Understanding the market size of a business can often be overwhelming for a first time start-up founder but worry not we are here to help you understand everything about market size including how to calculate TAM, SAM & SOM.
As a founder, it is extremely important for you to understand the market size of the sector you are trying to build your business in.
Messing up the target size of your start-up is sure shot way to fail in raising the capital for your start-up.
TAM, SAM & SOM: An Overview
Before we dive in to understand how to calculate the TAM, SAM & SOM for your business we will learn more about some terminologies and will try to understand why it is important to always mention CAGR (compound annual growth rate) when talking about Market size.
- Total Available Market (TAM) :
Total Available/Addressable Market also known as TAM is an estimate of the revenue that your company can make in a year if you were to acquire 100% of your target audience.
It is used to understand the growth that your business can take in that sector along with a rough estimate of how your business will do in case a solid competitor pops up into the picture. - Serviceable Available Market (SAM) :
Serviceable Available Market or SAM is an estimate of the revenue that your company or business can make in a year if you were to acquire 100% of the customers in the regions where you are planning to launch your services.
For example: Let us assume that you are building a product that can be used in 200 cities but initially you will be targeting only 20 cities then your TAM will be calculated in reference with 200 cities but your SAM will be calculated in reference with only 20 cities.
Read the example at end to understand the same. - Serviceable Obtainable Market (SOM)) :
Serviceable Obtainable Market or SOM is the realistic estimate of what percentage of this market size can you acquire with your product and services.
For example: Let us say you were to launch an International news site today, so your TAM would be all the people who read international news, SAM would be all the people who read international news in your targeted region and SOM will be realistically how many people will be reading the international news through your platform/site.
An exercise to calculate TAM, SAM & SOM
Since the concept is a bit tricky so we will try to understand the same using the example of an EdTech Platform named XYZ that teaches coding and robotics to students only in India that are currently studying between classes 4 to 12.
Step 1:
Find the total number of school going students in India using reliable resources and calculate the ones that are currently studying between classes 4 to 12.
Step 2:
Calculate the total number of students that are currently studying between classes 4 to 12
Out of 250 million students the students that will be studying in classes 4 to 12 can be calculated by: (9/15) × 250 Million = 150 Million
Note: There are a total of 15 classes from Nursery to Class 12 and a total of 9 classes between 4 to 12, therefore we have multiplied the total number by 9/15
Assuming the average selling price of the product is ₹12,000 then the TAM can be calculated as: 250 Million × ₹12,000 = ₹1,80,000 Crores or $ 21.6 Billion Dollars
Step 3:
Based on the cost Identify what percentage of students can afford a product worth ₹12,000
Assuming that only 20% of the total target audience calculated previously have the financial feasibility of buying this product we can calculate the SAM.
The number of students who can afford the product are: 20% of the 150 Million students = 30 Million Students
SAM will be: 30 Million × ₹12,000 = ₹36,000 Crores or $ 4.32 Billion Dollars
Step 4:
Now that we have understood TAM and SAM, it is time to calculate to SOM
Out of these 30 Million Students spread across India, the Start-up ideally targets to start it’s operation in 4 cities namely Delhi NCR, Mumbai, Bengaluru and Lucknow.
These 4 cities contains 40% of our target audience from SAM: 40% of 30 Million Students = 12 Million Students
Out of these 12 Million Students the expected conversion would be barely touching 10% therefore the total students for SOM would be: 10% of 12 Million = 1.2 Million Students
Finally, the SOM will be calculated as: 1.2 Millions × ₹12,000 = ₹1,440 Crores or $172.8 Million Dollars
Why is CAGR important in Market Size?
More often than not you will see that CAGR or Compound Annual Growth Rate is mentioned whenever and wherever the term Market Size is used.
The simple reason why you should always mention it is because investors invests in a business for a minimum of 10x – 30x returns in 5-10 years so the CAGR helps them to understand how big the market will be in 5 – 10 years from now.
It helps to estimate how big your next round of investment would be and also if you can achieve more than you aspire today.
One such classic example is Uber, when Uber raised their first round they had a market size of $4 Billion but they made a total revenue of $31.8 Billion in 2022 alone.
The above image shows how you can calculate the CAGR of a Sector. You can check out our Premium Start-up Resources here.
Conclusion
While understanding and calculating the market size can be a bit tricky and lengthy process for a first time founder yet when your calculations are correct it surely goes well with the Investors.
You should always ensure that you take the data from reliable resources and should double check before citing it in your decks.
Now that you have understood about how to calculate the market size for your business it is time for you to also have a look at the best sectors for you to start your business in 2024.
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