A couple of months in the past, I got here throughout a Tweet that clearly enunciated one thing that had rankled me for a very long time as an early-stage investor:
TAM presumes zero future creativity.
I imagine firmly that, for early-stage startups, TAM is meaningless, and over-focusing on TAM really finally ends up being counter-productive within the long-run.
For individuals who aren’t acquainted, TAM is shorthand for Complete Addressable Market. It’s a metric meant to offer a rough heuristic for how many users an organization’s product may ever probably attain, within the excessive upside case. For example, one may calculate that the TAM of the web is presently 7.88 billion folks (the population of the world – ie. every particular person can solely ever be one “web person”), whereas the TAM of a US bank card rewards product can be 166 million (the full number of current credit cardholders within the US).
TAM is supposed to be an unrealistically giant quantity, ostensibly to reveal to traders and workers that the potential progress of the corporate – simply from promoting into its core market – is unbounded. Of the 1,000 or so startup pitch decks I’ve seen within the final half decade, TAM is sort of at all times current – and it’s uncommon to see a quoted TAM below 100 million customers. This metric is often rapidly adopted by a declare that if the corporate can seize simply 1% of the market, it could possibly notice [x] in income (the place x is likewise a really excessive quantity).
An unimaginable quantity of consulting and company analysis assets are devoted particularly to the calculation of TAM for various merchandise. In case you have ever seen a information article with a headline like “the marketplace for Synthetic Intelligence is predicted to surpass $35 billion by 2027” or “crypto transactions forecasted to be over $100 trillion within the subsequent 5 years,” there’s a fairly good probability that there’s a large 4 consulting agency behind the analysis, utilizing it as advertising and marketing to draw enterprise.
So what’s the downside?
There are three elementary shortcomings of TAM – one with the metric itself, and two with how it’s often utilized in completely different company contexts.
The Situation With TAM
First, with TAM itself: The calculation of TAM by default at all times embeds a laundry listing of assumptions, most of that are not often annotated.
Let’s take cryptocurrency market dimension projections for instance. TAM is often decided through a bottoms-up evaluation (ie: give attention to the specifics of crypto customers after which extrapolate to the broader inhabitants that matches these traits) or top-down (ie: give attention to the macro drivers that will affect crypto adoption after which drill down into their implications for whole market dimension). These elements are held to be fixed, after which forecasted into the long run assuming no main adjustments. Usually, TAM is just not constructed on the subject of all relevant user-specific or macro elements, so every estimate references an incomplete set of key drivers.
That is how you find yourself with projections of the 2030 market dimension of crypto starting from $2.4 billion to $4.9 billion to $11.7 billion to $12.1 billion to $347.5 billion – two orders of magnitude between the upper and decrease projections. And every extra 12 months into the long run that TAM is predicted introduces a major quantity of uncertainty (who may have forecasted a European land struggle or a banking disaster?) Internet-net, it needs to be unlawful to publish TAM with out a said confidence degree and annotated assumptions.
TAM For Corporates
The second concern is with how giant firms reference TAM. As beforehand talked about, one of many major causes that consulting corporations publish projected market sizes – with roughly about as a lot predictive energy as guessing – is to promote to purchasers. The purchasers are often giant corporates who wish to perceive the funding case for a brand new product, enterprise line, or acquisition. For example: if I’m a software program developer and I launch a brand new {hardware} product, how many individuals may that {hardware} product realistically attain? Relying on how I worth this product, how a lot annual income may it probably generate?
For these type of bigger strategic choices – which have important downstream implications and suggest a serious allocation of assets – it is very important have a tough t-shirt sizing of the chance. An unique gear producer (OEM) that dominates its area of interest in workplace pc manufacturing ought to have a superb sense for whether or not the scale of the cell phone market ends in hundreds of thousands or billions earlier than deciding to launch a brand new telephone {hardware} line.
