This article is part of our Market Research Series “Assessing Market Potential with TAM, SAM, and SOM”
- Why are TAM, SAM, and SOM important and examples of how to assess market potential.
- How to calculate TAM, SAM, and SOM in multiple ways, from top-down to bottom-up, including examples.
Calculating TAM, SAM, and SOM requires a detailed approach using various data sources and analytical methods. Each metric is built from specific assumptions and calculations.
Required Basic Data for Calculations
The following is an overview of the basic data you would need to start with your calculations:
- Population Data: Demographic and geographical data to define the universe of potential customers.
- Penetration Rates: Estimates of what percentage of the population could reasonably be expected to purchase the product.
- Usage and Purchase Frequencies: How often the average customer will purchase or use the product.
- Pricing Information: Average sale price per unit or service.
- Distribution Capability: Physical and logistical capabilities to reach different market segments.
- Competitive Landscape: Current market share of existing entities and competitive strengths.
By combining these methodologies and formulas with specific market and internal company data, you can derive precise estimates for TAM, SAM, and SOM, which are critical for strategic decision-making and prioritization in business development.
We’ll guide you through this process, focusing on empirical data and systematic analysis, to equip you with the skills to perform grounded, strategic market assessments essential for business leadership and decision-making:
- How to calculate TAM, SAM, SOM
- Explanation of the methods, variables involved,
- How to source reliable data for making strategic business decisions.
Methodologies to Calculate TAM
Total Addressable Market (TAM) represents the entire revenue opportunity available for a product or service if 100% market share were achieved. It's used to estimate the potential scale and viability of a market segment a business might consider entering. Read Understanding TAM for an introduction to TAM, the variables for calculating and sourcing reliable data.
There are generally two primary methods to calculate TAM:
- Top-Down Analysis
- Bottom-Up Analysis
We add a 3rd approach:
- TAM Analysis based on Value
Top-Down TAM Analysis
Uses industry reports, market research data, and economic indicators to estimate the total market size. This approach takes broad market data and narrows it down using relevant segments.
Formula: [ \text{TAM} = \text{Total Population} \times \text{Penetration Rate} \times \text{Average Revenue per User (ARPU)} ]
Top-Down Analysis Example: Estimating the TAM for Electric Vehicles (EVs) in the United States
By using this top-down analysis, you begin with a general understanding of the entire vehicle market and progressively refine it using specific data pertinent to electric vehicles. This provides a realistic estimation of the market size that your business could potentially address, assuming ideal conditions of market penetration and growth.
Gathering Broad Market Data:
- Obtain data on the total annual sales of all vehicles in the U.S. Assume this number is 17 million vehicles per year based on industry reports.
Identifying Relevant Segments:
- Focus on segments relevant to electric vehicles, such as the percentage of consumers interested in green technologies and the growth rate of EV sales. Assume market research shows that 30% of new car buyers are considering electric vehicles.
Applying Penetration Rates:
Use the penetration rate to narrow down the total market. In this case, if 30% of the 17 million potential car buyers are considering EVs, the market for EVs can be calculated as:
[ \text{TAM for EVs} = 17,000,000 \text{ vehicles} \times 30% = 5,100,000 \text{ vehicles} ]
Refining with Economic Indicators:
- Factor in economic indicators like consumer spending power, federal and state subsidies for electric vehicles, and trends in fossil fuel prices that might influence buying decisions. Assume an economic report predicts a 5% annual growth in consumer spending on environmentally friendly technologies.
Calculating Final TAM:
Adjust the initial TAM based on the growth rate:
[ \text{Adjusted TAM for EVs} = 5,100,000 \text{ vehicles} \times (1 + 5%) = 5,355,000 \text{ vehicles} ]
Top-Down Analysis involves estimating the Total Addressable Market (TAM) by starting with macro-level data and refining it with specific market or demographic factors to arrive at a relevant market size.
Bottom-Up TAM Analysis
Builds the market size estimation starting from the smallest unit (like customer or transaction) and scaling up using potential customer counts and average sales figures.
Formula: [ \text{TAM} = \text{Number of Customers} \times \text{Usage Rate per Customer} \times \text{Price per Unit} ]
Bottom-Up Analysis Example: Estimating the TAM for a Cloud Storage Service
This bottom-up approach leverages specific, actionable data from the smallest relevant unit (in this case, the storage needs and purchasing capacity of a single small business) and scales it up to the total market level. This method is often more accurate in markets where the business has direct sales interactions and clear visibility into customer behavior, allowing for precise estimates based on real-world data.
