Tips for start-ups: Looking at total addressable market

The Entrepreneurship for Impact challenge (e4i Challenge) that ran last Friday was one of the biggest events for entrepreneurs in East Africa. The challenge was an occasion to vet, recognise and award the greatest impact start-ups in East Africa.

More than 300 startups had made it for the second round of the challenge but only 100 made it to the final round. One of the slides presented by those who didn’t make it to the final round was the Total Addressable Market (TAM).

Too often, entrepreneurs digest some unfamiliar numbers that some research groups publish about their market size. They tell us things such as “My market is everyone who eats cookies,” or, “Everyone in my community who drives a car,” or, “Anyone in the world who uses social media”.

The problem with these numbers is that they do not represent the market opportunity that is realistic for their startup in the time frame in which they are raising capital. Don’t get me wrong, it is important to paint a picture for investors that shows a huge potential opportunity.

However, most investors will be looking for a thoughtful answer regarding what your immediate addressable market opportunity is. You need to drill-down and get more realistic and specific about the true size of your market or they will question your credibility.

 Marketing plan

TAM is the number of potential customers, clients or businesses that you can hope to reach who may be interested in your product or service. Defining the total addressable market can be difficult, but correctly assessing your potential target market is key to calculating whether your marketing plan is sufficient, or whether your small business startup is viable.

There are two methodologies used for determining your TAM: top-down and bottom-up. The top-down method uses a broad market size figure (often provided by an analyst, industry participant or other) and narrows it down to the target market segment while the bottom-up method builds up the total addressable market by using the main variables of the revenue model.

For example, expected price times the total number of potential customers will yield a bottom-up addressable market. Venture capitalist ultimately want to see that you have used a logical method to generate a realistic yet enticing TAM.

Too small, and you may not be a bankable high-growth startup and too large and you may have unintentionally exaggerated your true addressable market.