Evaluating what’s known as TAM, SAM and SOM can be one of the more confusing concepts in startup land, but it needn't be. In fact, in one sense, I wouldn't dispute varying definitions and interpretations, so long as you use them consistently and insightfully.
Conceptually, these evaluations are built on the total amount of money spent by the entirety of your potential customers.
This takes into account your direct and indirect competitors. It reflects the value of the problem felt by customers but, very importantly, it helps you to identify (with unit economics) the unit level of customers who have the problem your business is trying to solve.
TAM - Total Addressable Market
This is the value of the market if every buyer in the world, that had the problem that you can solve, paid for a solution. Any solution!
If my product addresses a large company's need to link their CRM with their financial accounting tool, then my TAM is the value spent by all companies in the world on linking their CRM tools to their financial packages.
It is not the CRM market value from Gartner. Nor is it the value of all accountancy service providers
Ideally, you might estimate the number of companies who have large CRM systems installed
- and you can assume that all of these have large financial packages
- and you can probably assume that 80 per cent (Pareto) might want to link the two
so now you can estimate a unit level number of companies who reflect the total market value.
You could then understand the potential value of your market, by multiplying the number of customers by the possible price of your product. That does not account for the fact that the price you place on your product could be wrong – it is almost always undervalued. While this wouldn’t be your TAM, if it was identified as this calculation, we could then be able to apply the same insight.
SAM - the Serviceable Addressable Market
This is how many of these customers that can be reached, taking into account geography, language, resources, product definition etc. Each of these qualifiers needs your insight and research. Again, the numbers could be wrong, but your underlying logic is the important part.
If you are, for example, planning to use resellers or platforms in your distribution, you should be aware of that in your unit economic business modelling at this stage.
For example, if my product is built for the Salesforce platform, I cannot target more than the 150,000 companies who are using Salesforce. So my SAM is therefore smaller than the TAM, taking into account this segmentation, geographic access, language barriers etc.
While big numbers are important for investor economics, too big a number steals your credibility
SOM - the Serviceable Obtainable Market
This is the market I intend to capture within a set period of time, with either my current resources or the resources and investment I am currently pitching for. This might look like a revenue target that your business plan suggests you will achieve. It shouldn’t be more than three years as it becomes far more difficult to estimate figures over a longer term. Your short-term pitch should demonstrate both ambition, insight and a route to market. It should also feature a strategic plan that will enable you to get there.
This calculation is much closer to a defined number of customers, multiplied by the price you intend to charge.
Furthermore, don’t confuse SOM and Beachhead – even though they reflect the same thing.
- SOM is a value/monetary statement
- Beachhead is a description of a group of customers with similar characteristics that make it slightly easier to market and sell to them.
We have now built a TAM from comprehensive top-down market knowledge, and a SOM from ground-up unit economics.
What makes your company worth €250 million?
This is built on the value that customers are spending to solve the problem you address, and it understands the unit number of possible customers
Your insights that lead you to (i) identify TAM and then (ii) slice to SAM and then (iii) plan to achieve SOM are more interesting than the raw numbers.
While big numbers are important for investor economics, too big a number steals your credibility. On that note, consider an investor point of view.
If they have a €100 million VC fund, the VC maths are that they would hope to invest about €5 million in your company and end up with about 20 per cent equity.
They hope for 10x return so hope to get €50 million back, which implies a valuation of your business of €250 million (note, very simplified portfolio economics in play here).
What makes your company worth €250 million? About €50 million in sales, in approximately seven years’ time.
That means you probably have to achieve sales in year 1 of €500,000, year 2 of €1.5 million, year 3 of €3 million, year 4 of €6 million, year 5 of €12 million, year 6 of €24 million and year 7 of €50 million.
Bringing this blog to a close, what is your TAM/SAM/SOM, i.e. your available market, that makes €50m sales in 7 years’ time credible?