TAM is a SCAM!

Or how using TAM (Total Addressable Market) to validate business strategy is one of the biggest falsehoods a business leader can be caught in and why the alternative is so much better

Written between May 5th, 2024, and August 6th, 2024 on topics that have been aggravating me for decades

Michael Kors in 2016, GoPro in 2015, Smartsheet in 2018, PagerDuty in 2021, UIPath in 2021.  Prominent start-up Klarna in 2022. What is common amongst all these companies? Their stock or valuation all crashed hard and never recovered.  Why? They all lied to themselves about their TAM: their Total Addressable Market. Maybe not in those exact words. Maybe not publicly. But they sure as hell experienced the same consequence.

TAM feels ageless, but it’s not.  If you can believe it, it has been around for only a quarter century, but it is another example of the 20^th century disease of heuristic approaches to strategy.  It assumes total market penetration, is achievable making any fraction of that figure sound reasonable just because the TAM figure is often so atrociously big.  It feeds the ego.  It is the perfect metric to for the non-objective business leader.

TL/DR: using TAM as a justification for the validity and viability of a company’s business strategy is one of the most self-destructive references a leadership team can make.  Sadly, many organizations publish TAM estimates for various industries as clickbait or a shiny lure for fish, I mean subscribers, without ever conducting due diligence on the reality, or lack thereof, behind their figures.

If you think that TAM is a good enough metric, then read this piece and tell me if your thinking has altered by the end.  If you already think it totally insufficient, then I hopefully have given you some reinforcement for your scepticism.

In an earlier piece I couldn’t stop the stream of consciousness from escaping about how I have a hate-on for TAM.

TAM is such an easy and cheap calculation to conduct.

TAM has an easy soundbite.

TAM feels ‘credible’.

However, …

using it becomes addictive and this is ultimately destructive to the business that uses it.

I’m going to start with all the messed-up ways I’ve seen companies calculate TAM/SAM/SOM.

These calculations are not one-offs, these are all examples of the disease of ‘TAMitis’, a new disease I’ve made up that infects founders, investment bankers, analysts, CEOs, and board of directors alike.

TAM = Total Addressable Market or how much customers spend in a category,

SAM = Serviceable Addressable Market or how much customer spend in a geography that we can sell to,

SOM = Serviceable Obtainable Market or what share of the customers can buy our offer.

Here are some really goofy or bizarre outcomes that very smart people reach using this approach to calculating TAM/SAM/SOM.

Calculation 1: Take the number of people in a market, say America, with ~320 million and assume that every single one of them would buy your product for $100 per year (remember, TAM assumes total market penetration).  That is a $32 billion market! But we’re only in California, so let’s make it 38 million people – that is still a $3.8B market, but we can’t serve every nook so we’ll only sell to the top 4 major metros, so that is still like 32 million people – we have a plausible SAM of $3.2billion that we can reach! We can’t really sell to people in the military or prisons, so that makes it like $2.8billion. And we’re only talking about America! Think about the global population which is over 8 billion!  This TAM is massive! We can’t mess it up, we have so much runway!

What fails here?  There is no sense of time.  When can this be achieved by?  What is the cost of reaching that TAM?  When do you hit diminishing returns?  How much of the spending is already taking place in similar forms?  Essentially, what existing spending in someone else’s TAM do you need to stop so that it switches to your TAM?

Calculation 2: The market for product X today is estimated to be $150 billion/year in the world today because a number was published in a news article (TAM).  Our product is way better but we don’t sell it globally as we can only focus on the US, but the US is like 25% of the global economy so let’s make our SAM $37B, but we can’t get distribution at Walmart and they’re like 20% of the retail environment so we’ll round our SOM down to $30B.  Can’t you see how much people are already spending on products like us? We just need 0.1% of our SOM to buy our products and our revenue would be $30MM/year!

Oof.  It seems so reasonable!  Only 0.1% of a really small number!  Yet, this approach is failing a lot more frequently than people realize.  The media doesn’t publish the thousands of TAM/SAM/SOM estimate failures.  It generally publishes the times it was ‘right’.  This reminds me of the adage that even a broken clock tells the right time twice a day.  In the above case I’d add further questions.  What is the cost of switching for your customer?  How distributed are the customers that would buy from you?  The calculation is implying that 1 out of 2,000 people buying the category need to buy THIS product for it to succeed.  Where are these people? How do you find them?  What’s the cost of finding/marketing/selling to them?

