In order to effectively develop their business, an entrepreneur should be aware of both the underlying forces driving activity in their market, as well as their competitive positioning relative to other market participants. This article identifies the three levels into which a market opportunity can be analysed and presented for a growing business - the total addressable market, the serviceable available market and the serviceable obtainable market.
These metrics are important both for investor conversations, where the focus will be on understanding the scale of the opportunity ahead of a company, but also to facilitate effective decision making. By examining the structure of the market, a management team can identify where best to deploy resources in order to gain (or protect) market share. In a simple example, certain sub-sectors within an industry may be expected to see rapid growth over the coming years and, as a result, companies operating in this market may look to open a new business line in order to capture this opportunity.
In this article we will lay out a framework for your market assessment and how Ithaca can support you in this.
Total addressable market (TAM)
The total addressable market is the broadest of the three definitions of the market, and therefore produces the largest figure. In short, the TAM is used to reflect the full revenue opportunity available annually for the provision of a given set of goods and services within an (often international) industry.
How should you calculate total addressable market?
There are three ways to estimate TAM, the top down approach, the bottom up approach and using the value theory method. Of the three, the bottom up approach is broadly considered the most useful and represents a good starting point for your analysis.
This approach turns the TAM discussion from a simple statement of industry size into a much more interesting discussion: the breadth of potential product market fit. Instead of an opaque and uncertain statistic,
the TAM number is built up with assumptions about which types of customers the company can serve and win.
The 'bottom up' approach to TAM
The bottom up approach creates a market size estimate that is built upon your understanding of your customer base. By considering your trading activity to date, you can estimate the average annual amount of revenue you earn from each individual customer.
For example, if you run a subscription revenue model charging £25 per month, your annual revenue per user is 12 x £25 = £300. You then look at the total number of potential customers that exist for your product or service, say 50m people across the globe. By multiplying revenue per user (£300) by the number of potential users (50m) we can calculate a TAM of £15bn.
You may also want to increase the sophistication of this approach by forecasting future values for the revenue per user and market size. Your estimates should be informed by factors such as demographic trends, evolving buying habits, and disposable income.
The best way to build up this data is through direct engagement with your audience – primary research. This typically involves, surveys, questionnaires and testing. Tools such as Google Forms, SurveyMonkey or ZohoSurvey can be great in this exercise. For online businesses, keyword research tools such as Semrush or Google Trends also offer great insight into consumer sentiment through the lens of web searches.
Ithaca's network of specialists have significant experience in using these tools and are able to support with customer segmentation and audience research analyses.
The 'top down' approach to TAM
The top down approach leans heavily on available industry research that quantifies the market size and growth rate. Typically shown as something along the lines of "according to Gartner research, the £Xm market for workflow productivity tools is expected to grow by X% each year until 2026". The advantage of this approach is that it can be used at a very early stage of the business, before any actual customer data has been collected.
However, when presented without customer data, the top down market sizing figure contains very little information and is highly uncertain. The process for Gartner (or others) to conduct accurate market research is hard and often relies on self-reported user data and challenging estimates relating to the revenues of private companies. These issues are made more acute when a market contains multiple pricing models - think for example about a software segment from license to SaaS pricing. As such, this approach only tends to be used in the absence of customer data.
Another critical pitfall with this approach is the implicit assumption that the company's disruptive products will not change the TAM. A founder may believes that their offering will out-compete the incumbent operators by offering an equivalent product or service at 50% of the current market price. In this case, they should not reference the current market TAM, but instead use a figure that is 50% as large. Imagine, for example, that you saw a pitch for an online encyclopedia in 1999, and the sales of physical encyclopedias were used to frame the TAM. In reality, online encyclopedias shrunk that TAM meaningfully as users adopted a superior service at more competitive pricing.
The value theory method
The final of the three methodologies is the value theory approach. This is the most abstract of the three, but allows you to frame your market opportunity in more detail. The idea here is to quantify the amount of value that will be added to customers using the product or service, and then estimate how much of this can be captured through the pricing model.
For example, imagine a simple market in which 1,000 customers pay £10 a month for a product or service. A new entrant is preparing to launch a competing offering that achieves the same goal as the customers but for only £5 per month. The new entrant would be able to save 1,000 customers £5 every month, creating a value of 1,000 x £5 x 12 months = £60,000.
How this value accrues depends on how effectively it can be captured through the company's pricing model. If the customers believe that the further new entrants will commoditise the product, and thereby lower prices, they may be unwilling to pay more than £5 a month and capture all of the value themselves. If the company is able to demonstrate a resilient competitive advantage, they may be able to capture the majority of the value.
The value theory approach is often used when companies are considering expanding their product offering and cross-selling into existing customers. A key advantage of this approach is that it helps management teams to demonstrate that they are have considered both what customers find valuable and are willing to pay for.
Serviceable available market (SAM) and Serviceable obtainable market (SOM)
Typically only a portion of your TAM will be serviceable using your current product and business model. Perhaps your offering focuses on a niche within the market, out-competing the more generalist solutions here but without wider appeal in the broader market. If your chosen niche represents 10% of the overall market, then your serviceable available market will be 10% of your TAM.
In addition, your product or service may be designed for specific users within this niche. For example, providing an workflow solution to businesses with 2 - 10 employees. The potential revenue opportunity from these businesses are referred to as your serviceable obtainable market.
To sum up
Considering the dynamics of your market will help you to refine your positioning relative to your customers and competitors. Ithaca can support you in determining your business’ function within the broader landscape. We would do this by providing you with a freelance expert to apply a framework (such as the Five Forces model) to further develop your knowledge of the market.
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