Metrics that are commonly referenced by early-stage startups include Total Addressable Market (TAM), Serviceable Addressable Market (SAM), and Serviceable Obtainable Market (SOM). While these metrics may help provide insight into a startup’s potential market size, investors should carefully assess these metrics, as they may be ambitiously overstated. In this blog, learn more about assessing startup market size, TAM vs SAM vs SOM, and how to evaluate each metric.
Assessing Startup Market Size
Some of the most common metrics startups may use to present their potential market size include TAM, SAM, and SOM. These three metrics measure specifically different markets, and investors should be aware of what each metric represents.
Total Addressable Market (TAM)
TAM represents the total revenue opportunity available for a startup if it were to achieve 100% market share in its relevant market. In simple words, what is the overly ambitious best case scenario if the startup had no competitors and every potential person within the target market became a customer. For example, the TAM for a product management software would encompass all global business spending on project management software. In reality, it is highly unlikely that any startup will ever be able to achieve its complete TAM.
Instead, TAM should represent the outer boundary when taking a look at other metrics like SAM and SOM.
Serviceable Addressable Market (SAM)
SAM narrows down the focus within TAM to provide a more realistic segment that the startup’s specific business model and operational capabilities may be able to serve. This metric takes into account geography, language, regulatory environment, and specificity of the product or service. Using the same example, the SAM of the project management software might be small and medium-sized businesses (SMB) in North America. A well-defined SAM can represent strategic focus and a clear understanding of the initial market while still viewing through a best case scenario lens of every North American SMB implementing the product.
Serviceable Obtainable Market (SOM)
SOM focuses even further in on the TAM and now the SAM. Representing the portion of SAM that the startup can realistically capture in the short term, this metric is grounded in real-world constraints. Existing competition, sales and marketing capacity, and customer acquisition cost all factor into the SOM calculation. Using the same example, the project management software might set a goal of obtaining a SOM of 1% of its SAM in its first year, 3% in its second year, and 5% in its third year. SOM reflects the startup’s current execution and operational capabilities, however, it can also be overstated due to ambitious hopes of fast product-market fit and traction.
Evaluating TAM, SAM, and SOM
Startups can be very optimistic about their current situation and future growth trajectories. As such, investors should carefully assess metrics like TAM, SAM, and SOM in order to understand how the calculations were performed, and if they actually represent realistic market sizes.
Identifying Methodology
Investors should consider finding out how the startup arrived at its TAM, SAM, and SOM numbers. Broad industry reports and market research can be a good starting spot to establish TAM, but an over-reliance on top-down data can lead to oversimplification and exaggeration.
Scrutinizing Assumptions
Investors should also question the assumptions used to narrow down the TAM to SAM. A claim that 10% of the SAM can be captured within the first year without a detailed plan supported by early traction or comparable benchmarks can be a red flag. SOMs based on gradual market penetration supported by early traction metrics can be a better guide for helping to assess potential growth.
Assessing Consistency
As a startup forecasts market size, these numbers should be consistent with the rest of the pitch. If a SOM projects $5 million in first year revenue, the startup’s sales forecast and customer acquisition strategy should be able to logically support this number. If the SAM is defined as U.S.-based SMBs, the go-to-market plan should be tailored to that audience. Inconsistencies between market sizing and other parts of the business plan can reveal a lack of integrated strategic thinking.
Final Thoughts
For private market investors, being able to make an informed assessment of TAM, SAM, and SOM can help paint a clear picture of the startup’s current position and future growth targets. While startup’s can be ambitious with projections, there are multiple ways that investors can assess startup market size to aid due diligence efforts.
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Want to learn more about investing in startups? Check out the following MicroVentures blogs to learn more:
- Understanding Tender Offers
- Understanding Valuation Caps
- Calculating a Startup’s True Runway
- Subsequent Funding Rounds: Follow On Investments
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
