I Like Small TAMs and I Cannot Lie
We’ve all seen this before — at demo days, pitch competitions, or just in individual meetings with investors — the “Total Addressable Market”, also known as simply “TAM”, slide in a pitch deck.
It’s usually some gigantic number — just absolutely the largest figure that the founders could find that some (we think) reputable source put on the Internet somewhere. It also happens to be the most problematic slide in presentations.
At best people gloss over it and at worst it generates skepticism amongst the audience. Investors have been perpetuating this disservice to founders by blogging, tweeting, and claiming in all manners that you have to be going after a huge market opportunity.
This is by now conventional wisdom, but it’s a bit silly.
Instead of using a top-down Total Addressable Market, founders and investors would be better off discussing a bottom-up Specific Addressable Market.
For example, rather than saying our TAM is the talent management software industry and it’s a $5 billion industry in the U.S., companies need a market segment that is tangible enough to build a product for.
Instead use a bottom up approach and say we make software for HR managers and we plan to sell it at $100/year/user and we are going to focus on the segment that recruits for rapid turnover retail jobs. Say there is about 500,000 people who recruit for retail jobs so the Specific Addressable Market is about $50 million ($100 per user times 500,000 potential users). Now, that’s a lot lower than $5 billion, but the clarity in thinking is worth the trade off.
Clearly defining a Specific Addressable Market will help founders get to product-market fit much faster because it narrows the product focus on the customer group you are actually building for. Building a product for a small core customer base that both loves the product and pay for it is a huge milestone that lets a company expand into other segments.
Whereas having no clarity on the exact customer demographic you are building for in this massive ocean of interesting opportunities in your gigantic TAM is a death knell for a startup.
Having a gigantic TAM is not only inaccurate and useless, but it also distracts and is an excuse not to have a clear customer group to build for.
Size doesn’t matter. Growth does.
In fact, market growth is the only real enabler of major new companies being built. A large but stagnant market means that established corporations are already attacking it in every way imaginable. But an emerging market segment is often off of the radar for bigger corporations.
What was the market size for online commerce when Jeff Bezos started Amazon? What was the market size for online social networking when Mark Zuckerberg started Facebook? What was the market size for virtual reality when Palmer Luckey started Oculus? What was the market size for renting out your house when the three Airbnb founders got started? And so on.
When Jeff Bezos read a study in 1994 that the Internet was growing at a rate of 2,300% per year, he saw an opportunity to start a company. When he started Amazon, there were less than half of one percent of the world’s population online.
In every meeting between founders and investors, there should be a real discussion of the Specific Addressable Market and the plan to achieve product market fit rather than some unproductive handwaving about how “huge the market is” in the form of a vague TAM number.
Having a more nuance discussion, a more focused market based on specific bottom-up analysis will be a great service to both the founders to help startups get to product market fit faster and for the investors to set realistic targets for the company and its board.