Total Addressable Market

What is the total addressable market?

Total addressable market (TAM, in German Gesamtmarkt or adressierbarer Gesamtmarkt) describes the annual revenue that would arise if an offering won all customers with the matching need. It describes a theoretical upper limit at a market share of 100%, regardless of whether the company can reach these customers with its present product, language versions or sales organisation. In the common delimitation, TAM is meant worldwide. Less often the abbreviation is expanded as total available market; the same thing is meant.

TAM is the top of three levels of market sizing. Beneath it lie the serviceable addressable market (SAM), the part that can be served with the present offering, and the serviceable obtainable market (SOM), the part that can actually be won in a given period. A bakery makes the levels tangible. What all households together spend on bread each year would be its total market. The bread spending of households in its delivery area forms the serviceable market. Of that, the obtainable part is the revenue of the households that it really wins as regular customers over the next years.

TAM appears in the market chapter of the business plan, on the market slide of the pitch deck (the presentation for investors) and in the information memorandum, the detailed sale document for prospective buyers. There is no legal or standardised definition. The figure becomes meaningful only when delimitation, sources and reference year are disclosed.

Delimiting TAM by need

TAM is determined by the need that an offering meets, not by the industry to which the provider belongs. For a provider of maintenance software for manufacturing plants, neither the worldwide software market nor the market for enterprise software is a sensible reference. The question is which organisations have the problem that the product solves and what they would spend annually on a solution.

Three specifications follow from this, which should accompany every TAM statement:

• Customer unit: whether companies, sites, users or devices are counted. The unit must fit the pricing model; anyone who charges per site counts sites, not corporate groups.
• Price: the average achievable annual value per customer unit after discounts, not the list price.
• Reference area and reference year: worldwide or expressly limited, in each case with the year to which customer numbers and price relate.

Some companies limit TAM to the regions in which their business model can in principle work, for example because of the same legal position. This is defensible as long as the limitation is named openly and carried through in the calculation. Not defensible is a definition based on the world market that is then calculated with the figures of a single region.

Calculating TAM: formula and sources

Formula: TAM = number of potential customer units × average annual revenue per customer unit

This calculation from below (bottom-up market sizing) is verifiable because both factors can be evidenced individually. The number of customers comes from official statistics, trade associations, registers or company databases, the price from the company's own contracts or from published prices of comparable offerings. If prices differ greatly by customer size, the calculation is done per segment and the results are added.

As a cross-check, the calculation from above (top-down market sizing) is used, which starts from a published total and narrows it through shares. It generally measures today's spending of all customers with all providers, that is, the market volume. The calculation from below, by contrast, describes the market potential, that is, the revenue that would arise if all suitable customers bought. The two values may differ, but the difference must be explainable.

For recurring revenue models, TAM is stated as an annual value. One-off revenues such as set-up fees belong in only if they recur regularly, for example because customers renew their systems at fixed intervals. Otherwise the figure mixes ongoing revenue with one-off effects.

How investors and buyers examine TAM

First look in the pitch deck

Investors first use TAM as a filter for order of magnitude. Venture capital funds acquire minority stakes in young growth companies and expect that a few successful holdings bring the largest part of their return. They therefore ask whether the market can support a company whose later sale or stock market value alone brings back a large part of the fund. As a rule of thumb, a TAM in the billions applies there. Growth investors, family offices (managers of large family fortunes) and strategic buyers from the same industry pay more attention to how much growth is still possible in the existing segments.

On the market slide, investors usually check within a few minutes whether TAM, SAM and SOM are stated with customer unit, price, reference area and source and stand in a comprehensible relationship to each other. A single large figure without this information, such as the world market of an entire industry, is regarded more as a sign of imprecise delimitation than as a strength.

In-depth review in due diligence

Before a contract is signed, due diligence follows, the thorough review of the company. There, investors recalculate the derivation from the appendix or the data room. Three points are in the foreground. For sources, the question is whether the number of customers and the price are evidenced and from which year they come. For delimitation, it is checked whether the need by which the market is defined fits the product and whether overlaps between sub-markets have been cleared. For plausibility, finally, what counts is whether TAM, SAM and SOM form a chain whose last stage matches the financial model, the planning calculation for revenue, costs and liquidity.

