Total Addressable Market — the devil is in the buying cycle

The customers. They’re out there somewhere. I just know it.

Yesterday I had lunch with an entrepreneur friend. Something came up that I see time and again, so time to write a Medium post. It relates to Total Addressable Market (“TAM”) but an element that nobody talks about. UNTIL NOW*.

Let’s take a startup with the following characteristics:

1. B2B model, recurring revenue;
2. Product with medium to high switching costs;
3. TAM of £1bn pa, Serviceable Available Market (“SAM”) of £300m and Serviceable Obtainable Market (“SOM”) of £100m;
4. Reasonable sized customer base — TAM made up of at least 100,000 potential customers; and
5. Seed stage funding to the tune of 18–24 months of runway to prove something and move on to Series A.

On paper this looks pretty good. Let’s assume the startup can get in front of 100 potential customers per month and that 10% of them agree that their product is better than the incumbents. So they close 120 deals a year and 240 deals before the money runs out. That’s pretty good. With their seed funding, this startup has cornered 2.4% of its SOM and has monthly MRR of c. £200K. To simplify let’s assume that these customers are all the same size and that they are acquired at the same rate and their revenue accrues evenly. Year 1 and Year 2 revenues look like this:

Revenue, so round, so predictable ….feels so good.

Great right?

Wrong!

Because of the 240 customers during the lifetime of the seed funding that are eager to buy:

1. 64% had an existing long term agreement for the product or service in question that was expiring sometime in the next 9–36 months;
2. A further 18% had to wait for some other unrelated event or other to happen (e.g. the start of a new financial year), with an average waiting time of 6 months;
3. A further 7% had to wait for someone to join their organisation who would have an opinion about this with an average waiting time of 3 months;
4. A further 8% have to serve notice on an existing supplier before they can switch plan with an average waiting time of 6 months.

The net effect on the business is that after the seed funding runs out, the startup has revenues that look like this:

I’m sorry we’re not going to invest but we really liked meeting you and the team.

A Series A investor looks at this very differently and concludes that the TAM isn’t that big, the product isn’t that good or that the team is not capable of getting in front of the market and selling. Despite the fact that in both scenarios, the market is the same size, the product/market fit is identical and the founder has shown the same level of energy and focus to get it out there.

So what?

So when considering TAM, founders (and investors) should also consider buying cycles. How often do the customers buy? If it’s irregular, how can the entrepreneur make it more regular and what does it mean for her funding requirements?

A good founder will make the best of the funding cycle by making multiple connections, noting renewal times (preferably automating them) and keeping in touch but the buying cycle still brings considerable risk:

1. The client moves jobs, the founder has to start the sales cycle again when the time is right;
2. They get innovated out of the market while they’re waiting;
3. They run out of money waiting for the buying cycle to deliver;
4. They have less chances to learn.

This is a lesson in the collision of maths with day-to-day business. TAM is not defined by the total amount of revenue in a sector per year from customers to suppliers. Instead it’s the total amount of new or switched revenue paid from customer to supplier. You need to survive long enough to get the chance to sell to the true TAM.

Photo by Vlad Chernolyasov on Unsplash

*I’m sure some people have spoken about it but 99% of people I meet don’t mention it at all when talking about TAM.