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Do you know the art of calculating TAM SAM and SOM to derive the market size for your business? If not, this blog will help you derive complete knowledge about this subject.
Starting a new company comes with a lot of energy and enthusiasm. You may have also envisioned its success in the market and earning huge profits from it. For this vision to come true, you must have a fair idea of the market you are operating in – you will have to know the size of the market and the share you have in it.
When you know your market size and share, you can set a realistic revenue goal and forecast your profit potential.
If you are yet to find them, this guide will be of immense help. The guide discusses TAM, SAM, and SOM in detail – the three key metrics to calculate your market size and share.
Let us get started.
These acronyms sound quite interesting, aren’t they? They stand for –
The three metrics give you the necessary inputs about the market that you are operating in. They furnish the necessary details associated with the businesses’ market size and accessibility. This is also a key reason why these metrics serve as the key components of both – a business plan and an investor’s pitch. They are also important when drafting your marketing and sales strategies.
Let us now discuss each of the metrics in detail
TAM – the Total Addressable Market – the broadest metric of the three – refers to the maximum market demand for your product/ service. Taking a broader view, TAM gives you the figure of the maximum revenue you could generate in the market of operation.
The Total Addressable Market is extremely useful for businesses, especially B2B start-ups, as it provides insights into the market’s potential for growth. A critical point to remember is that TAM calculations do not consider constraints such as geographic boundaries, competition, marketing budgets, etc.
The TAM is the very first market calculation in a business case and is also an especially important piece of information when identifying new business opportunities. Venturing into a new business without knowing the number of people interested in your offering is baseless. At the same time, lacking the knowledge will make it extremely difficult to validate the revenue and growth assumptions.
While the Total Addressable Market (TAM) calculation paints quite a rosy picture of opportunity, it is important to understand that it is not likely for you to capture the entire market. For instance, you might have to share your market share with the competition, or your target audience might prefer an alternative product. Therefore, you should be considering SAM to narrow the market.
The Serviceable Available Market is the market segmentation metric that answers an important question “what part of your TAM is the most appropriate for you?” By taking factors such as geographical reach, production capacity, and diversification, SAM provides a fair, realistic estimate of the potential customers for your product or service. SAM provides you with the market percent that you should be addressing based on your business model.
SAM, a subset of TAM, eliminates irrelevant market segments your company will not be able to serve. As these segments are eliminated, the target market becomes narrow. At the same time, it also serves as a good reminder for evaluating factors such as competition, culture, resources, etc., impacting the business.
As SAM makes the target segment more precise, it also helps in enhancing the efficiency of the activities of your marketing & sales teams. Additionally, investors emphasize SAM as it highlights the business’ growth and success prospects in the market.
The Serviceable Obtainable Market (SOM) is yet another important part of the market segmentation analysis. SOM, also known as the Share of Market, is the subset of SAM and gives the most realistic estimate of the market share that the business can capture in the immediate future. The metric gives a short-term estimate, i.e., 3 to 5 years.
Serviceable Obtainable Market is a particularly important measure for organizations trying to establish their financial projections. SOM calculations also serve handy when making decisions related to the operations of the firm.
For instance, it makes it possible for businesses to create sales projections based on the potential market share that they may have. At the same time, SOM also helps businesses compare themselves with their competitors to analyze their position in the market. This could be useful when drafting strategies to position and set the business offering apart from competing products.
A Serviceable Obtainable Market is also helpful for identifying future growth possibilities and even the gaps in the market. It can also help come up with distinctive strategies the company could use to advertise its product and/or to create and launch new products. This aids investors in doing a more thorough analysis of each possibility.
As we have already discussed, calculating TAM, SAM, and SOM helps understand the market size and share. This makes it especially important for companies, especially start-ups, to know these values concerning their ventures. The quick formulas for calculating TAM, SAM, and SOM make this task easy.
Let us discuss these calculations
To calculate the TAM for your offering, it is advised that you start with a bottom-up analysis of the industry. Once this is done, multiply the total potential customers with the average annual revenue per customer.
Here is the formula –
Total number of accounts in the market * Annual contract value
The total number of accounts in the market can be gained through market research.
Annual contract value can be derived from the company’s customer data.
To calculate SAM, you should list out the TAM from a specific target market. The next step is to multiply the number by the average annual revenue generated by each customer.
TAM from specific target market * Annual contract value
To calculate SOM, you will have to divide your previous year’s SAM and multiply it by this year’s SAM.
Previous year’s Market Share * The current year’s SAM
Take the case of a start-up operating in the cloud services industry. To calculate the TAM of this company, start by counting the total number of businesses paying for cloud services (in the world). Imagine that there are 50 million businesses.
The next step is to find the average spending/customer in the market. If that is found to be about $2,000/year.
Now, you will have to multiply the two numbers to get your TAM, i.e., (50 million * $2,000)
To calculate the SAM, let us narrow down the target market – let us say that the start-up specializes in providing cloud services to companies in the Finance industry.
So now, you will have to identify the number of potential customers in this particular target segment. Say the number is 20 million of the 50 million counted for the TAM.
Now, let us consider that the average annual spend/customer is $3000/year for 20 million businesses.
Then the SAM = 20 million * $3000
Now, to calculate the SOM, you will have to list out the previous year’s sales of your start-up. Let us assume that the start-up generated $30 million in sales during the previous year. The next step will be to multiply it by the SAM of the current year.
To wrap things up, we re-iterate that “market analysis is essential for both existing companies as well as start-ups.” For start-ups seeking funding, investors use the TAM, SAM, and SOM as key metrics for evaluating market size and revenue potential. Such standardization lowers the possibility of misunderstanding, gives investors a statistical baseline from which to assess a business opportunity, and articulates the potential for short-, mid-, and long-term growth.
The SOM demonstrates the short-term potential of the company. The SAM/SOM ratio helps define the market share that the business aims for. Likewise, the TAM demonstrates the highest market potential.43
We have defined all three, i.e., TAM, SAM, and SOM, and we have also provided the formula to calculate the market size. So, start-ups… get to calculate your market size.
Rohan has over 11 years of experience in client services, marketing and hospitality field. Previously, he was head of digital marketing for a hi-tech mobile application. Rohan is driven by new challenges and the possibility of making an impact on individuals and businesses.
Published September 07, 2022, Updated October 28, 2022
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