1: TAM Formula
TAM is a very important number for investors and your business plan depends upon these numbers of TAM.
TAM can be explained with the help of formula as above:
TAM = Number of end-user profiles in the beachhead market x Annual revenue such user
This can be explained in the following steps:
After knowing your beachhead market, you have to see how many end users you have. These are the actual users who pay for your product & services.
Once you find this number, you have to find the amount that an end-user can spend on your product. This amount can be based upon ideas or actual data. You can calculate this through Primary Research or you can check how much money a user spends in one year on a similar product like yours.
Multiply 1 x 2 & calculate TAM.
2: How to reach TAM?
TAM Top-Down Approach:
There are 2 methods to understand TAM.
1.Bottom-up Research:
This is also known as Primary research. In the primary research, you sit with one on one user and discuss face to face to understand him.
2.Top-down Analysis:
This is also known as Secondary research.This can be explained with the help of the following example:
Suppose you have a beachhead market, but you don’t have much clarity. Therefore, to get the clarity you created a Google form. You can send this Google form to your complete WhatsApp list and asked them to fill this form.
You will use this form to understand who is your customer or not. In this type of research, you are not sitting face to face, you created a form and sent it to users. Many market companies follow this method of secondary research.
After calculating your TAM number, now you have to calculate the revenue potential of your product in the beachhead market. You can calculate it as follows:
Suppose you have found the annual revenue per user through primary or secondary research. Now you have to multiply this with the number of end-users.
Revenue Potential = Actual revenue per user x Number of end-users
This is your entire revenue potential that shows how large you can grow your business.
3: How to find out if you are doing the right business or not on the basis of TAM?
If the worth of your TAM (total addressable market) is less than 5 million dollars, it shows your business is very small, but if you want to make the large business your TAM should be at least between $ 20-100 million.
This can be explained with the help of the following example:
Many entrepreneurs go to investors and say that they have a TAM of more than 1 billion dollars. They assure their investor of 1 billion sales during the first year. If you do the same, investors will immediately understand that you have no idea of anything.
He will think you have no idea about your TAM, end customer, market segmentation & beachhead market. All he will conclude about you is that you shoot an arrow in the dark by quoting a big number.
Many startups do not understand this TAM number till their first year, but many startups have clarity about their TAM on day one.
Ideally, you should invest at least 4-6 weeks in your primary research. If you invest your first 6 weeks to understand your TAM, you will not face any problem in the future.
If you understand your TAM after 6,12 or 24 weeks it will be late because you might have entered in unsuitable markets, your product will not be getting much value, your funds will end and everything will start in a negative spiral.
You can understand this with the following examples:
Facebook had clarity about TAM.Mark Zuckerberg did not launch Facebook on day 1 in the entire world.He had a clarity that he will start with Ivy League colleges of USA and 2 or 3 rd grade college will be covered in 2 & 3 round. He thought, if he succeeds in expanding in these colleges, this will be a big thing.
All this happened because his TAM was very clear.
Quora.com had clarity about their TAM. Initially, this question & answer network website was launched for intellectuals, thinkers& content creators.it was not launched for consumers. It was launched as an invite-only network, where some people connected for creating content and further they connected more people in this site.
This network operated in a refined way and grew because their founders have clarity about TAM.
You should calculate your TAM. If you have clarity about your TAM, you will be able to create a company where global investors invest. You should have clarity about all these concepts: