Many businesses in growth mode want to understand how big their product can be. How many people, households, or customers are in their universe? How does the number compare between new and existing markets? Which should be invested in for growth?

The Total Addressable Market (TAM) is a way to put numbers behind a market opportunity for investors, prioritizing growth, and understanding how big a product or service can be. Calculating a TAM isn’t always difficult - it’s just a math exercise - but sourcing reliable, targeted information at the right level of geography to inform the numbers proves more challenging for business owners and operators.

When thinking about the TAM, business operators oftentimes want to know about how many customers are in the market and where they are, and investors want to know the corresponding dollar value of the market. Good trusted data helps answer both of these questions.

Number of Potential Customers

The number of potential customers is the first component of the TAM. This metric is sometimes straightforward, and other times requires assumptions and educated guesses to come up with a feasible number. Let’s look at a couple examples:

A food home delivery service is selling to households, a pet daycare catering to dogs is targeting households that own a dog, and someone selling into restaurants is looking at all restaurants as their addressable market.

In case of the food home delivery service, finding the number of households in an area represents the number of potential customers. For the pet daycare, we would need to estimate - or source data on - the percentage of households that own a dog, then apply that percentage to the number of households to get the number of potential customers. For the last example, we would be looking for the number of active restaurants operating in the area.

For consumer-facing businesses, common starting points for potential customers include:

• Population

• Households

• Housing Units

For B2B customers, the starting point might be:

• Number of Office Workers

• Number of Businesses (by certain industry and/or size)

• Number of Establishments

The number of potential customers might sometimes feel unrealistic - just because a person or entity exists doesn’t necessarily mean they’re in the market for your product. For example, every household with a pet won’t consider putting them in daycare - some will not be economically able to do so, others might be retired without the need for the service, and others in jobs that allow them or another member of the household to stay with the pet most of the day.

In these cases, it’s generally advisable to keep them in a total addressable market while also looking at additional metrics like a Serviceable Addressable Market (the universe of people that are likely to be using your product). The TAM is about how big your product and market can be, while other metrics better capture the segment of the market where your product has higher relevance and value.

This exercise gets trickier as you layer in more assumptions. In our pet example, we need to find a reliable estimate for the percentage of households that own a pet (or, more specifically, own a dog). What if our target market is dog owners that have at least $75,000 and go to work 3 or more days per week? Now we need to estimate the percentage that own a pet, and earn above that level of income, and are in an office job, and go to work 3 days or more per week. Sometimes good data exists to estimate these market segments, and sometimes it requires best estimates based on other similar data points.

You also have to consider the size of geography to use - do you plan to serve a city? County? Are you thinking broadly about state or regional expansion? A restaurant expecting to open one location may find a county too wide, but one with plans to blitz a market and open several locations may find a county to be just right.

When thinking about how to calculate your number of potential customers, we recommend:

• Find the right customer type - If you’re consumer-facing, consider whether households or population is a better starting point for you (or something else). If you’re B2B, which specific types of businesses are in your market (think industry and size of company)?

• Use targeted top-level filters - You don’t want to narrow your market too quickly, but you also don’t want to leave it overly broad. A pet daycare can’t serve households without pets, so that filter should be applied to create a more realistic total market. A pediatric dentist’s target market is best defined as the population 18 and under, and including the whole population isn’t the best representation of their target market.

• Create customer segments when applicable - When you have multiple distinct product lines, like consumer and business products, or high- and low-priced items, consider creating multiple market segments. Breaking out customer segments may create more reliable estimates than grouping all customer types together and also provide insights on which product lines could resonate better in different markets.

Revenue per Customer

Once you have the number of addressable of customers, the next step is to calculate the revenue available from those customers. This is oftentimes more relevant to investors than to business operators. Investors are generally interested in how much a company can grow - a total market size of $50M suggests that the company has lower growth upside than when the total market size is $100M. A business operator looking to grow their revenue from $5M to $10M may not be as concerned about the dollar size assuming there are enough customers to reach the revenue goal.

The revenue per customer calculation can be dramatically simplified or highly segmented.

Let’s start with a simple calculation - for our food home delivery service, if we sell weekly boxes that retail for $100, then our total addressable market - the available revenue in a given year - is number of households x $100 per box x 52 weeks per year. This is the simplest TAM - one price and one market group with no other assumptions.

In a more complex example, we can segment by customer type. A company might sell to both consumers and businesses - in this case, there will be multiple customer segments and multiple price points. One component of the TAM is the residential opportunity and the other is the commercial opportunity. Collectively they represent the company’s TAM.

An example of where this is relevant might be a restaurant that has both a catering and storefront business. In this case, they may want to know the opportunity for both the business and residential portion of their business. The storefront might include local office workers and surrounding area population, while the commercial catering may be the number of offices with 10 or more employees. The revenue per customer for the storefront might be the average ticket price, while the revenue per customer for catering will be the average catering bill.

Revenue per customer may seem straightforward - and oftentimes it is - but there are a couple nuances to take into account:

• Are you moving from a higher to lower cost-of-living market? If you start in New York City then go to Raleigh, NC, you won’t be able to charge the same prices. This should be considered in your market sizing.

• Do you have significant differences in product prices? If yes, it might make sense to do a more detailed total addressable market. If your prices all center around the same point, a simpler approach may do just fine.

• Has anyone sold anything similar before? Businesses in established industries with known price points can generally use their own data to estimate revenue, but when the market is new or the data opaque, look at similar competitor pricing or if the market is truly new and never-before-priced, provide a best guess based on your knowledge of the industry and target customer.

Resources and Tips

Want to calculate your TAM? Here are a few resources we use to make our calculations:

• For data on households, housing units, or population, the US Census Bureau is the most reliable place to look. Use the Quick Facts table to quickly pull up aggregate information on states, counties, cities, and zip codes.

• For information on businesses, try the County Business Patterns data. This is less user friendly than the Quick Facts table, but has useful information on business establishments, payroll, and employment.

When calculating a TAM, remember that directional is oftentimes good enough. There is no right or precise answer - these are data-informed calculations with the purpose of helping understand a market’s potential and how it might compare to another.

One way we like to combat the inherent uncertainty of a TAM is to look at ranges, particularly when the TAM calculation requires several assumptions. What does the TAM look like if we use the most conservative assumptions? What if we use the most aggressive? The true value is probably somewhere between the two, and if we know what both ends looks like, we can be more confident in the floor and ceiling of what the market could be.

Our last tip is to use your common sense and do a sanity check on your TAM before calling it a day. If the number feels too high or too low, try the following. First, double check your math. Sometimes a number has an extra 0 or was added instead of multiplied. Then check your inputs - perhaps a number was accidentally mis-copied or wasn’t updated. If neither of these works, take a look at what’s driving the number higher or lower. Remember, we only have two main inputs - number of customers and revenue per customer - so one of those must be off. Start with price - with a fresh pair of eyes, does it look like a reasonable market price? Then go to customer volume - is there an assumption that has an outsize impact on your number of customers? If yes, is it right?

If you can’t find what’s driving the value, and you’re not sure what to change, we recommend transitioning over to the ranges suggested earlier. Try changing some inputs and use that new number as a lower or upper limit, then report the TAM as being somewhere in that range.

Interested in this topic? Get in touch with me here or by email at jordan@jordanbean.com.