Measuring a market is a basic essential for any business, especially in today’s global world. If you are working in business now, you might be familiar with the new foundational metrics: TAM, SAM and SOM. And if you’re not, you have come to the right place. In this article, we will explore what these metrics measure, how they’re used and why they are important.
The TAM, SAM and SOM are different sub-categorizations of a market:
The Total Addressable Market (TAM), also known as the total available market, is a measure of the how much revenue your product or business can accomplish, if your product or business were able to capture the total possible market share or customer base.
For example, let us take two fictional businesses: a café business based in France (“Café Bredoteau”), and a China-based homeware and furniture marketplace (“Home2Home”).
The TAM of Café Bredoteau would be, the European café industry, and for Home2Home, it would be the Asian furniture and homeware industry.
In these examples, we can picture both businesses’ TAMs as such, relative to their global markets:
For a businessperson, measuring your TAM is akin to asking, what is the total possible market size of my business’ or product’s space?
After contemplating or calculating your TAM, comes the contemplation of limiting factors. Naturally, every product, business and even idea comes with certain natural limitations. The most natural limitation, for example, is geography (even for digital businesses).
The market your product and/or business can actually serve, after identifying your limitations, is called the Serviceable Addressable Market (SAM).
Some of the factors that limit any product or business can include:
Returning to our examples, let’s evaluate their SAMs:
Café Bredoteau’s SAM would be the French café industry market (where the business is located); and Home2Home’s SAM would be the Chinese homeware and furniture industry market (where the business is located).
For a businessperson, measuring your SAM is akin to asking, what is the total market size that my business or product can serve?
As the diagram at the beginning of the article suggests, the final and most compact of the market sizing metrics is the Serviceable Obtainable Market (SOM). This is the percentage of the SAM that can realistically be achieved, and ideally - captured. This takes into account your business’ service and/or product comparative advantages, location and market nature.
Following on our examples, Café Bredoteau’s SOM would be café-goers in Paris; Home2Home’s SOM would be homeowners, renters and students in Shanghai.
This process of qualifying these subsets within the industry of your business necessitates ongoing market research that will allow you to understand the proportions of each area.
Market sizing is inherently an estimate, but it can be done with a degree of calculated accuracy. There are 2 methods that are commonly used to calculate the market size, based on these three categories:
The top-down method moves from TAM, to SAM, then SOM, and does so via the process of elimination. We start by taking a given size of a large population, which comprises the target market and steadily narrowing down via qualifiers, to a specific market segment. The top-down analysis follows the concentric circle diagram at the beginning of this article: from the largest size, we narrow down to a smaller population by using market research in the form of industry reports to serve as estimates, or assumptions.
Using our Café Bredoteau business as an example, we know from public sources that the global coffee shop market is estimated at around US$198.8 billion, of which the European market constitutes about 20%, so US$39.8 billion (this is our TAM). We know from public sources that France’s market share in the European coffee shop market is around 8%, so the SAM is therefore around US$3.2 billion. Café Bredoteau is located in Paris which research shows holds one-fifth the coffee shop spend in France, so the SOM is estimated to be around US$636 million. So the addressable market is around US$640 million.
Clearly these are very broad parameters, and the SOM that results will be strongly resultant from the nature and bases of the assumptions that are used, which themselves are also up to the reader’s discretion. This is why many investors inquire as to sources of assumptions, in order to understand projections.
Whereas the Top-Down approach tries to move from TAM to SOM, the bottom-up approach is typically lauded as more accurate as it moves directly into calculating the SOM. Thus, it is more direct, especially for evaluating the actual market that a new business, product or service is meant to target.
Using the bottom-up approach is more reliable because typically, it uses primary market research and more reliable data on the current pricing, product usage and consumer behavior. Returning to our example of a French café, we can use the following assumptions:
So the SOM estimate would be US$651 million (which is not very far from our top-down calculation, but arguably more justifiable).
The advantage of using a bottom-up approach is that the company can explain why it selected certain customer segments and left out others. The company relies on data from its research or survey and, therefore, the addressable market would be more relevant and accurate rather than when relying on inarguable data.
For very nascent, or less formal, business sectors, an alternative is to sum all the revenues of all comparable/competitor firms, if such information is available. This is useful when there are few competitors operating in the space.
Whether it is to forecast revenues or run scenarios, financial modeling is an integral part of any business. The SOM is particularly important in building the growth forecast for a company, especially for its revenues.
The more that your financial model is based on credible and verified information, sources and assumptions, the more realistic that your outputs will be and the more buy-in – literal and figurative – you will have from your investors. Aggressive goals are great; however, without the benchmark of current market metrics – such as the SOM – claims of seizing 30% of market share, when you only hold 0.3% of the market, are just not feasible – maybe even outright laughable.
Even the most aggressive and effective business will not be able to fully capture the SOM, hence the need for a realistic market size percentage as the basis of the growth assumption. This “sanity check” against a realistic market size will provide a credible forecast for what revenues can be expected.