What if Total Addressable Market can’t be estimated accurately?
What if Total Addressable Market can’t be estimated accurately? What then?
What is Total Addressable Market (TAM)?
Total Addressable Market, or TAM, is the number of buyers who are Willing To Pay (WTP) for a solution to a problem they have now, or are Willing To Pay (WTP) your firm instead of the firm they’re currently paying to solve a problem.
Why is TAM important?
TAM determines the life and death of a firm.
The leading cause of startup failure, and perhaps all business failure in general, is the failure to penetrate and/or retain TAM (Including bureaucratic capture and rent-seeking).
In this context, I’m concerned about the introduction of a new product into the market in an effort to generate both enough adoption, and enough switching, to validate a startup hypothesis.
This goes for intrapreneurism (an effort within an existing firm) and entrepreneurialism (an effort within a new firm).
TAM is commercial life and death.
How is TAM measured after the fact?
TAM is often calculated after the addressable market has decided that it’s a market.
That is to say, after all the data is in, a Total Addressable Market is called.
For instance, what is the Total Addressable Market for residential dishwashers?
We know after the fact that the penetration of dishwashers maxes out at around 61% of households. At the time of writing, there are 12.4 million households. The Total Addressable Market for dishwashers in Canada is around 7.6 million households, not 12.4. Roughly. And we know this after the fact.
Why isn’t 9 million households? Why not 11? Why not 7?
Different products have differing maximum adoption curves for a whole bunch of different reasons, and these vary from country to country, direct marketing area to direct marketing area, block to block, and segment to segment.
It’s relatively easy to watch slowing market penetration in a given market. It appears in the aggregate data. It’s harder to predict.
To provide you with some closure as to why not everybody in Canada owns a dishwasher — roughly 30% of Canadian households rent their homes. Dishwashers aren’t exactly the most durable of appliances. And, they’re expensive to run from an energy perspective (Ontario alone has 2.2 million people aged 65+, and electricity rates where increasing even during the late naughties). Finally, dishwashing has a social time-spent component in many families, such that the dishwasher itself is an unwanted technical solution. That is to say, the Job To Be Done by doing the dishes isn’t so much about washing the dishes, but, to connect with family and the creation of a high interaction chore.
If you’re a dishwasher manufacturer in 1950, when penetration was very low, you may have been very frustrated by the penetration of these appliances in the home, and you may have preferred a world where all 12.4 million Canadian households in 2017 would own a dishwasher.
It took 50 years for the dishwasher to go from 1% penetration to 58% penetration in Canada.
It took 17 years for the Microwave to go from 1% to 80%.
It’s easy to fit the curve after the fact.
But what if you have to predict it before the fact?
How is TAM predicted today?
There’s insane optimism.
Reasons to believe are more likely to be found in proportion to the seniority of the person asking for those reasons, and the number of direct reports looking for validation.
This goes for entrepreneurs as well.
The power of uninformed optimism is profound in generating behavior that has better odds in generating positive outcomes. Belief in the inevitable powers lumpy behavior that may, under certain conditions, generate great performance.
“You’d have to be insane to undertake the risks you take as an entrepreneur” is how one lucky gentleman put it to me.
So that’s being insanely optimistic.
Then there’s the top-down method.
There’s the toothbrush way. You say that there’s 1.3 billion toothbrushes in China, and if you can just get 1% of that market, well, that’s a lot of money. Top-down estimates can be run from where the knowledge is known.
There are various ways of doing top-down estimates. The best market segments are self-referential when making purchasing decisions (Moore, 1993). That’s especially true of teenagers. It’s also true of people at the golf course.
So they tend to come into contact with each other regularly and they tend to have a lot of homogeneity in some targetable feature. If they tend to be of a similar age, they’ve had similar cultural backgrounds generally. There’s a lot that can be done with all of that information to address a market.
These are imperfect. Just because there are 120,000 men between the ages of 18 and 34 in the Northeast that are ultra passionate about poker doesn’t necessarily mean there’s a TAM of 120,000 for your poker inspired app.
But it’s taken that way.
There’s a also a head counting method. You can think of how many people in your social network have a given problem, calculate a ratio, and then look for evidence to support or reject your estimate of network size. Such bottom-up approaches are more likely to generate disruptive insights than they are to yield an accurate estimate of TAM.
What if it can’t be estimated? What then?
Well, what if you’re not insane? What if you fear uninformed optimism more than anything and you really don’t want to rely on luck exclusively?
The downside is that so many risks aren’t taken. And your stance on the opportunity cost is proportional to your risk perception curve.
What if viability is assessed in the early stages and validated back?
We take a lean approach to product development, and we tend to think exclusively about that.
We probably don’t think of it as taking a lean approach to market development though.
What’s good is that some platforms, like kickstarter and Steam, enable one to assess the likelihood of viability.
What if the bottom-up approach for TAM estimation is sufficient? Before betting the farm on the existence of a specific product-solution-market fit, why not do everything in your power to understand the fit?
The Bottom Line
An experimental stance on TAM may overcome attempt-inertia and kickstart learning.