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January 23

How Total Addressable Market Sets up Startup Success [Uber Example]

Awad Makkawi

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Walaa Hamdan

Is it possible to pitch your startup without knowing your Total Addressable Market?


Whether you are pitching to family, friends, investors or whoever else, you will need to explain the size of your market opportunity.


And the last thing you want is for this number to be an outright guess.

 

Even a highly educated guess won’t cut it if it isn’t backed with evidence and information.

 

That's why in this article, we will:


  • Explain what Total Addressable Market is, and how it fits in with SOM and SAM
  • Share 2 different methods of analysis for the most accurate TAM calculation
  • Breakdown Ubers complete process from TAM to Expansion markets

Let's get to it!

What is Total Addressable Market?

Simply put:


Total Addressable Market (TAM) is a quick metric to measure the size of the market and how big the business opportunity is i.e. the total market demand for a product or service. 


For example: 


The global beauty industry in 2019 was valued at $532 billion, this refers to the total available opportunity for businesses operating in this industry. 

Source - For cosmetics alone

Total Available Market is measured in terms of revenue. 


It represents the financial size of the available market per year for your initial target market plus your follow-on markets if you were to capture 100% of the customers.


So:


If your revenue per customer is say $500 per year and you are looking at a market with a potential 50 million customers.


That makes your total addressable market:


$500 x 50M = $25 Billion per year


But here's the catch:


Unless a company has a complete monopoly, there is no way of one company capturing every single customer in a given market.


And that’s where the next two market size terms come in.

Serviceable Available Market (SAM) And Serviceable Obtainable Market (SOM)

SAM refers to the subset of TAM that you can access and serve based on factors such as your geographical target location, regulations, financial and resource limitations.


As a result both SAM and TAM, are unrealistic goals for your first step. They are indicators of the potential upside and not the place where you target your efforts.


Which is where SOM comes in. 


Your Serviceable Obtainable Market (SOM) is the realistic market share your company can capture through the distribution channels and resources available to you. 


It is a subset of SAM.
TAM SAM SOM

Let’s make this easier.


We said the beauty industry is estimated at $532 billion. 


If you were a UAE based Organic Personal Care Beauty company with global ambitions, this figure would be your TAM. 


Your SAM when you’re just starting out is the size of the organic personal care market in UAE.


$82.5 million


To calculate your SOM you'd then dive into more research on how many customers:

  • Would realistically be interested in your product 
  • You could capture with your marketing efforts and Go-To-Market strategy

You’d then multiply this number of customers with the financial value you anticipate to obtain per customer per year to reach your SOM.


This SOM determines your short term goals.


And is what investors look at in order to evaluate de-risking their investment. 


Furthermore, success in capturing your SOM provides credibility that you are capable of delivering on your objectives.


Question is:


What do you get out of knowing this?

How To De-risk an Investment Using Total Addressable Market, SAM & SOM

Let's assume you have found an investor willing to back your startup.


She's looking for a 10X return on her investment.


And you've agreed on $250K for a 20% stake in your company.


Here's how an over-the-napkin assessment might go:


TAM: $2 Billion

SAM: $100 Million

Beachhead TAM: $65 Million

SOM: $10 Million in 3 years

Net Margin: 20%

Valuation at Exit: 8X Net Margin


Now:


Lets make it juicy and say you deliver on your goal of $10 Million in revenue SOM.


This puts your Net Margin at $10 M x 20% = $2 Million


Your startup valuation if you were to exit would be around: 8 x $2 = $16 Million


20% of which is for your investor = $3.2 Million i.e. is a 12.8X return on her 250K investment.


The investor meets her minimum 10X ROI and your company has 10% market share of a SAM segment that represents 5% of the total TAM.


Meaning there's still plenty of room for growth.

Why is Total Addressable Market Important?

What can we learn from this hypothetical example?


For starters:


The Total Addressable Market in itself is not what we’re after. At least not when starting out.


Rather:


The core is in how you will capture a portion of that Total Addressable Market.


That's why, when starting out, the wiser approach is to attack a beachhead TAM market which is big enough for you to reach cash-flow positive and grow from there.


The beachhead is the available market for the specific niche that you will first target. We'll cover this in more detail a little later.

Total Addressable Market Follow On

Your aim is to capture as much of that market as quickly as possible.


If this initial market is too large you will be unable to compete and either not succeed or have to raise money without much of a track record for investors to see that you can deliver results. 


That’s why understanding these figures right from the outset of your startup is so fundamental. 


It defines the tone of your startup growth or whether pursuing the opportunity is even worth your time.


Think of it like this:

  • Market and Growth Potential: If you do market research, assess the revenue potential and realize that the market opportunity is not a suitable fit for your own personal goals, you can move on to another business idea rather than investing time and money into a project that won’t provide the returns you desire.
  • Seeking Funding: If you plan to approach investors, it’s important to have your figures nailed down and as they'll want to evaluate your growth potential, the total market opportunity, exit potential and potential size of return on their investment.
  • Go To Market Strategy: Once you understand the anticipated addressable market, you can set defined market share goals and determine the fastest marketing plans to achieve those goals.