Calculation 3: Our new technology is so much better than what all these other companies sell.  Their combined revenue is like $80B globally (TAM) and we’re sure that once people know about our 10X better technology, they’ll buy ours instead.  We’re going to start in the US which is like 50% of the revenue for these companies so that makes our SAM $40B, and I read that only like 5% of companies can buy newly at any given time (they read all the 95/5 threads about market sizing) so we’ll make our SOM conservative at $2B.  Isn’t this such a sound and responsible calculation?  Even the SOM seems so low, it must be viable, right?

There are others, however, the above are scarily frequent.  What is common amongst all of them?  They all assume a universal competitive advantage and that a natural monopoly can be achieved – remember a monopoly is when there is only one vendor for the whole market!  These are also emotional estimates, they’re both grandiose and achievable.  They’re big enough that people should care.  They often sound quite legitimate, so due diligence was conducted, right?

I’ll give an example from a medical technology company I worked with years ago.  It was a great invention that provided a treatment that significantly reduced the dependency on prescription drugs that were expensive and had negative side effects.  They got to their TAM using two different ways making their figures quite legitimate sounding.  (These numbers are slightly modified to maintain confidentiality, but the proportions are the same).

Method 1: Existing spending on drug treatments and alternatives in the category based on competitor revenue and 3^rd party estimates put the existing spending in the market at about $36-40 billion per year. Great! Lots of money is already being spent on this, we’re just going to switch who the $ is going to!

Method 2: Based on medical and population estimates, they assumed that there were 40 million Americans diagnosed with the condition that they could treat and that two of their treatments at $500/treatment/person/year would amount to $40 billion. Well look at that, we’re being conservative here because we know that not all 40 million people are being serviced in Method 1 so Method 2 must be an even more conservative estimate, right?  Sounds plausible! Let’s go with it.

This was a public company.

They published this figure in their annual report.

They never verified if any of this was possible.

None of the analysts covering the stock questioned the math.

Seemingly, neither did their shareholders (mutual funds, index funds, and individual investors).

The company was nowhere close to this revenue after several years.  Where was the flaw?

The TAM calculation did not consider how fluid the spending was within the category. What were the incentives to continue buying what was already being bought and the disincentives to switch.  There was no understanding of whether behaviors would change if the price changed, or whether the treatment, while better, was better enough than the status quo.  The status quo is the enemy business strategy that is being validated by TAM.  It is crucial to measure the impact of the status quo because, in the end, a business strategy is only as viable as the market’s willingness to change and shift their spending to a new offering vs what they were doing before.

Successful businesses are built on understanding the composition and taking advantage of commerce when the market wants change.  The size of the TAM doesn’t matter.

So, what do businesses need to do instead?

They need to measure the Winnable Addressable Market (WAM).

WAM is at the intersection of two audiences. First is your ICP (Ideal Customer Profile). These are the types of customers you want to buy from you because they will be profitable to sell to. The second is your IVP (Ideal Vendor Profile) . This is what your company can do to fulfil  the wants and needs of your ICP so you can to change them from their status quo .

WAM is a minority of the total market.

WAM accounts for time. The time it takes to buy something new in place of what’s already there.

WAM helps prioritize who in the customer base are worth selling

WAM enables a company to understand

who is buying, of whom,

            you want to buy your offer (because you’ll make money), of whom

                        actually could/would want to buy from your company.

WAM is one of the most critical ingredients for business strategy a company can use today.  It identifies which objectives are achievable given the constraints of your profitability minimums and the resource of available customers that would actually buy from you.  Yes, customers are a Resource in approaching Strategy using Objectives, Constraints & Resources (OCRs) (see my other pieces introducing and unpacking OCRs).

The total market is NEVER available at the same time.  WAM solves for that.  It requires work. It's not simple, it is not as grandiose, but it is much more credible.

Why?

Because it demonstrates pragmatism. 

Achievability. 

It demonstrates that you understand your customer.

Because in the end, you don’t have a business without a customer.

WAM is more expensive to source and calculate, but it is actionable, not aspirational or worse, delusional, like TAM. A company can never win its entire WAM in a short period of time because humans and organizations can be only so predictable.  WAM, however, is sufficiently predictable to inform product, marketing, sales, and customer success to make better decisions that take weeks/months/years to manifest.

I’m going to stop here because there are many places where these concepts I’ve introduced can go in future pieces.

Keep reading this space.

Yours, until next time,

Edgar

Shamelessly challenging out of date strategy practices and the universe of bad habits that perpetuate because of them.

PS: writing this piece has made me realize that way too much of business is grounded in an acronym soup that abstracts the reality. 

It reminds of Elon Musk’s quote from a few years ago.

“Don’t use acronyms or nonsense words for objects, software or processes at Tesla. In general, anything that requires an explanation inhibits communication. We don’t want people to have to memorise a glossary just to function at Tesla.”  Elon Musk