How to calculate your startup’s TAM, SAM and SOM

Understanding and presenting the size of the market you’re targeting is critical to securing funding for your business. Angel investors and VCs alike want to see a breakthrough product or service that scales and can acquire a significant share of a sizable market.

At any stage of investment, be it seed or a Series B, it’s necessary to include a slide in your pitch deck that explains the size of your market from three perspectives — TAM, SAM and SOM.

When you present your market size data to investors, they’ll look for TAM, SAM and SOM information. These data points pack a mystique about numbers that can appear colossal and out of reach, but if you approach market sizing methodically, you’ll realize it’s really not that complicated.

I recently attended a presentation by a company that produces innovative, nutrient-rich olives and peppers. Because their data point scenario is straightforward and easy to understand, I’ll use it here to explain their TAM, SAM and SOM.

Step 1: Capture TAM

While TAM (total available market) tends to cause the most anxiety, it’s the easiest of the data points to handle. TAM describes total revenues within a larger sector. You can calculate TAM three different ways.

First is the top-down approach, often attained through publicly available market research reports or extrapolated from publicly available data reports.

Next is the bottom-up approach, which relies on a calculation of actual and projected pricing, along with the current and total projected use of your products or services.

Last is the value theory approach. This theory applies an educated analysis of the projected value and total anticipated use of your product or service, followed by calculating how much of that value can be reflected in its pricing. Value theory most often applies to entirely new products, services and categories. Let’s apply the theory to Airbnb.

Airbnb disrupted the hotel industry by imagining a technology that would enable homeowners to match up with travelers seeking a place to stay. To apply the value theory, assess how much a traveler would be willing to pay for this new type of lodging, how much the homeowner would want to be paid per night, and what Airbnb could collect from the homeowner for using its technology.

When a product or service category has already been well-researched, TAM is often calculated using publicly available market research reports. If the product or product category is new and hasn’t been researched thoroughly — which happens often in tech and also applies to other industry verticals — I recommend hiring a seasoned market research consultant to secure TAM data using either a bottom-up or value theory approach.

“Olives and peppers” is a well-researched category in plant-based foods within the specialty foods space. The TAM for specialty foods in the U.S. is $146 billion.

Don’t be surprised by the seemingly astronomical number, and don’t spend too much time thinking about it. Only be concerned if the number is small. The TAM number gives investors an overall macro perspective of your company’s potential.

You’ll find the TAM for your technology through credible market research companies such as Frost & Sullivan, Nielsen, Statista and Gartner. You may not even be required to pay for a report because the TAM data you need is likely available in one of these companies’ abstracts. Copy and paste the data into your spreadsheet and move on to SAM.

Step 2: Secure SAM

Continuing with our olives-and-peppers example, within the larger U.S. specialty foods space is the plant-based foods category. Plant-based foods is the SAM category, or service available market, of specialty foods.

For olives and peppers, plant-based foods within the specialty food category, SAM is valued at $7 billion. Again, tap the aforementioned market research organizations to obtain your SAM number. Copy and paste the SAM data into your spreadsheet and progress to SOM.

Step 3: Calculate SOM – your share of the market over time

Pour your calculation efforts into SOM — serviceable obtainable market, or market share. In our U.S. plant-based foods example, the SOM would be the $2.5 billion “olives and peppers” product category of the U.S. plant-based market.

Investors really care about a product category’s SOM. The olives-and-peppers company’s quest here is to estimate how much of the U.S. olive-and-peppers market they can capture in the next five to 10 years. They could estimate capturing 0.5% of U.S. market share in year one of shipping the product, 1% in year two, 3% in year three, and so on.

To get more specific about your market share over time, consider bottom-up forecasting. You calculate a bottom-up forecast by estimating expected and potential sales.

Estimate how quickly you’ll obtain a share of the market and at what rate over defined periods of time. Also look for how much competition you anticipate, challenges the competition is likely to pose, and other potential obstacles or barriers to entry.

Going back to the olives-and-peppers example, we can estimate sales to 75 specialty stores in year one, 200 in year two, 500 in year three, and so on. Multiply the amount of product you anticipate you’ll sell to these stores by month and year. It’s that simple.

To refine your calculation process, speak with potential customers, market research consultants, industry leaders, board members and advisers in your space. Gather information through conversations with CEOs in the same industry whose companies have complementary products. This information will be vital to determine the market penetration rate of your product.

Your SOM calculations are integral to the sales cycle along with the sales close rate you anticipate. Don’t inflate your estimates, because investors will expect you to achieve these numbers. When your company has revenues, not achieving estimates can come back to bite you in the form of diminished credibility with investors, and potentially tank your ability to secure funding.

The importance of credible sources

While no investor expects accuracy down to the penny, take extra care to present realistic metrics. Never rely on market size figures you read about in an article you ran across without first digging into the methodology used to size the market. I’ve read seemingly reputable articles where sizing methods were faulty, leading to misleading information.

The antidote to questionable information is to secure market data from credible sources. If this seems like a lot of work — and it is — here’s my advice: Don’t be tempted to resort to hand waving, meaning don’t quote something you’ve heard and not verified as realistic.

Approach data with a good dose of skepticism, and it won’t take long for you to get good at spotting bad numbers and becoming comfortable using credible market sources.

Add a specialty research organization to your team

If you don’t have a comprehensive understanding of your markets or solid data, or if your technology and market are new, I strongly suggest hiring a market research consultant who has experience in your market and understands new products and market trends. An expert researcher will prove more than worth their weight in gold.

Custom market research will give you a clear focus into a specific market covering TAM, SAM and SOM. These custom reports typically cost anywhere from $15,000 to $75,000 or more, depending on scope and industry.

Before you hire, be sure to check references with others in your industry. Rely on your network, including board members, advisers, investors, and other professionals in your industry to seek out consultants they have worked with. You could also consider consultants who are frequently quoted in the trade press.

I also advise against engaging a larger firm, because it’s likely they will assign your research to a less-experienced associate. Smaller firms frequently specialize more in certain markets, and the principals often do the research themselves. Small firms also may have pricing plans better suited to your budget.

Most market research firms do not work for equity, but will establish terms based on achieving milestones. That way you can spread out payments over time.

I retained a market research consultant in our niche while growing the business I led. I found him through his frequent quotes in the trade press. I was impressed with his solid and grounded analyses, and after we checked his references, he became an integral part of our team.

Using his predictions going out 10 years, we selected a small subset of products based on the future market potential we gleaned from TAM, SAM and SOM market data points. His predictions were 90% correct, which proves the outsized value of bringing in this kind of specialized expertise.

Get advice

Reach out to board members, advisers and other entrepreneurs for guidance and feedback. Many will have been through similar calculations with their own companies and can offer valuable, seasoned perspectives.

If you do your homework, you’ll eliminate financial projections guesswork, show prospective investors how they stand to gain from investing in your company, and put yourself in the best possible position to achieve your goals.