The TAM / Niche Paradox
When I tried raising money for my first startup, I was perplexed…
Investors, especially larger venture capitalists, wanted to see an enormous opportunity (in fact, it’s still commonly understood today that you need to show at least a $1 Billion market). But at the same time, investors prefer to see a startup tackle a small targeted niche, so the startup can better meet the specific needs of that market that also has fewer competitors, thereby increasing chances for success.
But how can you have a targeted niche and a big opportunity? Aren’t those trade-offs?
Problems with TAM / SAM / SOM
A common approach for pitching to investors is to show TAM (Total Available Market), a smaller SAM (Serviceable Available Market), and smaller still SOM (Serviceable Obtainable Market). You’ll see many early-stage startup investor pitches with a diagram something like this:
These are typically “top-down” estimates, looking at overall market sizes and market share. This approach comes across as academic. To make matters worse, the definitions are vague. Just do a web search for “TAM SAM SOM” and you’ll get results with different meanings. This leads to incorrect or at least inconsistent usage. For example, if a startup were making a new side-view-mirror for cars, they might be tempted to list the size of the entire auto industry (or total car sales) to convey a large TAM. However, unless they intend to sell all the products that make up the auto industry, that is not the relevant TAM to use. The result is that many audiences discount these imprecise, often exaggerated or inaccurate numbers…if they even consider them at all.
The TAM Onion
Instead, I suggest creating a “TAM Onion”. Think of an onion with many rings. The center ring is small, but all the rings combined can make a large onion. So, the center ring is your smaller, targeted spearhead or beachhead market. [If you don’t know how to identify your initial spearhead market, subscribe to my newsletter for future blog post to help with this.] The subsequent concentric rings represent the markets you will pursue next. Collectively, these markets aggregate to create your overall TAM, or larger market opportunity. You need a good reason for picking your spearhead market, and for the subsequent sequential markets. Make sure you explain your rationale. Ideally, these are intentional rather than just opportunistic. Remember, you want to build a predictable, scalable business. Don’t confuse the TAM Onion as a TAM/SAM/SOM model with more rings. The TAM Onion provides both a planned sequence for growth and an accumulation of layers to build a larger TAM that the TAM/SAM/SOM model does not.
For example, if I’m selling side-view-mirrors, rather than say, “I’m targeting the automotive industry,” you can start with say “2-seater sport convertibles in the US.” This would allow you to focus on the specific needs of that niche and beat a smaller field of competitors. And you’re picking this segment perhaps because (and I’m making this up) 2-seater sport convertibles have unique requirements of side view mirrors, and their owners are likely to be early adopters, and/or less price sensitive. From there, you might expand to 2-seaters in other geographies, or you might expand to 4-seater sport convertibles in the US, or you might expand to 2-seater sport sedans depending on the strengths you build in the previous ring.
These rings can also be grouped. Market segments can be grouped to show a convincing path towards the larger TAM. The sequencing should be done first. Then logical groupings may surface. Perhaps the next segments are logical because of similar needs, or similar go-to-market (GTM), or solution. In my example, I might group my segments into cars, then trucks, then buses because of similar needs and GTM within the groups.
I find that frequently, pre-market/fit entrepreneurs are unsure of their spearhead market, so they attempt to go after multiple segments at once. This is almost always a mistake [but that’s for another blog post]. However, sometimes, it is legitimate to go after a couple spearhead markets at once. For example, opportunities may have pulled you into two reasonably adjacent segments at the same time. Real onions sometimes have multiple inner rings but eventually merge at some level with common outer rings.
Consider Amazon. Did Jeff Bezos initially pitch or plan to be just the biggest bookstore online? I seriously doubt it. He probably pitched that he’d start with books (because they’re easy to evaluate online, have high global demand, huge selection, easy to inventory/ship, etc.). Once be built the e-commerce platform for books, he could leverage that technology and learnings to sell the next obvious products like CDs, videos, software, etc., etc. Eventuality, selling “everything” online…an enormous TAM.
The TAM Onion solves the investor pitch quandary by showing a) that you have a large total opportunity, and b) that you have identified a spearhead market niche that is targeted enough for you to understand the requirements intimately and to beat competitors at servicing customers. In addition, it shows a logical path, and thus a believable plan, from growing your initial market to building a large business.
When initially presenting to investors, you probably do not have time to get into execution details for every segment. Besides, you probably won’t understand those segments well enough until you get experience in them. So, present your TAM Onion early to demonstrate the big opportunity. Provide the rationale for picking your spearhead and subsequent sequential markets. Then focus the rest of your pitch on the details for that spearhead market such as value props (use my “Business Value QuadArrow” to build a comprehensive list of value props), solution, GTM, traction, etc. [More on investor pitches in future post.]
Most importantly, the TAM Onion is not just about convincing investors. Entrepreneurs should use it as a plan for your business. Creating your own TAM Onion forces you to finely segment and sequence your markets, which is a prerequisite to building an effective go-to-market (GTM) strategy. And of course, it helps you articulate a convincing bottom-up TAM to investors. Your goals and investors goals are mostly well aligned. But an entrepreneur’s biggest cost is usually his/her opportunity cost. So, make sure you convince yourself first. Done correctly, a TAM Onion can be sweet.