TAM SAM SOM - Explained

If you’re looking to raise funds for your early-stage start-up, then you need to prepare a killer pitch deck with which you can convince investors that you have a guaranteed roadmap to success. 

One criterion that potential investors are bound to inspect is the viability of your business model. The key metrics that are used to gauge your business model are referred to as “TAM,” “SAM,” and “SOM.” Don’t know what those are? Don’t worry. It’s not as complicated as you might think.

Understanding these terms and how to calculate them can help you reach the fundraising goals that you set for your start-up.

TAM - Total Addressable Market

TAM is an acronym for Total Addressable Market. Quite simply, TAM is equal to the total possible market demand for the product or service you are selling. This includes the entire universe of potential markets. Investors will want to know the size of a market before investing in any early-stage startups. 

How to Calculate TAM 

You can calculate TAM by running a bottom-up analysis of your industry. Meaning that you start at the bottom by estimating the number of potential customers worldwide – every person/company in existence that could potentially make use of your product service, should be included. You then multiply the number of total potential customers by the average annual revenue per customer. That’s it!

Example of TAM 

To illustrate, we will use the example of a startup in the cybersecurity industry. If we were to calculate the TAM for this startup then we would have to go through the following steps: 

• First, have to look for the total number of businesses (in the world) who are willing and able to pay for cybersecurity services. For the sake of this example let us assume that there are 100 million businesses that would pay for a cybersecurity service.

• You then have to find out how much the average spending per customer is in the cybersecurity market. If that is found to be about $5,000 per year

• Finally, you multiply these two numbers (100 million by $5,000) to get the Total Addressable Market size you’re looking for!

SAM - Serviceable Addressable Market

This metric refers to the number of customers that you are able and willing to target i.e.: customers who fall within the geographic, demographic, and/or psychographic segments you are targeting, and not even all of those, but only the sub group of customers who you can realistically reach with your marketing messages.

How to Calculate SAM

You can calculate SAM by counting up all the potential customers in your specific target market. Then you multiply the number of customers by the average annual revenue generated by each customer. 

Example of SAM

In the TAM example, we dealt with the entire worldwide cybersecurity market. Now, we need to zoom into a more specific market.  Let’s say that our made-up start-up specializes in offering cybersecurity services specifically for organizations in the healthcare sector. 

• Find out the number of customers in your target segments: Of course, not all the 100 million businesses (from the example above) work in healthcare. Upon further research, we discovered that only 10 million of the 100 million businesses fall in the healthcare sector.

• Find the average annual spend per customer: If we find out that on average, these 10 million businesses spend about $4,500 a year each on cybersecurity service.

• Finally, you multiply the number of customers (10 million) by the average spend of ($4,500) to get a SAM value of $45 billion dollars.

SOM - Share of Market  

Share of Market is the size of customers that your start-up will be able to capture. This number will help give you and your potential investors a clear picture of what your potential revenue will look like. The SOM will be able to give investors a concrete number that can help determine your business’s startup valuation. 

How to Calculate SOM

You can calculate SOM by dividing your revenue from a previous year by the SAM (Serviceable Addressable Market). This percentage is your previous year’s market share. Now, take your market share percentage and multiply it by this year’s SAM. 

Example of SOM 

Going back to the healthcare cyber security start-up example we have to go through the following steps to get to SOM:

• - First, we need to know how much sales the startup has made in the previous year. Let’s assume that our imaginary startup made $40 million in sales last year.

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• - Now you have to divide the $40 million obtained in the first step by the startup’s Addressable Market value (SAM) from the previous year (same year you calculated sales for) which we calculated as $45 billion above. This calculation gives the start-up a market share of 0.00088%.

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• - Finally you have to multiply the market share figure of 0.00088% by the current year’s SAM of $50 billion (assuming an 11.11% annual growth rate). That gives the start-up a SOM (revenue potential) of $44 million. 

Why is it Important to Use TAM, SAM, and SOM?

If you are an early-stage startup, then you will likely need outside funds in order to remain in business. Early-stage start-up investors will want to know the viability of your business and your startup’s potential for growth. TAM, SAM, and SOM are helpful indicators that can answer many questions about the potential of a startup. For example, these indicators help you discover:

• - Upside potential - Are you part of a big market. Most investors will likely invest in a business that has a huge upside potential.

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• - Current viability of market - Investors will want to make sure that your target market is growing in size and revenue.

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• - Current viability of startup - Investors will also want to know if the startup has the revenue to sustain itself. 

Making the Most of TAM, SAM, and SOM 

TAM, SAM, and SOM can be useful indicators for early-stage startups and investors to determine the potential revenue, market size and growth of a business. By making the most out of these calculations, anyone involved in early-stage startups will have a better chance of valuating the business.