How to calculate & interpret TAM

Do you know market size? How big it is or is there any space left there to grow? It can be understood by Total addressable market (TAM). TAM refers to the total market demand for a product or service. It is the maximum amount of revenue a business can possibly generate by selling their product or service in a specific market. No matter what kind of business you have- start-up, small-medium enterprise, or large enterprise. It is the most powerful metric to understand your potential market size and major players. Even a monopoly cannot capture total addressable market because it would be difficult for them to convince them to buy their product. So most of the business measure how many customer they can reach through their marketing and sales channel so that they can estimate their actual target market. However TAM can be used to estimate the potential growth in specific market.
Even multi-billion-dollar corporations don’t sell to “everyone”.
Lets take an Example,
Consider an Hair salon in Mumbai City with population of 12.5 million. Majority are female customer that is approx. 46% of total population sums to 5.75 million out of which only the age group between 20-30 years are the most users. Approx. 40% are females with age between 20-30 years And out of 5.75 million only 2% of female users come in middle or upper middle class category because this salon provides high end services. And average haircut price for high end salon is ₹250.
Total Females between 20-30 years are 40% of 5.75 million = 2.3 million
Total middle or upper middle class category in females is 2% of 2.3 million = 46k
46000*250 = ₹11.5 million
This means High end salon service TAM is ₹11.5 million and only 46k female customers in Mumbai city. And in Mumbai city there are approx. 30-35 high end salon service because of this the TAM will be shared with competitors.
There are three ways to calculate your business’ total addressable market:
1) Top down, this approach uses industry data, market reports, and research studies to identify the TAM. In these type of data you can even find subsections and you can also get estimate of total market of that subsections. But the niche element of business is not considered here. For example if a company has provided their store retail sales TAM but after a certain time their TAM can change due to online applicability/utility and other factors. But on the other side due to online applicability can also increase their TAM for example E-learning during COVID-19.
2) Bottom-up, this approach uses past data like sales and price. This the most effective approach for computing TAM. Lets say you are selling a product to various retail shops. So first you need to calculate your annual turnover i.e Sales or annual Revenue of ₹100million. And lets say there are in total 200 retail shops in your city.
Total addressable market = Total number of customers in a market x Average annual revenue of a customer in the market
= 200*100 million
=₹2 Billion

3) Value Theory, this approach basically means how much value your customer gets through your product/service. And how much premium they are willing to pay for it. Value theory is used to calculate TAM when a company is introducing new products into the market or cross-selling certain products to existing customers. Lets take an example of SWIGGY- a food delivery service. User are opting to ordered their food online by just adding food to cart and paying online or COD and getting them hand delivered to their address. Since users are willing to avoid all the other ways and they are willing to premium service charges can be use to value their pricing. This approach often also comes when companies are considering expanding their core product and cross-selling into existing customers as part of a long term strategy.
With a good knowledge of TAM, start-ups and enterprises can achieve their sales goals and can predict realistic path towards success. This can increase confidence among investors. TAM allows your sales and marketing team to identify your ideal buyer, prioritize the right market, and to generate revenue faster. You can also predict the amount of Revenue you can generate within your market. Share of market is the size of your actual customer base of your addressable market that you can capture.