Identifying the Unit Basis:
- Start with the average amount of cloud storage space a typical small business purchases. Assume from sales data that this is approximately 1 terabyte (TB) per customer per year.
Pricing the Unit:
- Determine the average price per TB per year for cloud storage services. Let's say the average price is $300 per TB per year.
Estimating Potential Customer Count:
- Calculate the number of potential small business customers. For instance, market research indicates there are about 30,000 small businesses in your target geographic area that could be interested in cloud storage services.
Calculating TAM:
Multiply the number of potential customers by the average purchase size and the price per unit to estimate the TAM.
[ \text{TAM} = 30,000 \text{ small businesses} \times 1 \text{ TB per business per year} \times $300/\text{TB} = $9,000,000 \text{ per year} ]
Bottom-Up Analysis calculates the Total Addressable Market (TAM) by starting with detailed, granular data at the individual customer or transaction level and aggregating upwards to estimate the entire market size. This method focuses on actual sales data and direct customer interactions to build a realistic market view.
Value Theory TAM Analysis
Estimates market size based on the perceived or derived value of the product to the market rather than traditional metrics.
A formula for Value Theory TAM would involve estimating how much value customers perceive in the product and how this translates into willingness to pay. Multiply the estimated number of customers by the average willingness to pay, adjusted for adoption rates.
Formula: [ \text{TAM} = \text{Number of Target Customers} \times \text{Average Willingness to Pay} \times \text{Adoption Rate} ]
Value Theory Example: Estimating the TAM for a New Pharmaceutical Drug
Value Theory in market size estimation involves calculating the Total Addressable Market (TAM) based on the perceived or derived value that a product or service offers to potential customers, rather than on traditional metrics such as unit sales or market penetration rates. This method focuses on the economic benefit or utility that the product provides, which in turn can justify a premium price or higher market adoption.
Defining the Product Value:
- Consider a new pharmaceutical drug designed to treat diabetes more effectively than current options. The value of this drug could be defined in terms of its ability to reduce medical complications, lower healthcare costs, and improve quality of life for patients.
Quantifying Economic Benefits:
- Calculate the average cost savings per patient by using the drug instead of existing treatments. Assume research shows that the drug can save $2,000 annually in other healthcare costs per patient.
Identifying the Target Population:
- Determine the number of diabetes patients in the target market who could benefit from the new treatment. Assume there are 1 million diabetes patients in the target region.
Calculating TAM Based on Value:
Multiply the number of potential customers by the economic benefit per customer to estimate the TAM.
[ \text{TAM} = 1,000,000 \text{ patients} \times $2,000/\text{patient per year} = $2,000,000,000 \text{ per year} ]
This value-based approach emphasizes the added benefits of the new drug in terms of cost savings and improved health outcomes, rather than just sales potential based on population and penetration rates. It’s particularly useful in industries like healthcare, where the product’s value can be translated directly into cost savings for the healthcare system and improved patient outcomes, leading to a willingness to pay a premium for such innovative solutions.
Methodologies to Calculate SAM
The Serviceable Available Market (SAM) is the portion of the TAM targeted and reachable by a company's products or services, within its geographical reach and sales channels. SAM is a more practical measure than TAM as it reflects the realities of what a business can actually service given its current business model and market constraints.
Segmentation of TAM
Identifies and quantifies only those segments of the TAM that are within your operational reach or serviceable range due to product features, regional boundaries, or regulatory environments.
Formula: [ \text{SAM} = \text{TAM} \times \text{Percentage of TAM Serviceable} ]
Segmentation of TAM Example: Mobile Payment Services in Southeast Asia
This process segments the broad TAM to focus on reachable markets, aligning market size estimates with the company’s operational capabilities and market presence.
Identifying the Overall TAM:
- Assume the overall TAM for mobile payment services in Southeast Asia is calculated at $50 billion, considering all potential users and transactions.
Segmenting the TAM:
- Narrow this TAM to specific countries where your company is licensed to operate, such as Thailand, Malaysia, and Singapore. Suppose these countries represent 60% of the overall Southeast Asian market for mobile payments.
