How to calculate your startup’s TAM, SAM and SOM
Understanding and presenting the size of the market you’re targeting is critical to securing funding for your business. Angel investors and VCs alike want to see a breakthrough product or service that scales and can acquire a significant share of a sizable market.
At any stage of investment, be it seed or a Series B, it’s necessary to include a slide in your pitch deck that explains the size of your market from three perspectives — TAM, SAM and SOM.
When you present your market size data to investors, they’ll look for TAM, SAM and SOM information. These data points pack a mystique about numbers that can appear colossal and out of reach, but if you approach market sizing methodically, you’ll realize it’s really not that complicated.
I recently attended a presentation by a company that produces innovative, nutrient-rich olives and peppers. Because their data point scenario is straightforward and easy to understand, I’ll use it here to explain their TAM, SAM and SOM.
Step 1: Capture TAM
While TAM (total available market) tends to cause the most anxiety, it’s the easiest of the data points to handle. TAM describes total revenues within a larger sector. You can calculate TAM three different ways.
First is the top-down approach, often attained through publicly available market research reports or extrapolated from publicly available data reports.
Next is the bottom-up approach, which relies on a calculation of actual and projected pricing, along with the current and total projected use of your products or services.
If you do your homework, you’ll eliminate financial projections guesswork, show prospective investors how they stand to gain from investing in your company, and put yourself in the best possible position to achieve your goals.
Last is the value theory approach. This theory applies an educated analysis of the projected value and total anticipated use of your product or service, followed by calculating how much of that value can be reflected in its pricing. Value theory most often applies to entirely new products, services and categories. Let’s apply the theory to Airbnb.
Airbnb disrupted the hotel industry by imagining a technology that would enable homeowners to match up with travelers seeking a place to stay. To apply the value theory, assess how much a traveler would be willing to pay for this new type of lodging, how much the homeowner would want to be paid per night, and what Airbnb could collect from the homeowner for using its technology.
When a product or service category has already been well-researched, TAM is often calculated using publicly available market research reports. If the product or product category is new and hasn’t been researched thoroughly — which happens often in tech and also applies to other industry verticals — I recommend hiring a seasoned market research consultant to secure TAM data using either a bottom-up or value theory approach.