But tread carefully.


Getting your TAM wrong can fire back on you.


Exaggerating your total addressable market figures gives the impression that you and your team aren’t well informed about your own industry. 


Additionally, a relatively large TAM could mean a very fragmented industry, many competitors or little availability of raw material for your products.


The aim is to produce a conservative TAM number that you can defend against questioning on the rationale behind your figure.


So how do you calculate your Total Addressable Market as accurately as possible?

Market Size Calculation

Have you heard this before?


“We have a market of 50 million customers.

Our product is priced at $1000 per year.

Making our TAM $50 Billion.

If we get even just 1% of that market.

Our company is worth $500 million”


Now:


Before getting to the high 5’s, fist bumps, hugs and changing your door locks to hold back all the investors from jumping at you.


There’s just one thing.


This type of analysis is complete nonsense.


It's a Top Down Analysis the wrong way.


Here’s how it should be done.

Top Down Analysis The Right Way

Involves conducting in-depth industry research in various scopes; global, regional or national depending on the ultimate scope of your business.


In our region of the world, either the GCC or the broader MENA region, access to reliable sources of data is not always easy to find.


However, a good place to start is the global scale to understand the size of your industry, its trends and industry status. 


There are a few resources that you can tap into:

  • If you have the budget you can begin with market research firms such as Forrester or Gartner whose research, although expensive for startups, will give you a detailed understanding of most industries.
  • If not, then news articles about these reports is a good bet to find significant information that would give you a good indication of market size data, potential customers and revenue opportunity. Here's a Gartner report for the Global Cloud Services Industry.
Gartner Cloud Services Total Addressable Market
  • You can also research annual reports of companies within your sector. Understanding the total amount of business each potential competitor is doing will give you an understanding of the market size and their share of the market. See the sample image below.
  • Another potential source of information would be government authorities monitoring specific sectors, such as the Chamber of Commerce or Regulatory Organizations

But what if you’re creating a product or service in a new category and there isn't much market research available? 


This is where Value Theory kicks in.


You'll create forecasts and estimates based on the alternative products/services you’re competing with and the value that your new offering brings in order to estimate a revenue opportunity.


For example: 


When online bookstores were launching there wasn't much market data as this was a brand new category.


So creating forecasted numbers based on that of existing competition i.e. physical stores was key. 


Just like Amazon did.


Bezos looked what traditional brick-and-mortar stores were offering and compared things like size of inventory, cost structure, user experience to name a few.

Gartner Total Addressable Market CRM Competitors

This research sets you up with a top of the line figure from which you can then determine your SAM & SOM.


Here’s how.

Calculating SAM and SOM

To identify your SAM figures you would look at sales channels and customer acquisition strategies. 


Start by asking yourself questions to drill down into these figures.


For example: 


How many potential customers are in your target area? How many could you reach through your sales channels and strategies? 


These questions would result in your SAM figure.


Then take it a step further.


Look at how many customers would be interested in your product or service based on other trends you can observe in the market? How many customers in your target market can you realistically capture


These questions would result in your SOM figure. 


The more rigorous and relevant your questions, the more accurate your figures will be.

Top Down Approach Example

Have a look at this theoretical example of a top-down analysis for an on-demand tomato delivery company taken from the Towards Data Science publication.

Top down analysis example

Bottom Up Analysis

How is this different to the Top-down approach?


Where the top-down approach begins by looking at the broader industry and narrowing down to the customer, the bottom-up approach is basically the opposite.


You start by finding the number of available customers who fit your end user profile that you can reach through your sales and marketing channels.


It is the best way to count the number of end-users that fit your target user profile. 


Which is why it’s also known as “counting noses” because we’re getting specific in counting the exact number of end-users and finding where they are.


Customer lists, trade associations and other customer sources help identify the number of existing customers.


Once you have that, you’d identify the price of your product or service to determine the average spend per customer per year.


But what if you don’t know how much your product will cost?


In that case:


Build an estimate based on factors such as :

  • How much are customers currently spending on other solutions similar to what your product provides (whether direct or indirect)
  • The value that you are creating for customers
  • How much they have paid in the past for new solutions

Once you know the number of customers and the price of your product annually.


The next step is to build on this based on your SAM plans. 


For example: 


If you’re launching in one city, how many other cities are in your SAM?


Here’s a bottom-up analysis for the above example, Tomatology:

Bottom up analysis example

The aim of this simplified example is to demonstrate the difference in how the calculation works for a bottom-up analysis vs top-down analysis.


A more comprehensive analysis takes other factors into consideration such as the reasonable time required to expand, churn rates of customers among factors such as competition.

Which Should You Use?

