GUEST: A LOOK INTO THE FACETS OF TOTAL ADDRESSABLE MARKET.
While trying several funding options, I’ve come across this question: *”What is your total addressable market?”*
The Total Addressable Market, also known as “TAM”, is a common metric potential investors and funders *use to size up your business opportunity.*
And if you ever meet a professional investor, like a venture capitalist or a private equity investor, it’s VERY likely that one of the first questions they’ll ask is:
“What is the size of your total addressable market?”
If you look clueless or don’t have a figure, they may think you’re not serious or ready for investment.
Most investors want to know the *size of the total addressable market* because it gives them an idea of how large or small your market is.
If your market is too small, most investors will not play.
A small market means the number of customers who actually want your product, service, or whatever you’re selling, is too small for anyone to bother.
And that’s because a small market usually does not provide the *kind of returns, visibility and impact funding* organisations are looking for.
So, let’s say you’re about to start a corn production business that plants, harvests, processes and sells dry corn to the Kenyan market.
You approach an investor, and the first thing she asks you is:
“What is the size of your total addressable market?”
What she means is, how large is the *total demand* for corn in your target market which, in this case, is Kenya?
Even though there are hundreds of other corn producers in Kenya, the investor wants to know the size of the full pie. She wants to see the big picture.
If the size of the total market is $100,000 for example, the investor may not be interested.
And that’s because, even if you’re the only corn producer on the market (which you’re not), the ceiling or *maximum amount of money* you can ever make in the business is *$100,000.*
But if the size of the market is $100 million, for example, you may get a smile from the investor.
And that’s because, even if all you get is a *small slice of the market* – like 1% — that’s still huge.
*1% of $100 million is $1 million.*
So, here’s the logic.
Even if you get *100% of a small market*, your business opportunity will only yield small returns for investors.
But if your market is large, and *you only get a tiny slice of it,* you could still be an exciting opportunity for investors.
*So, how do you calculate the TAM?*
Calculating the *size of your target market* is one of the key areas I focus on
So, there are *two approaches for calculating the size of your TAM.*
The first is a Top-Down approach….And the second is a Bottom-Up approach.
The Top-Down is *easier and faster* to calculate but in some cases it can be too generous and misleading.
The Bottom-Up on the other hand is a rigorous approach that requires *on-the-ground* market surveys, questionnaires and industry/market analysis.
I’ll start with the Top-Down Approach
Using the corn production business example I used above, I’ll calculate the TAM using the Top-Down.
So, the first question I’ll ask myself here is, *how much dry corn is consumed in the Kenya market?*
To get that figure, I go to Google to find credible research or reports from third-party sources.
I find a good one. It’s the GAIN Report from the USDA Foreign Agricultural Service.
Here’s the link: https://gain.fas.usda.gov/Recent%20GAIN%20Publicat…
The data in that report shows that in 2017, the total consumption of corn in Kenya is estimated at *4.023 million metric tonnes.*
But to get the full figure in dollars, I need to know the *unit price* of dry corn in Kenya.
I go to Google again and find information from the Kenyan Government’s Agriculture and Food Authority (AFA).
Here’s the link: http://agricultureauthority.go.ke/category/prices/
According to the data, the price of a 50kg bag of dry corn in Nairobi (as at 5thDecember 2017) is 3,000 Kenyan Shillings.
That comes to about $29 per bag, based on exchange rates on the same day.
So, the *total consumption and size of the market for corn* in Kenya is:
4.023 million metric tonnes multiplied by $29 per 50kg bag.
That gives me $2.33 billion.
This is the size of the total addressable market for corn in Kenya, as of 2017. And, wow! It’s a really huge market.
So, even if you start your business and you’re only able to capture *0.1% of the market, that’s a revenue of $2.33 million.*
Remember, in this example, I focused on Kenya because it’s my target market.
If I plan to sell my corn regionally or internationally, then my calculation needs to cover the markets I’m targeting.
So, this is how to use the Top-Down approach to calculate the size of your total addressable market.
This approach relies on data, research and analysis from third parties.
Unlike the Top-Down approach, the *Bottom-Up* relies on first hand data, research and information you gather yourself.
And it’s common to use this approach when it’s difficult or impossible to find any reliable and credible third-party resources.
So, let’s say you want to start a *laundry and dry-cleaning business* in Kenya.
You search Google, and you can’t find any useful information about the size of the market for laundry and dry cleaning in Kenya.
The only option you have is to hit the streets and do some *market research* of your own.
I would prepare a *questionnaire and support it with interviews and probing questions.*
After the survey, here’s what you find (hypothetically):
The people who use laundry services are male and female between the ages of 22 and 60.They belong to the middle class and upper class of society and most of them live in urban areas; towns and cities.
Most of them are employed and busy people. Only about 4 out of 10 people you met use laundry services and spend an average of $25 per month.
With all this information, you now have the information you need to estimate the size of the total addressable market for laundry services in Kenya.
So, what’s the total population of Kenyans who are between the ages of 22 and 60, and who live in the main urban areas; Nairobi, Mombasa, Kisumu, Nakuru, etc?
You can find out this figure from the country’s census office or the World Bank database.
For this example, let’s assume that figure is 10 million people.
Now, remember that only *4 out of every 10 people* you surveyed actually uses laundry services.
So, of the 10 million population, it’s actually *4 million* that fits your market.
Also, your survey results show they spend an average of *$25* per month on laundry.
So, the size of the *total addressable market* will be:
4 million people multiplied by $25, and multiplied by 12 months of the year.
That gives us: *$1.2 billion*
This is the size of the total addressable market for laundry services in Kenya.
As you can tell, the Bottom-Up approach is more *rigorous, but the results are first-hand, very logical and can be explained.*
Which of the approaches is better?
*Should you use Top-Down or Bottom-Up?*
Well, it depends on your *type of business, and the amount of data and information you can find* to calculate the size of your target market.
If you can find very credible third-party sources of information, that’s good enough.
But if you can’t find anything great, I recommend you follow the Bottom-Up.
In my experience, the Bottom-Up will help to open your eyes to facts, expectations and preferences of your target customers you didn’t know before. That’s why I always recommend it.
Explaining calculations in text can be hard. But I hope I did justice to the topic
I trust this will help a lot of people out there who are struggling with this issue.
Untill Next year, Do have a blessed happy festive season and successful year in anticipation