What is total addressable market and its importance?

By Indeed Editorial Team

Published 9 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Total addressable market (TAM) is a business-based term that describes the market share a business can feasibly target. This means TAM is an important figure for both new and established businesses to calculate. Not only does it help an organisation learn how well it's doing in comparison to its competitors, but it also gives some insight into the areas in which it could improve. In this article, we look at what TAM is, why it's important, how to calculate it and what the associated benefits are of an organisation using these figures.

What is the total addressable market?

The total addressable market (TAM) is the size of the market a company can realistically serve. It includes all potential customers within a given geographic area or those with common characteristics such as similar income brackets or demographics. Employees calculating TAM typically know the overall market size, what percentage of this market the company can realistically serve and the geographic area the business is targeting. For example, a small business owner based in a certain city might determine the market size for their product/service by analysing the population size and factors that might influence demand for the product/service.

The next step might be to look at the size of their TAM. This includes all potential customers in all markets (domestic and international) where the company could sell its product/service. So if the business wanted to sell its product/service in certain areas, the TAM would include all potential customers in those markets.

Why is TAM important?

TAM is important because it helps new businesses (or businesses wishing to extend their product line) gauge the potential market size. This gives them an idea of how big their potential customer base could be and whether this is feasible to operate with. Calculating a business's TAM also brings more advantages, such as:

It reveals scalability opportunities

TAM typically fits into two categories: existing and potential. While the existing market is the subset of the TAM a company has already captured, the potential market is the remaining portion. Determining the size of both markets is critical for businesses, as it can help them understand their current reach and identify new opportunities. When a business has identified these scalability opportunities, it business can begin researching why its products aren't as successful in these areas. For example, if its marketing campaign confuses consumers, a business can craft a plan explaining how it's attempting to change this.

It tells a company how much effort is necessary for launches

TAM is a calculation of how much business a company can reasonably expect to capture. Determining this figure can help business managers prioritise their efforts and allocate resources appropriately when launching new products and can ensure they use their resources in the most beneficial areas. A business known for a certain shoe style may allocate the marketing department a set budget to advertise this popular shoe in a wider variety of colours. If they're creating a new handbag to go with the shoe, this unproven product may need a larger budget allowing for promotion on social media and billboards, etc.

It can help increase shareholder interest

TAM is a key metric for shareholders, as it reveals the market size a company could potentially sell its products/services to. The larger the TAM, the more potential revenue a company has, and the more attractive it becomes to shareholders, although angel investors may invest in companies with lower TAMs. Overall, it's important to note that the TAM isn't a guarantee of future success. A company may have a large TAM but still fail to capture a significant market share. Additionally, a company's TAM can change over time as new markets open or existing markets shrink.

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How to calculate TAM

TAM refers to the maximum potential market for a product or service. A business can calculate it by estimating the size of the current market and then extrapolating that number by projecting future growth rates. While TAM doesn't account for any possible competitors, it can often serve as a starting point to determine the potential market size. There are a few different ways to calculate TAM:

1. Calculate the TAM for that product type

One way in which a business can find its TAM is to calculate the market potential for the product/service. This method of calculating TAM is more relevant for start-ups than established businesses. To do this, the organisation collects information on how much of the market its product or service can possibly address. A business also gathers information on what percentage of the market it can potentially capture.

This allows it to calculate an estimate of the average spending per customer. An employee of the business can then multiply these figures to reveal the organisation's total market potential.

2. Analyse the customer lifetime value

Another way to calculate TAM involves analysing an organisation's Customer Lifetime Value (CLV). This is a method of measuring the average revenue a customer generates over the course of their relationship with a business. A business bases its CLV on three things: average customer lifetime, average transaction value and customer retention rate. To determine a business's TAM based on these factors, employees first calculate this information regarding CLV. Next, they can multiply that number by the number of current customers of the business. This reveals an approximation for that company's TAM, though this can change according to business evolution.

3. Examine market potential

To calculate TAM based on current market potential, a business first researches its desired industry. This research allows a business to examine the potential market growth available. An organisation can do this by using various resources, including examining analyst reports, government data and surveys that consumers take to evaluate like-minded businesses. With this data, employees can begin to analyse the numbers.

This often informs the subsequent decisions of a new business regarding where to allocate its resources and how best to grow its business. For example, it can reveal how much investment is necessary to promote market growth.

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What are the benefits associated with calculating TAM?

There are many benefits associated with calculating a business's TAM. The calculation of TAM can help an organisation get a much more accurate estimate of the size of its potential market and help the business to make more informed decisions. For example, TAM can:

Help a business to accurately estimate its market size

TAM is a very important metric for businesses to estimate their market potential. By understanding the TAM for products or services, businesses can get a better idea of the size of the potential customer base they could possibly target. This marketing information is essential for making informed business decisions about whether to invest in a new product or service, how much marketing spend to allocate and where to focus sales and operations efforts. It also helps a business to streamline its spending, which is especially important for start-ups to address to ensure their business success.

Help a business to identify its target audience

TAM is all about figuring out who a business's target audience is. Basically, it breaks down the market into segments and then helps employees within an organisation to identify which ones are the most important. Once a business knows exactly who its target audience is, it can focus its marketing efforts on those specific groups. This is a great way to ensure that the business is investing in the right place.

For example, organisations that are more orientated to women between the ages of 16 and 24 can hire a social media manager to create a business page for them.

Related: How to define your target market: examples and types

Help a business to differentiate its products or services from competitors

TAM can help businesses to differentiate their products and services from those of their competitors. By understanding the needs of the customer base and the overall size of the market, businesses can develop products and services that are more tailored to the needs of consumers. This can give businesses a competitive edge and help them to attract more customers and increase sales.

For example, a business that streams reality TV shows orientated towards fashion lovers might attempt to diversify its market share by creating shows that follow famous sportsmen. This allows them to stand out.

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