Further Refinement:
- Consider only urban populations with access to smartphones and banking services, as your mobile payment product targets this demographic. Assume this urban, banked, and smartphone-owning segment constitutes 70% of the populations in these countries.
Calculating Segmented TAM:
- The Serviceable Addressable Market (SAM) can be derived as follows:
[ \text{SAM} = $50 \text{ billion} \times 60% \times 70% = $21 \text{ billion} ]
Segmentation of TAM involves refining the Total Addressable Market by focusing on specific market segments that are realistically accessible to a company based on product features, geographical boundaries, and regulatory conditions.
Adjusted Market Size
Factors in adjustments based on company’s distribution channels, logistical capabilities, and geographical presence.
Adjusted Market Size Example: Specialty Coffee in the United States
This refined estimate provides a realistic view of the market that the company can actually service, taking into account specific operational limitations and geographical coverage. This ensures that the business strategy is grounded in practical realities rather than theoretical maximums.
Initial SAM:
- Assume the SAM for specialty coffee drinkers in the U.S. is $10 billion, based on your targeted demographic of urban consumers with high disposable income.
Adjustments for Distribution Capabilities:
- If your company’s distribution network covers only the East Coast, which represents 35% of the potential specialty coffee market in the U.S., adjust the SAM accordingly.
Further Logistics Considerations:
- Additionally, if your delivery capabilities can effectively reach only 80% of coffee shops and retail outlets in this region due to logistical limitations:
Calculating Adjusted Market Size:
- The Adjusted Market Size (practical market your company can serve) is calculated by further refining the SAM:
[ \text{Adjusted Market Size} = $10 \text{ billion} \times 35% \times 80% = $2.8 \text{ billion} ]
Adjusted Market Size takes the SAM and refines it further by considering the company's specific logistical capabilities, distribution channels, and geographic presence, providing an even more focused estimate of the market size that is realistically serviceable.
Methodologies to Calculate SOM
Market Share Approach
Estimates the market share achievable within the SAM based on competitive analysis, market readiness, and company capabilities.
Formula: [ \text{SOM} = \text{SAM} \times \text{Expected Market Share} ]
Market Share Approach Example: Streaming Service in Europe
This method provides a focused target for operational planning and marketing efforts, reflecting realistic expectations based on competitive dynamics and internal capabilities.
Calculating SAM:
- Assume the SAM for streaming services in Europe is calculated at $5 billion, targeting urban populations with broadband access.
Competitive Analysis:
- Analyze market competition, recognizing major players like Netflix and Amazon Prime. Suppose competitive analysis suggests you can secure 10% of the market, given your unique content offerings and localized pricing strategies.
Market Readiness and Capabilities:
- Assess market readiness for new streaming options and your company’s marketing strength and technological infrastructure.
Calculating SOM:
- Using the Market Share Approach, the SOM can be estimated as follows:
[ \text{SOM} = $5 \text{ billion} \times 10% = $500 \text{ million} ]
The Market Share Approach to estimating the Serviceable Obtainable Market (SOM) involves calculating the portion of the Serviceable Addressable Market (SAM) that a company can realistically expect to capture. This calculation takes into account the company's competitive positioning, market readiness, and operational capabilities.
Sales Data Projections
Utilizes historical sales data, pilot markets, or initial sales periods to project future market capture.
Sales Data Projections Example: Eco-Friendly Household Cleaners in the U.S.
This method uses concrete sales figures from a controlled environment to project broader market potential, providing a basis for scaling operations and investment with a clearer expectation of revenue.
Pilot Market Testing:
- Suppose a new range of eco-friendly cleaners was initially launched in a pilot market in California. Sales data from the first six months show $1 million in revenue.
Scaling to National Market:
- If the pilot market represents approximately 10% of the potential national market based on demographic and lifestyle alignment:
Projecting Sales Data:
- Project the national sales based on the pilot market success. Assume the same market conditions and consumer behavior scale nationally:
[ \text{SOM} = $1 \text{ million} \times 10 = $10 \text{ million} ]
Sales Data Projections estimate the Serviceable Obtainable Market (SOM) by analyzing historical sales data, results from pilot markets, or sales during initial launch periods. This approach provides data-driven insights into market capture and growth potential.