In a company sale, TAM serves as evidence of growth reserves after the acquisition, for example in new regions or segments. Buyers have such statements checked in a commercial due diligence, which examines market, competition and customers, often with their own customer interviews. In the purchase price they generally take into account only the growth that is backed by customer numbers and prices.

Worked example: calculating TAM

A hypothetical provider develops software for planning maintenance and repair in manufacturing plants. All figures are freely chosen and do not describe a real market. The same example market underlies the worked examples for SAM and SOM.

• Potential customers worldwide: 400,000 manufacturing plants with their own maintenance
• Average list price: EUR 15,000 per year, average discount 20%
• Average annual value achieved: EUR 15,000 × 0.8 = EUR 12,000
• TAM: 400,000 × EUR 12,000 = EUR 4.8 billion per year
• Calculated at list price: 400,000 × EUR 15,000 = EUR 6.0 billion, that is, EUR 1.2 billion or 25% too high
• For comparison: SAM EUR 144 million, which is 3% of TAM; SOM after three years around EUR 4.4 million, which is around 0.09% of TAM

The example shows the limit of what the figure can tell. A TAM of EUR 4.8 billion presupposes that the product works in all languages, for all plant sizes and with every ERP system. ERP systems are the enterprise software for purchasing, warehousing, production and accounting. None of these conditions is met today. For valuation, therefore, TAM matters less than the question of which part of it can be moved into the serviceable market with what investments.

Distinctions: TAM, market potential and market volume

• Market potential: a term from German marketing theory that is used in market analysis. Like TAM and SAM, it is a value at full penetration and can be formed for any delimited market; for the total market it corresponds to TAM.
• Market volume: the actual spending of all customers with all providers in a year. It is generally below TAM because not every organisation with the need is already buying a solution.

Common mistakes

• Industry instead of need. The market for enterprise software or for digitalisation is not a TAM for a product that solves a single task in a single target group. The figure becomes large and meaningless at the same time.
• Defined worldwide, calculated regionally. Anyone who defines TAM across all potential customers worldwide and then calculates with figures of one region is in truth stating a SAM. Definition and calculation need the same reference area.
• List prices. The average price actually achieved is regularly below list price after discounts and introductory offers. In the example, the list price overstates TAM by a quarter.
• Outdated studies. Market figures without a year or from surveys that lie several years back describe a different market. Anyone who extrapolates them must disclose the growth rate used.
• Double counting. If overlapping sub-markets are added or corporate groups and their sites are counted side by side, a market arises that does not exist.
• Total market as a revenue target. TAM describes a theoretical state. Anyone who derives a revenue share from it without passing through the SAM and SOM stages does not show where a single customer comes from.

Frequently asked questions

What is the difference between TAM, SAM and SOM?

The three levels narrow the market step by step. TAM covers all customers with the need, SAM only those that the company can serve with its present product, in its regions and through its sales channels. SOM is the part of SAM that it actually wins in a defined period with the planned resources; only it is a planning figure.

Must TAM always be calculated worldwide?

No. The worldwide version is common, but limiting it to certain regions is permissible if it is objectively justified and named openly. Definition and calculation must then use the same reference area, and SAM must represent a genuine narrowing relative to TAM.

How large must TAM be for venture capital financing?

There is no fixed minimum; the common rule of thumb names the billions. More important is whether a company in this market can reach a multiple of its present size. A small, narrowly delimited market with high profitability appeals more to growth investors, family offices or strategic buyers.

Can TAM grow?

Yes, in two ways. First, the need itself can grow, for example through new regulations, technical developments or a rising number of potential customers. Second, a company enlarges its TAM when it extends its offering to a further need; that is then a new delimitation, which must be labelled as such.

How is TAM presented in the pitch deck?

On a joint market slide with SAM and SOM, usually as three nested circles or as a funnel. For each level, the amount, customer unit, price and source with reference year belong. The detailed derivation belongs in the appendix or the data room, where investors can recalculate it.

The Roemer Capital view

In financing materials, Roemer Capital always shows TAM as the starting point of a chain, never as a single figure. The market slide carries TAM, SAM and SOM with customer unit, price, reference area and reference year; behind it lies a calculation sheet in the financial model from which each level can be traced.

Roemer Capital pays particular attention to which part of TAM is to be opened up with the capital raised: a further language version, a further segment, an additional interface. This turns the largest figure in the market analysis into an argument for the use of proceeds, that is, for the deployment of the capital. Investors can measure it against concrete assumptions in review.