Thinking about your TAM
How big is your market?
When I was getting close to finishing my engineering degree, i still didn’t have a clue on what i wanted to do. Punting the ball forward, for the future Pau to figure out, seemed like a perfectly reasonable strategy. Keep your options open. I looked into management consulting as the perfect combination of challenge and broad business exposure. I applied and got an interview at McKinsey and BCG.
My first interview was as large a failure as my lack of business sense. In the business case section of the interview that these companies as famous for, I was given a problem to nibble on. I was supposed to calculate the future market share of a tomato sauce manufacturer. I remember asking the interviewer what “market share” meant. I know. I can’t believe they hired me.
Funnily enough, the math behind many business concepts is not hard, and yet, most entrepreneurs I come across get it wrong.
Know your math
I have a pet peeve. I can't stand a misleading TAM slide in a pitch deck. TAM stands for Total Addressable Market, and it represents how big the pie you are attempting to eat is.
The general formula for TAM is, in reality, very simple: how much can you charge per year, and how many customers can you aspire to have. Multiply the two, and you're done.
Most pitch decks have a TAM slide where they size the industry market in which their opportunity is. That's like selling olives and claiming your market is the entire food industry. I like olives, but i don't expect the entire world population to feed only on olives. I get you want to show as big of a TAM as possible, but entrepreneurs should be more honest with themselves. If you are not, you risk losing credibility with potential investors.
So let's calculate the formula.
As a refresher: TAM = price * num_customers.
Knowing your pricing is easy. You set it, so you know it.
On the other hand, sometimes, knowing how many potential customers there are can be very difficult. At Olapic, a grew tired to hearing from VCs the question: “how many brands are there in the US?". Don’t go to wikipedia for an answer, i've already tried. It's very hard to know exactly how many brands there are, because there is not one place that aggregates all the brands in the world.
Once my frustration grew to the size of the laziness from the VCs asking the question (in my opinion it was as much their job to answer it as it was mine), I opted for calculating a slightly different number: how many companies sell more than $1M online?
At least I would be able to get the number of brands that could afford our software.
To do that, i got the revenue numbers from the Internet Retailer 1000, ploted on excel the exponentially decreasing regression line of those revenue data points. Asked excel to spit out the formula of the regression line. Took the formula to wolframalpha and solved for volume $1M. Solution (back in 2011) was 7,411. Used the wolfram alpha again to integrate the regression line between 0 and 7,411 and got that they represented 89% of the ecommerce market in the US. We had our target.
You should have seen the VCs face when he asked, in a cocky way:
Investor: But, how many $1M ecommerce brands are out there?
Me, quickly and nonchalantly: well… 7,411.
And went on to show how I had arrived at the solution.
The VC did not end up investing, but I never got as much satisfaction from an investor meeting as in that one.
Current vs future market
Going after an existing large market can be a great opportunity, but you ought to know why existing businesses that dominate it can be upended. Or, if there is no large player owning it, why that is. “No one thought about it” should, by default, be your 5th or 6th reason, not your 1st.
Going after a new, hopefully large market in the future, can be a great opportunity as you can play a meaningful role in its creation and, as a result, capture a big part of it. You should, though, acknowledge that it will be more challenging to gather the evidence that such a market can be created.
Pick your challenge!
Why does it matter?
Most early stage investors would agree that the entrepreneur(s) are the most important determining factor in the success of a company. In my previous post, Mistakes or strokes of genius, I argued that one key to success comes from the entrepreneurs ability to navigate a succession of “doors” that will eventually lead to a winning execution. I also hinted to the challenge of identifying this specific skillset in an interview.
I believe a large (or fast growing, large potential market) tends to capture the attention of investors because it serves as a hedge of the ability (or, rather, lack of thereof) of the entrepreneur to navigate those doors.