Nevertheless, apart from tough order of magnitude, the specifics of the brand new product line matter infinitely greater than the market dimension. Which early customers will you market to? May the cell product line leverage any of the core competencies developed by the pc enterprise? Are the merchandise themselves compliments or substitutes? Can the corporate generate ecosystem lock-in by rewarding customers for purchasing each merchandise? These particulars will finally be rather more predictive of the potential top-line of the brand new product than whether or not the full addressable variety of customers is 10 million, 20 million, or 30 million. A cell phone constructed for a market of 1 billion may flop, then add a characteristic that solely appeals to a distinct segment user-set within the hundreds of thousands, after which considerably scale income and person numbers consequently. (I’d argue that for many merchandise – not all – figuring out and specializing in the issues of particular units of customers is a greater path to success than one-size-fits-all, however that’s a distinct dialog.)
TAM For Startups
The final use case for TAM is one which I work together with personally: early-stage startups quoting TAM as a purpose to speculate. Because the GP of The Fintech Fund, I’m very fortunate to be the recipient of many illuminating and thrilling early-stage fintech startup pitch decks. I like studying about founders’ deep conviction for resolving particular issues, their evaluation of why these issues haven’t but been solved, their proposed options, and the staff they’ve constructed to sort out them.
I at all times skip the TAM slide.
And the reason being that profitable tech merchandise are likely to develop in concentric circles over time. To borrow the analogy from Dimitri’s tweet above – when TheFacebook.com initially launched, its addressable market was decidedly area of interest: a web-based listing for school college students to attach with others at their school. Over time, as Fb’s userbase grew and the community results attracted new units of customers, the product broadened – first to an inter-college community, then to non-college college students with a .edu handle, after which to the world at giant. In the present day, Fb boasts 2.9 billion customers – however no one would ever have quoted that as a sensible TAM in a pre-seed or seed or Collection A or Collection B assembly.
The explanation that profitable merchandise are likely to develop in concentric circles is that good groups determine tips on how to construct one thing that appeals massively to a selected viewers, develop learnings from these customers, after which leverage these learnings to launch extra merchandise: both those who additional monetize (and serve) their core customers, or those who construct on their preliminary product’s core competency to succeed in new customers.
The MVP Pyramid: Construct quite a lot of options for a broad market poorly, or just a few options for a slender … [+]
Making an attempt to construct one thing that appeals to everybody on the outset is often a recipe for catastrophe, as illustrated above. (The implied x-axis right here is addressable customers.)
This impact is much more highly effective if the preliminary merchandise are profit-making. Taking Stripe for instance: the corporate started its life as a web-based cost processor, earlier than increasing into an enormous suite of ancillary merchandise. In combination, the transactions that Stripe processes are unit-profitable, ie: it makes cash on every transaction, quite than shedding cash. (On common; chargebacks, fraud, and many others. make some particular transactions unit-negative.)
By leveraging a profit-making core product, Stripe had the power to successfully subsidize its entry into adjoining merchandise like enterprise incorporation, fraud instruments, card issuance, and many others., even when these merchandise misplaced cash. A cash-flow optimistic baseline product provides firms the stability sheet and suppleness to put money into R&D and experiment with new merchandise that finally find yourself rising their TAM considerably greater than the place it was ever projected to be.
So to translate that to investing: if I’m taking a look at an early-stage pitch deck, it’s not essential to me whether or not the full variety of customers {that a} product may ever have is within the billions, and it’s not essential to me that 1% of the market equates to [x] income. (How does the corporate credibly suggest to win over 1% of the market to start with?)
A way more compelling narrative to me is “we have now this particular person set that’s loopy about our product, inform us they’ll’t reside with out it, aren’t interested in any aggressive merchandise, and are keen to pay us for it.” The variety of potential customers could also be within the hundred hundreds, but when the corporate is that good at serving them, they may rapidly win market share in a means that permits them to broaden into their subsequent adjoining product and develop their TAM.
On the finish of the day, the one significant use of TAM that I can consider is as an interview query for undergraduate consulting candidates. Aside from that, I feel it’s secure to keep away from ever overfitting for TAM.
