room and trying to hold a conversation with someone, all without having a clue whom you’re supposed to be speaking to. It’d be rather difficult — you wouldn’t know which way to face, or even if you were within earshot of the right person.

The above scenario is like your business trying to conduct sales and marketing without knowing your audience. That’s why it’s critical to identify your target audience before you do anything else. And part of that process involves finding your total addressable market.

But what is total addressable market? Why does it matter, and how do you calculate it? We’ll answer all those questions below, so just keep reading to find out more. Then subscribe to Revenue Weekly — our email newsletter — for more digital marketing tips!

What is total addressable market?

Your total addressable market (TAM) is the maximum amount of revenue your company can make by selling in a particular market.

Bear in mind that it’s virtually impossible to earn the amount of revenue represented by your TAM, so don’t get confused. TAM indicates the total revenue opportunity available to you, not the amount you can actually expect to make.

To earn as much revenue as your TAM represents, you would need a monopoly over the entire market — and even then, it’s not a guarantee, since not everyone in that market will buy from you.

That said, it’s still useful to keep up with your TAM, as we’ll cover below.

Why do you need to know your TAM?

Since TAM doesn’t represent an amount of revenue you earn, you might wonder: Why bother to calculate TAM at all? What value does it offer you?

The answer is that you need to know your TAM to determine how much revenue you can expect to acquire. After all, when you’re first planning your budget, you’ll need to know how much income to expect. But you can’t do that without knowing how much revenue is available.

For instance, let’s say you estimate that you can earn about 10% of the revenue available in a particular market. How much is that in actual dollars? Until you figure out the total amount of revenue available, you’ll have no idea. Only after you calculate TAM can you multiply that by 10% to determine your expected income.

In short, TAM serves as a reference point for your expected revenue.

How can you calculate TAM?

There’s no single formula you can use to calculate TAM. That’s largely because unlike other metrics, TAM is not an exact number — it’s only a rough estimate. It would be impossible to calculate the exact maximum potential revenue down to the dollar.

Instead, there are a few different methods you can use to estimate your TAM. The two most common methods are the top-down method and the bottom-up method, both of which we’ll explore below.

Top-down method

The first method you can use to calculate TAM is the top-down method. In this method, you estimate your TAM by looking at the big picture. More specifically, you look at industry data and research studies to make an educated prediction.

You can find this data from various sources. Sometimes, companies in your industry may put out studies. More often, though, you’ll want to get your information by partnering with a consulting firm that knows exactly what channels to go through.

While this method has the advantage of being based on thorough research, that research might not reflect the state of your exact industry niche or your individual business.

Bottom-up method

The second TAM calculation method is the bottom-up method. This method is the opposite of the top-down method — instead of looking at the big picture, it focuses on the details of your company. To be more specific, it uses your past and current data to provide an estimate.

With the bottom-up method, you’ll look at numbers like your average number of customers and your product or service pricing. Because this method is more specific, it comes with a formula you can use:

(average sales price) x (average number of sales) x (total number of customers in market)

So, let’s say you sell a type of cookies to grocery stores. Within a given period, you sell an average of 100 cookie packages, with each package costing $4.00. Finally, you find that there are 50 grocery stores within the area where you sell.

To calculate your TAM for that period, you would multiply all three of those numbers together — 100 x 4 x 50 — and come up with $20,000. This number represents how much you could make if you sold your cookies to every grocery store in the region.

TAM vs. SAM vs. SOM

TAM isn’t the only revenue measurement out there you can use. We mentioned how TAM only covers the maximum potential revenue, and not how much you might earn. Well, that’s where SAM and SOM come in.

Read on to find how TAM differs from those two terms!

TAM vs. SAM

Let’s start by comparing TAM vs. SAM. SAM stands for serviceable available market. It’s very similar to TAM, but on a smaller scale. Basically, SAM is a version of TAM that’s been further limited by various factors.

So, let’s say you sell within a particular industry, but only to a specific niche within that industry. Your TAM might consider the whole industry, but your SAM would consider only the businesses within that particular niche. Alternatively, your SAM might be limited by geography or customer demographics.

TAM vs. SOM

Now let’s look at TAM vs. SOM. Your SOM — which stands for serviceable obtainable market — will be even smaller and more specific than your SAM. It represents the percentage of your SAM that you can realistically expect to earn. It involves looking at how many potential customers will become actual customers.

So, let’s go all the way back to our cookie example. If you sell cookies to grocery stores, your TAM consists of all the grocery stores you could sell to. Your SAM consists of all the grocery stores that are within your region and that have an interest in buying cookies.

And your SOM would consist of all the grocery stores that buy your cookies.

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WebFX can help you drive results for your TAM

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