TAM and its Many Misuses: How to Assess Opportunity in Emerging and Invisible Markets
TAM can be a valuable tool for founders, but it is often misused, especially when startups pursue markets that do not yet exist. This article explains how founders and investors can use a multistage TAM framework to assess and expand startup opportunity over time.
What is your TAM?
No other number is more widely quoted than TAM to describe the potential for a novel technology or startup. TAM – the Total Addressable Market – indicates the potential market opportunity and tells founders and investors whether a startup is worth pursuing. TAM is also indicator of founder ambition. No article or funding pitch seems complete without reference to TAM.
Yet TAM for early-stage markets is speculative. Most iconic startups emerged from markets that were essentially nonexistent when founders launched the business.
We launched NGP Capital to tap smartphone startups in 2005, for example, two years before the advent of the iPhone. Few anticipated at the time that smartphones would make possible companies like AirBnB, Doordash, Instagram, King, Lime, Spotify, Stripe, Supercell, TikTok, Uber, Venmo, Waze, WhatsApp and Zynga. The same may be said at the dawn of the Internet for companies like Amazon, Alibaba, Facebook, Google, Netflix, Nvidia and TenCent.
Artificial intelligence may be a more significant opportunity than mobile or the Internet. McKinsey claims the long-term AI opportunity is $4.4 trillion, yet the next generation of iconic AI startups remains unknown.
I am deeply skeptical of TAM as it is commonly used. Consultants compete for attention in TAM bidding contests as both media and entrepreneurs quote the highest number. Consultants and media are rarely held accountable for their eye-watering predictions. But entrepreneurs and investors may pay a price for TAM disillusionment as the Gartner Hype Cycle is built on a foundation of inflated expectations. Entrepreneurs compound inflated expectations by using broad market definitions of TAM instead of their targeted market segment. As a result, TAM contains more noise than signal. Savvy investors ignore quoted TAMs and adjust expectations using heavily discounted assumptions.
TAM deserves better treatment. TAM is a useful tool when applied properly. Founders should ignore TAM estimates from media and consultants and instead develop their own assumptions based on their target markets. Customizing TAM to measure startup opportunities requires more work up front but may ultimately improve startup outcomes. Testable TAM assumptions provide early indicators of business potential enabling the startup to pivot as needed to pursue larger opportunities.
To understand how entrepreneurs and investors can best use TAM, let’s first review a TAM framework then discuss how to use to guide your business.
TAM v. SAM: Known, Emerging and Invisible Markets
TAM comes in three buckets: known, emerging and invisible. These buckets coincide with the industry lifecycle as indicated in Figure 1. Since venture-backed startups are typically early in the industry lifecycle, TAM is rarely known or well understood in the early funding rounds.
Known TAM is SAM – proven demand from existing customers in the Served Available Market. Known TAM is a sign of a maturing market ripe for consolidation and is typically the province of private equity rather than venture capital. Entrepreneurs may nevertheless find opportunities in maturing markets by identifying underserved market segments reflected in the difference between SAM and TAM. Known TAM may also be a target for incremental innovation with improved products or services that seek to disrupt incumbents and win market share from existing customers. Assessing market potential in these situations is easier as startups pursue incremental TAM in largely served markets.
Figure 1: TAM v. SAM in the Industry Lifecycle
Emerging TAM is evident during the growth stage of an industry lifecycle and refers to early indicators of market potential based on initial customer traction. Emerging TAM often offers a sense of the market opportunity but may dissipate and significantly overstate TAM. Erosion of Emerging TAM occurs when customers churn out of the market, prices decline with higher volumes, or early adopters do not reflect the interests of the broader pool of potential customers.
Emerging TAM may also understate TAM if new products extend use cases to tap new market segments. Amara’s Law observes that we tend to overestimate the effect of new technologies in the short run and underestimate the effect in the long run. History offers many examples of understated TAM. DEC founder Ken Olsen dismissed personal computing, but advancements in semiconductors and software made Bill Gates’ vision of a computer on every desktop a reality. AT&T dismissed the mobile market, but smaller form factors and more compute power enabled Nokia to put mobile devices in every hand. Among my investments, Lime started in shared bikes before tapping wider demand with scooters.
Dominance in a lucrative, core market enables firms to expand TAM by extending into adjacent markets. Successful startups establish beachheads in core markets then offer product extensions to expand into adjacent markets. Amazon started selling books, then became the digital everything store, then offered hosting and delivery services for their ecommerce clients, then expanded into traditional retailing. Through such iterative strategies, successful firms may ultimately serve TAMs that dwarf their initial TAMs. Figure 2 illustrates how Amazon and other successful startups may expand TAM over a Three Horizons Model and how TAM may differ in the short, medium and long terms as startups win their core markets and extend into adjacent markets.
Figure 2: Iterative Win-Scale Strategy to Expand TAM over Horizon 1, 2 & 3
Assessing TAM in early-stage markets is a speculative exercise, especially for Invisible TAM in which markets that do not yet exist. The challenge with Invisible TAM is that it is unseen and thus not well understood. While Emerging TAM involves significant uncertainty and variability, Invisible TAM involves unknown unknowns that become evident only once products go to market.
Invisible TAM involves latent demand, which may remain elusive or be far greater than initially anticipated. As Figure 1 illustrates, the gap between TAM and SAM increases at earlier stages of the industry lifecycle. TAM is invisible where SAM is nonexistent, often when disruptive startups seek seed funding.
