Market Size Estimates
Written by Dr Laura Faulconer
Big Enough to be Interesting, Small Enough to be Realistic
Market opportunity is generally high up on an investor’s list of critical pieces of information when they are considering investing in a startup. To work out the size of the market for your venture, start with breaking it down into TAM, SAM and SOM.
TAM = Total Available Market
This is the total market demand for a specific product or service. Founders often plug in big numbers, usually measured in billions, found in market reports. Make sure this number actually represents the market for your product. You will often need to drill down a layer and find numbers for your specific opportunity.
It is fitting to look at the entire aviation market if you have a universal widget, but not if your widget is only ever going to have a value proposition for light aircraft.
SAM = Serviceable Addressable Market
This is narrowing down those big numbers to the demand for your type of products that is within your reach (e.g. geographic, market segments, interoperability, etc.).
e.g. Tour plane operators in US, EU, Australia and New Zealand that already use a specific navigation system
SOM = Serviceable Obtainable Market
Anticipated short-term market share based on marketing/sales reach, competitive response, product features, demand, your available resources and other market influences.
e.g. 5% market share based on 3 sales staff securing 5 major customers each
How to Calculate: Top Down & Bottom Up Approaches
You can get the TAM number – Total Addressable Market – from any number of market reports. But the methods used to generate this number aren’t typically made public, so you do not have much of a leg to stand on if you are asked to defend or explain this number. A better approach is to crunch the numbers yourself. There are two general methodologies: 1) top down, and 2) bottom up.
Top Down: Start with a big known number and narrow it down to your market subset
Bottom Up: Start with a small known number and extrapolate up
SOM is the most important number
The TAM, SAM and SOM numbers are context in a bigger picture – it isn’t enough to just know the size of your market. You need to know where the market is going: what are the trends shaping and driving demand within your niche and how your opportunity aligns with these trends.
It really all comes down to SOM – the Serviceable Obtainable Market. In a nutshell, SOM crystallises the underlying dynamics of who pays, what they will pay for, when they will pay, and why they will pay.
SOM is a number that investors will crunch to see if the investment opportunity stacks up. Let’s do some quick maths:
An investor is considering providing $1M for 30% equity stake and expects a 10x return
SOM = $10M at year 5 (typical window to consider liquidity events)
The typical liquidity revenue multiple for your sector is 2x (this can sometimes be obtained from market or analyst reports)
$20M x 30% = $6M, so the Return on Investment (ROI) for the $1M investment is $6M/$1M = 6x, which is well below the expected 10x return.
Therefore, this investor is not likely to view this investment opportunity favourably.
If your number doesn’t stack up, you can’t just play with the numbers until you make it fit unless you are making structural changes to your business plan. That’s because SOM is (or should be) the direct result of your strategy – it is the number that pops out the end of a bottom-up number crunch based on a suite of assumptions about your opportunity.
If you need to increase your SOM, you will need to have some logic to changes you make. Perhaps you bump your market penetration from 5% to 10%. What does this mean to your marketing budget? Your sales staffing needs? Your warranty and support needs? Your supply chain risks?
When An Investor Asks ‘What’s Your Market?’
$4.4 billion and growing at 9% per annum
If we only get 1% of the market…
Instead, one approach is to start with your TAM – Total Addressable Market. Position key market trends and define the subsectors most relevant to your opportunity with SAM – Serviceable Addressable Market – for frame of reference. Describe the competitive landscape in this subsector. Then describe your users, your unique value proposition to them, their buying behaviours and how that all translates to a specific projected SOM – Serviceable Obtainable Market.
Another approach is to start by describing your customers. Then define your SOM by describing how many of your customers exist and your pricing model and purchasing frequency. Explain your methodology to validate market demand and explain how your penetration projections are based on these insights.
Don’t be fooled into thinking that bigger is always better. There are always other layers that influence the attractiveness of an opportunity for investment. For example, you can have huge TAM and SAM, but your margins might not give you enough revenue to sustain or scale your business. Or you may have a smaller market potential but a significant SOM that is readily achievable with a single product in a short timeframe – this can be a very investable opportunity.
Founders that do not have market size insight backed up with realistic data will struggle to secure funding. TAM, SAM and SOM is a great start, but to really wow investors, use these calculations as a launching point to contextualise and back up your go to market strategy.