What Total Addressable Market (TAM) Is & How to Calculate It

What Is Total Addressable Market?

Total addressable market (TAM) is the amount of annual revenue your business would earn if you achieved a 100% market share.

In other words, it's an idealistic number representing all the money you'd make if everyone who could possibly buy your product or service did buy it.

You can arrive at your total addressable market using the following formula:

TAM = number of potential customers in your market x average revenue per customer

There are a few different ways to determine both components. We'll go over those later in this article.

The Difference Between TAM, SAM, and SOM

TAM represents the total market demand for your product or service if you achieved a 100% market share.

Service available market (SAM) is the demand for your product or service within the portion of the market you're capable of serving based on factors like geographical reach, product/service limitations, and regulatory restrictions.

Service obtainable market (SOM) is the demand for your product or service within the portion of your market that you can realistically capture based on factors like competition, marketing reach, and budget.

Let's illustrate these concepts using a company that makes project management software for small- and medium-sized businesses as an example.

• The TAM for this company will be based on all small- and medium-sized businesses worldwide
• The SAM would be based on the portion of that group the company is able to serve. Like only businesses in the U.S.
• The SOM is based on who the company can feasibly acquire among those U.S. small- and medium-sized businesses. Perhaps they use historical data and determine that's 15% of the total market.

Why Is It Important to Understand TAM?

There are a few reasons why you should look at total addressable market before or even after launching your business:

• It validates your idea. For soon-to-launch companies, TAM helps confirm whether your product or service has a large enough market value to support your business. A substantial TAM proves there's real demand for what you're offering.
• It conveys market potential to investors and stakeholders. Investors and stakeholders want to know a business's growth potential. Having an understanding of TAM helps you communicate the possible returns to attract funding or secure buy-in for decisions.
• It informs your resource needs. Knowing the market's size and revenue potential helps you make decisions about how much to invest in things like product development, marketing campaigns, and sales efforts

How to Calculate Total Addressable Market: 3 Methods

There are three main approaches to calculating TAM:

Top-Down Approach

The top-down approach to determining TAM starts with the global number of customers, narrows that down to your actual market based on your most basic criteria, and multiplies that value by your average revenue per customer.

Effectively, you need to rely on third-party sources like industry reports to narrow down to your actual market.

A top-down approach looks like this:

1. Identify the total number of potential customers
2. Determine how many of those customers actually fall within your market based on industry reports or other insights
3. Calculate your average revenue per customer (or your estimation of it)
4. Multiply the number of customers in your market by the average revenue per customer to get your TAM

Let's say you're launching a new project management software for small- to medium-sized businesses. You start with finding the total number of businesses in the world-perhaps that's 400 million.

You then narrow it down by focusing only on those that are small- to medium-sized businesses-let's say that's 350 million.

And you expect the average customer will spend $1,000 per year on your software.

So, your TAM would be:

TAM = 350 million x $1,000 = $350 billion

Advantages of a top-down approach:

• Provides a quick and easy way to estimate the overall market size and opportunity
• Useful for early stage startups where internal performance data may not be available yet

Disadvantages of a top-down approach:

• Relies heavily on secondary data, which can be outdated or inaccurate
• The final TAM estimate may be inflated if your market isn't refined enough

To simplify finding the information you need, use Semrush's Market Explorer tool. Which lets you search data for up to 110 markets and automatically gives you an estimated population you can use to calculate your TAM.

Bottom-Up Approach

The bottom-up approach to calculating TAM uses your company's internal data about revenue based on current customers and expands it to a larger group of potential customers to estimate the overall market value.

Here's how this approach works:

1. Determine your current number of customers
2. Identify your annual revenue
3. Calculate your average revenue per customer by dividing annual revenue by the number of customers
4. Estimate the total number of potential customers in your market by conducting research
5. Multiply your average revenue per customer by the total number of potential customers to determine your TAM

Imagine you offer a B2B SaaS product to law firms.

You currently have 50 law firms as customers. And these customers have generated a total annual revenue of $125,000. That means your average revenue per customer is $2,500 ($125,000 / 50).

After thorough research, you estimate there are roughly 100,000 law firms in the entire market that could potentially use your software.

So, your TAM would be:

TAM = $2,500 x 100,000 = $250 million

Advantages of a bottom-up approach:

• Provides more accurate estimates because it's based on real sales data
• Can be more convincing to investors for the same reason

Disadvantages of a bottom-up approach:

• Requires existing sales data, which may not be available for startups
• May not account for potential market expansions or pivots in the business model

Value-Theory Approach

The value-theory approach calculates TAM by estimating how much customers are willing to pay for your offering based on the value it provides and applying that to the total number of people you think could be in that market.

Here's how you can use this approach to estimate your total addressable market:

1. Start by identifying the problem your product or service solves
2. Quantify the value of solving this problem for a single customer
3. Estimate how much customers would be willing to pay for your solution
4. Estimate the total number of potential customers with this problem by conducting research
5. Multiply the estimated price by the number of potential customers

For example, imagine you're starting a new AI-powered inventory management system.

The problem it solves is inefficient inventory management that leads to running out of stock and/or overstocking. You might estimate that it saves an average retail store $50,000 annually.

Assuming retailers would be willing to pay at least $4,800 per year for this solution, you price it at that.

If you conduct research and determine there are 100,000 retail stores that could benefit from your software, your TAM would be $480 million ($4,800 x 100,000).

Advantages of a value-theory approach:

• Useful for truly innovative products or services that can't rely on historical data
• Focuses on the actual value delivered to customers, which can be important for investors
• Helps in developing a pricing strategy

Disadvantages of a value-theory approach:

• Relies heavily on assumptions about the value provided and customers' willingness to pay
• May overestimate the market if the value proposition isn't accurately assessed
• Doesn't account for factors like competition, market adoption rates, or pricing sensitivity

Get the Insights You Need to Succeed in Your Market

TAM is an important metric for understanding the potential your market offers, so every business should pay attention to it.

One of the easiest ways to calculate your total addressable market is by using Semrush's Market Explorer tool.

Open the tool, click on the "Analyze Category" tab, and choose your target industry or niche.

Then, click the "Research a market" button.

(Alternatively, you could choose the "Create List" option and enter a few competitors' domain names to proceed.)

The tool will give you an estimate of your total addressable market's size. Which you can then multiply by your average revenue per customer to get your TAM.

Plus, it includes a lot of other valuable insights. Like who the key players are and what the audience is like.

Try it today.

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