Founding a startup pursuing Invisible TAM is a precarious undertaking. Few of these startups strike oil on the first drilling. Among even successful disruptive startups that have gone public, over half pivoted and nearly half had difficulty raising seed funding. Investors dismissed early versions of Uber and AirBnB, for example, as they pursued niche markets before unlocking massive market demand by competing directly with taxis and hoteliers.
Yet situations involving Invisible TAM offer founders the broadest scope to define market terms both for customers and investors. These are the situations in which lofty visions supported by insight and well supported assumptions are most effective as we will see while exploring strategies for understanding and articulating TAM in emerging and invisible markets.
Assessing Opportunity in Invisible and Emerging Markets
TAM reflects potential revenue from the universe of customers who may purchase a product from you or a direct competitor. The key components of TAM are (1) all target customers and (2) what they would pay for your product. Key assumptions used in TAM definitions should be consistent with assumptions that inform business strategy, product requirements and financial projections. Investors cross reference assumptions across executives to assess rigor and collaboration among the founding team.
Assessing TAM becomes more complicated when considering market segments with different product requirements and price thresholds. TAM definitions give insight into both the market opportunity and founder. TAM definitions illuminate the scope of founder ambition by the breadth of the market they intend to serve.
Founders must balance breadth of vision with focused execution. This balance may be achieved through a multistage process in which founders focus on winning a market segment then extend the product to serve in adjacent markets as in Figure 2. This multistage process is consistent with a flywheel strategy that iteratively expands the business while showing how TAM expands over time in a way that is credible with investors and operational both near term and over longer time horizons.
Amazon followed a similar path developing its flywheel first for its ecommerce book business, then across many ecommerce categories and then into Amazon Web Services (AWS) and Amazon Prime deliveries. Amazon initially developed AWS internally to lower its cost structure then extended the service to sellers. Amazon offered Prime delivery to improve customer service and reduce prices while reinforcing customer loyalty. As Figure 3 illustrates, AWS and Prime both reinforced Amazon’s original flywheel and built a competitive moat around its core business. Amazon’s Day One mentality described in its first annual letter to shareholders in 1997 and included in each subsequent annual report reinforced a culture that enabled Amazon to extend its business over time.
Figure 3: Amazon Flywheel Extensions into AWS and Prime Delivery
One way to assess Invisible TAM is through First Principles Thinking. First Principles Thinking breaks down complex problems into smaller and more manageable components. Elon Musk used First Principles Thinking to conceive and launch SpaceX, Tesla, OpenAI, Neuralink, The Boring Company and Zip2. Entrepreneurs can use First Principles Thinking both to assess requirements for new technologies and key components of TAM. First Principles Thinking helps understand market opportunity and devise creative revenue models and sales strategies to bring the product to market.
A second way to assess Invisible or Emerging TAM is through early adopters or lead user experience. Many successful entrepreneurs begin as lead users of their service before launching their startup. Lead users identify a market gap and build a solution to fill the need. Early adopters validate initial demand and help refine the product, revenue model and go-to-market strategy.
Defining TAM can accelerate the path to Product Market Fit. Firms achieve Product Market Fit by developing a repeatable business that attracts customers with a common product, revenue model and go-to-market strategy. TAM uses these same inputs and can help define the target customer, product and business model needed to reach these customers. Assessing TAM also helps entrepreneurs anticipate competitive dynamics, requirements to win the opportunity, and market share achievable given the anticipated structure of the industry. This exercise may also offer insight into timing and capital requirements to reach Product Market Fit.
Assessing TAM helps both founders and investors assess whether, and under what conditions, an opportunity is worth pursuing. Time spent defining TAM is a good investment to ensure the prize is large enough for entrepreneurs to commit time, talent and treasure to the endeavor.
Estimates of Invisible or Emerging TAM estimates are speculative, especially in a multistage approach over three horizons. TAM estimates will surely change so the number is less important than the underlying logic. Testable key assumptions underlying TAM estimates enable a startup to continually reassess the opportunity with customers. These assumptions inform the unit economics of the business and provide early indicators whether the business is on track or must pivot to achieve the scale and profitability initially anticipated.
Related Concepts
The dimensions of TAM – known, emerging or invisible – depend on the Industry Life Cycle as the gap between TAM and SAM narrows as an industry matures. TAM may refer to a specific market segment or the broader universe of customers. For early stage startups pursuing a beachhead strategy, it is most useful to consider the TAM of a targeted market segment and then expand TAM across a Three Horizons Model leveraging your Flywheel strategy to extend into other markets.
Industry structure may alter TAM by impacting pricing and will effect unit economics and allocation of market share. Industry structure also informs founders about Key Success Factors, Economies of Scale and Critical Mass requirements, which anticipates capital intensity and what is needed to achieve Escape Velocity. The Five Forces Model and Value Chain help anticipate industry structure for early stage markets. Winner Take Most Markets may be most capital intensive but will enjoy higher profit margins for market leaders.
Invisible TAMs raise questions embedded in the Johari Window such as uncovering blind spots and anticipating unknown unknowns. Large TAMs may help establish a vision or BHAGs for the business but should not distract from fundamental business model questions. Entrepreneurs should use the TAM exercise to think carefully about Right to Win, Product Market Fit and Founder Fit.