In the two examples above, both approaches reached almost the same figures. 


$154M and $156M respectively.


Which is ideally what you’d want to see.


It's a sign your assumptions line up and adds confidence in your market numbers.


That’s one reason why you’d want to use both approaches because they compliment each other.


Together they provide a sanity check that your market assumptions are valid and that you’re headed in the right direction.


The second reason is that a top-down analysis on it’s own over-estimates the market because it’s not as specific to the end user profile as the bottom up analysis.


Just remember that your total addressable market number is not set in stone. 


As you get closer to launch, it’s useful to update and revise these figures and your GTM strategy as needed.

Targeting Your Full Total Addressable Market is Misleading

Amazon, Uber, AirBnB - what do they all have in common with regards to TAM?


They all started with smaller beachhead TAMs instead of targeting the full TAM.


Author, Bill Aulet, suggests aiming for a beachhead TAM in the region of $20 - $100 million. 


That’s not to say that an initial market less than $20 million means your market is not worth pursuing. 


It can work but you will require high gross margins in order to succeed in an initial market of that size.


Again:


The goal is to find a market in which you can quickly reach cash-flow positive and grow from there into your follow-on markets.


Watch his explanation here:

Expansion of Existing Markets

So you've consolidated your position in your beachhead market, whats next? 


Consider these factors for expansion into follow on market size and share:


Companies tend to shape and change the markets they are operating in to grow the customer base


A few ways this can be done include:


  • Product expansion
  • Improve convenience and customer experience
  • Removing friction
  • Creating more use cases
  • Reducing cost
  • Optimize sales and marketing

It’s important to have a plan for how will you expand your existing market share and how you'll capitalize on market expansion already happening.

Credible Adjacencies

Involves your acceleration into adjacent markets as explained by this Harvard Business Review Article.


Amazon went from selling books to selling practically everything you can think of. 


These adjacent markets should be credible i.e have a large enough TAM size, and easy to move into once you’ve established yourself in your beachhead market.


For example:


Toptal started by providing high-end freelance tech talent.


From they they grew to provide freelance design talent.


And more recently they started offering freelance finance talent as well.

Toptal Service

Specifying the follow on markets that you will enter in to and the TAM size of these markets is essential for knowing how you plan to increase your startup market share.

A Few Factors For Entering Adjacent Markets:

  • Nascency Market Potential: A new market that has plenty of growth potential is often tempting for businesses to launch into. Some of these markets will be big in the future regardless of that startup, even though they might look small today. 
  • Frequency of Product Use: The frequency of which your customers interact with your product or service will generally correlate with the size of that opportunity. How often are users on Whatsapp or Instagram per day? 5 to 10 times a day? This all translates to an opportunity to build a big business, even if your revenue per single use is relatively low
  • Partnerships
  • Customer Diversification
  • Product Diversification

Ubers Complete Process For Total Addressable Market, SAM, SOM & Expansion

We examined Uber's first ever pitch deck.


Let's wrap this up and take a page out of their playbook to see the whole process we've been talking about in action.


When we consider that Uber is in fact in the Service Transportation Market or Location Based Services Market that puts their global Total Addressable Market in the trillions of dollars. 


The cab hailing segment is a small subset of this market.


And as we all know:


Uber first started in the US market i.e. its the Serviceable Available Market.

Uber Serviceable Available Market

They then turned their focus onto a beachhead market where they could start to gain traction.


Here the decision was to start with San Francisco.

Uber beachhead market

From there they explained the amount of market share that they would realistically capture.


Along with the profit that capturing this share would translate too.


i.e. Serviceable Obtainable Market

Uber Serviceable obtainable market

So if delivering on the SOM objectives equates to $20 - 30M


That would mean a company valuation of $150M give or take.


Assuming the initial investors received just 10% stake in the company (this is just an assumption for the sake of explanation), their ROI would stand at $15M.


If they were looking for a minimum 10X return, their investment amount would be in the $1.5M region.


Take a look.

Uber seed investment

As mentioned earlier, Uber is in the Location Based Service market of which cab hailing is a small category. 


After becoming the market leader in the category, Uber went on to expand into follow on markets within their total addressable market.


This was a part of the business model right from the start and exactly how they planned it.

Total addressable market follow on market

Key Takeaways

Calculating your total addressable market is key to understanding the potential of your startup and building a scalable business model in line with your goals.


Define your beachhead total addressable market using a bottom up analysis to determine the number of customers that fit your user profile. 


Compliment this with a Top-down analysis to end up with a conservative size representation for the market you want to enter.


You want to be able to defend your TAM with solid evidence if anyone was to question it. 


But really, it’s for your own peace of mind as well. To give you confidence that you’re on the right track.


Focus your efforts on an initial beachhead market where you can quickly reach cash-flow positive and then grow from there into your follow on markets.


Cement your place in the initial market. 


Get to cash flow positive. 


Go after bigger markets.


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