STEP-BY-STEP GUIDE ON CALCULATING MARKET SIZE – TAM / SAM / SOM
With the enthusiasm that comes with beginning a new startup and estimating the profitability of its sector or anticipating sales goals for the startup, one must remember to ground these numbers in reality. If not done, then one risks entering a market with insufficient information on the market size or setting unrealistic sales goals for the company.
What is Market Sizing?
It involves estimating the number of end-users that might purchase goods and services; it entails using estimations to determine the probable market transaction volume and sales proceeds. It is important to determine the size of a market of a particular industry, in order to decide whether an enterprise’s idea is feasible or not.
CALCULATING MARKET SIZE – TAM /SAM /SOM
Defining the Target Market:
To forecast market size, one must first identify the target customers. The company’s product must meet a ‘need.’ It must tackle an issue in a unique way for a population. It is important for a company to first understand how it will gain access to customers, keeping in mind the competitive advantage – as it would be pointless to think about them if they cannot be reached affordably.
Market segmentation divides the market into distinct groups, which allows having a better knowledge of each target group. It allows a company to customize the product to the unique requirements of that group and determine the market segments that exist. In the end, the company may decide on what aspect to concentrate, in order to expand itself.
Total Addressable Market:
The overall market demand for goods or services is referred to as the Total Addressable Market. TAM is a critical indicator used by startups and established businesses to determine the potential addressable market based on overall sales and revenue. When a company is launching a new product or a new consumer segment, TAM assists in reducing these figures down to more manageable proportions (reducing cash burns). TAM is calculated through critical market research.
TAM = Total number of potential customers x Average product price
TAM may be calculated in three ways –
Top-down Analysis
This strategy follows the elimination approach, beginning with a huge population that the company is targeting, and then refining it down to specific market groups. Top-down analysis can be represented by an inverted pyramid, with the overall population at the top, and the specific market at the bottom. This form of study is primarily based on market research, but for a more detailed analysis, the study should be reinforced with other evaluations such as phone and email surveys.
Bottom-up Analysis
The bottom-up strategy is primarily based on first-hand market research, as it is more dependable. It makes use of a more trustworthy data collection method for actual product consumption and pricing. A bottom-up TAM study forces researchers to consider precisely how the product is a marketplace fit. Thus, the TAM number is based on a more solid understanding of exactly what makes the product marketable. The TAM could also be divided into numerous geographical regions or industry groups to demonstrate one’s strategy to market dynamics.
Value theory Analysis:
Value theory analysis relies on assumptions and educated guesses, making the TAM conclusions ambiguous, yet helpful. It evaluates how much value the product offers to customers and how much of that value may be incorporated into product pricing.
For example:
Let us look at a startup in the Electric Scooter market.
To determine the TAM for this startup, the startup should first determine the total number of consumers in the specific region (say, New York) that are willing and able to pay for the product. As for this example, let us assume that 4 lakh potential consumers are willing to pay for an electric scooter. Then, the startup must determine the average spending per customer on the electric scooter (say USD 2,000). Now, multiply 4 lakh clients with USD 2,000, in order to achieve the Total Addressable Market, the startup seeks.
Serviceable Available Market
The serviceable available market relates to the number of buyers a company is able to reach; it is the number of users who fall inside the geographic, demographic, and psychographic groups which the company is targeting.
For example:
In the TAM example, the company considered the whole NY electric scooter market. Assuming only 50% of the 4 lakh customers fit the criteria of the company, who are ready to pay an average of USD 2,200 per electric scooter – Thus, the SAM is of USD 440 Million.
SAM = Target segment of TAM x Average product price
Serviceable Obtainable Market
In a perfect scenario, the company’s product would have a 100% market share. However, this is not practical. The Serviceable Obtainable Market, or SOM, indicates how many customers a company can actually achieve. SOM is mainly helpful in determining short-term company goals. Simply defined, it is computed by multiplying last year’s market share by this year’s SAM.
For example:
Continuing with the same example – Suppose, the electric scooter start-up has generated USD 7 Million in Revenue last year, depicting the market share to be at 1.59% (SAM = 440 million). Assuming a 15% annual growth on the SAM , this figure will reach USD 506 Million for the current year.
Thus, in order to calculate the CY Serviceable Obtainable Market, we conjugate the startup’s previous year market share (1.59%) with the current year SAM (USD 506 Million).
As a result, the startup has a Serviceable Obtainable Market of USD 8.04 Million in the current year.
SOM = Market share of previous year x SAM for the current year
Thus, TAM, SAM, and SOM can be valuable metrics for early-stage companies and investors when estimating a company’s revenue potential, and market size.
