Failory - How to Estimate Market Size (TAM)

Hey — It's Nico.

In July, I'm publishing content related to Startup Ideas. This week, a guide on How to Estimate Your Idea's Market Size​

🙌 Welcome to the 412 founders who joined this week.

This issue is brought to you by Around:

A few months ago, I downloaded Around, looking for ways to improve my Zoom's calls with other startup founders.

I've since stuck to Around for two reasons: 1) it frees up my screen, which allows me to easily read and take notes as I have the call; 2) my background image and noise are always messy and Around helps me avoid founders from noticing this.

Why calculate Market Size? Estimating a startup idea's market size is useful for two things:

• To determine if it's worth going after it.
• To determine if it's suitable for VC funding.

What is Total Addressable Market (TAM)? It's the total possible market demand for the product or service you’re selling.

In other words, it’s the maximum revenue your company could potentially generate in a specific market if you were able to tap into 100% of the available market.

How is TAM calculated? 3 approaches:

1. Top-down: You use different industry researches to narrow down a large market to your specific TAM. It's limited by what data is available to you.
2. Bottom-up: You multiply the total number of potential customers in your industry by the average annual spending on your product or service. It's the recommended approach. Formula: TAM = Potential Customers in Market * Average Annual Spending.
3. Value-theory: You use estimates of how much value your customers receive from your product or service and how much they will be willing to pay for that product or service in the future. It's generally used when introducing a totally new product to the market.

​In the article, we share further details about these approaches.

What is Serviceable Addressable Market (SAM)? It's a subset of your TAM, limited to specific geographic areas that you can reach.

How is SAM calculated? Depending on what method you used to calculate your TAM, you could use the same one to find your SAM. If you used the bottom-up approach, the formula is: SAM = Target Segment of TAM * Average Annual Spending.

What is Service Obtainable Market (SOM)? It's a subset of your SAM that represents the number of people and revenue you are realistically able to capture.

Calculating SOM is generally something you do after you already have historical data regarding customers, sales, and revenue, as it is an estimate of your actual market size, rather than potential size.

How is SOM calculated? You can use this formula: SOM = Last Year’s Market Share * This Year’s SAM.

What are some other metrics?

• Market Penetration Rate = (Number of Customers / Market Size) * 100
• Market Value = Number of Customers * Average Annual Spending

Once you get both your market penetration and your market value, you can better understand the potential for increasing revenue as you scale and grow your business over specific periods of time.

If you want to learn further about estimating a startup idea's market size and read a real estimation example, check our latest article: How to Estimate Market Size.

If you found this week's article useful, you'll probably also like these two we published this month:

• ​How to Get a Startup Idea: 10 Actionable Frameworks​
• ​A 4-Step Framework to Validate Your Startup Idea​

As every week, here are 3 recommended resources:

• ​Content-Led SEO: Content-led SEO is a quality-first, content-driven approach to building internal topical authority. This playbook teaches you an 8-step process to execute a content-led SEO strategy for B2B SaaS.
• ​How Companies Use North Star Metrics: Loom, Airtable, and Calm are using the north start metric framework to improve their customer experiences and drive growth results. This article analyzes how they're doing it in practice.
• ​How to Hire Actually Good Engineers: It's hard to identify good developers when interviewing them. This article shares a way to conduct technical interviews by asking the engineers to bring their codes to the interviews.

I hope you enjoyed this week's newsletter!

Cheers,

Nico