Elizabeth Yin is the Founder and General Partner at Hustle Fund (and one of our favorite follows on Twitter). A few weeks back she Tweeted that fundraising is all about…
Modeling Total Addressable Market
The Free Visible Total Addressable Market Template and Evaluation Model “TAM” is one of those buzzy acronyms that VCs love to throw around. For those following along at home, TAM = Total Addressable Market.…
The Free Visible Total Addressable Market Template and Evaluation Model
“TAM” is one of those buzzy acronyms that VCs love to throw around. For those following along at home, TAM = Total Addressable Market. It helps paint the picture of how big the opportunity is and if the business deserves to be venture backed.
TAM is a funny thing. Early on, many investors passed on Uber, wrongly seeing it as little more than a black car service for affluent San Franciscans.
The type of analysis that led many to overlook Uber (when it was still called UberCab) mirrors the approach that Benchmark’s Bill Gurley criticized NYU professor Aswath Damodaran for a couple years later in a piece called “How to Miss By A Mile: An Alternative Look at Uber’s Potential Market Size”
“Let’s first dive into the TAM assumption. In choosing to use the historical size of the taxi and limousine market, Damodaran is making an implicit assumption that the future will look quite like the past.” – Bill Gurley
The most forward thinking investors were able to see past the limited size of the initial niche targeted by the company and see something closer to what the company has become — a $50 Billion valuation with operations in 67 countries and offerings ranging from food delivery to carpooling.
Where Does Your Total Addressable Market Start (and End)?
Before calculating the actual size of the market you are looking to capture, you first need to try to build an understanding of where that market begins and ends.
Many companies, like Uber, start out in a specific niche with plans to scale into adjacent markets that allow them to apply their product and operational expertise to a different set of customers or a different geographic location. However, taking a company that is excelling in one niche and extrapolating their growth across multiple markets is a difficult task for both companies and the investors evaluating them.
“Sequencing markets correctly is underrated, and it takes discipline to expand gradually. The most successful companies make the core progression—to first dominate a specific niche and then scale to adjacent markets—a part of their founding narrative.” – Peter Thiel, Zero to One
One year ago, Uber’s Gross Revenue in San Francisco was $500 Million. Assuming a 20% cut, we get to just $100 Million a year. 5 years ago, connecting the dots forward to see how they could move from that to what they have since become took a combination of masterful storytelling from Travis Kalanick and his team as well as a large leap of faith by the investors evaluating them. This is a potential pitfall of using a TAM based on historical market sizes for truly game-changing businesses (as Gurley’s quote from above illustrates).
Another oft-committed mistake surfaces with many Ecommerce companies, who claim to be chasing the $1.6 Trillion Global Ecommerce Market. Sure, it is a huge number. But it is one that investors will see right through, much like highly inflated financial projections or overly ambitious product roadmaps. In reality, most Ecommerce businesses are addressing the X $ spent each year on Y problem(s).
Why Knowing Your Total Addressable Model is Important
Going through a marketing sizing and pricing exercise can help shape your business and the decisions you make when it comes to your go-to-market strategy. How many customers are there in our market? What is their propensity to pay? How many customers can we realistically support? What % of the market can we get in 10 years? Can we be the market leader?
I shared this with team members, investors and advisors. The feedback I got was, “Wow this is awesome, I haven’t seen it displayed like this before”. I quickly thanked my K201 class back from my IU days and then decided we should “Open Source” this and make it available to other companies so they don’t have to re-invent the wheel.
Building Your Total Addressable Market Model
You can find the Google Doc here: Visible.vc – Market Sizing, TAM & Sensitivity Analysis. Simply open it up and click the arrow on the bottom left sheet and copy it to your own Google Sheet workbook. Below, I’ll explain the process and instructions.
First, you’ll want to start either with a top-down or bottom up approach (more on the differences here). For this model and exercise we recommend bottom-up.
If you are a SaaS company you may want to break down between SMB, Middle Market and Enterprise and the yearly contract sizes for each type. Ecommerce companies may want to break down by yearly revenue per customer type. The model should work for any type of business. For marketplaces we would recommend your transaction cut and not “Gross Merchandise Value” (this is 2016 where unit economics matter after all not bubbly 2015).
Feel free to replace the “Customer Type” headers with your own descriptions. The green cells are the inputs for number of customer and pricing for each respective type. The 100% market penetration is a quick gut check to say “If we captured 100% of the stated market how big would our business be?”.
After the inputs have been entered you’ll see a Sensitivity Analysis which provide Yearly Revenue based on your % of Market Penetration and Pricing. We use the Total Number of Customers from your inputs and various Yearly Revenue numbers to provide the results.
In the first column I just added a simple calculation for Number of Customers. This simply takes % of Market & Total Customers. It also provides a quick gut check…e.g. “Is it reasonable to acquire and service X customers?”.
The analysis is color coordinated. Red means your business is below $10 Million a year, yellow is $10 Million to $100 Million and green is >$100 Million a year in revenue. Most investors will want to see a clear path to $10 Million per year and the vision to get you to $100M. Anything short and they will likely tell you that “your business is not venture backable and you won’t be able to return our fund”.
We hope you enjoy this template. If you have any feedback, suggestions or questions send them our way! If you found this to be valuable we’d love for you to share it. Just click this link and it will craft a pre-populated Tweet (that you are welcome to edit).