The odds of you being successful will significantly reduce if you take dumb money. You need smart investors.
When you pitch, Smart investors want to know how big your market is before they commit their cash and time to your business. It helps them know the earning potential of their investment in your business.
You should be prepared to answer the question: what is your total addressable market? And this sometimes catches a few startups ( who have left out this all-important segment in their presentations ) by surprise.
Your Total Addressable Market (TAM) is how much your customers are worth if you happen to acquire 100% market share. The worth is usually in terms of cash. How big is the problem you are solving? What is the scale of the demand for its solution? How much money can you possibly make from this market?
If we are being real, you won’t own a 100% share of the market. It’s 2016, a scrappy startup in a garage will also have a share of the market you are addressing.
Entrepreneurs can often be blinded by their own optimism as to draw up a bloated TAM. The idea is not to give a big number, but to estimate a testable number that everyone believes in – you, your team and your investors.
How do you get a sense of what your total addressable market is?
There are two ways to find out:
1. Bottom-up analysis
Imagine a command chain. At the bottom of a command chain is everyone that will receive the order from the honcho. Using the bottom-up analysis, you should identify everyone that would use your product in that chain of command. You will find out how many people in a certain predefined area fit your end user profile.
This involves stepping out-of-the-building and counting noses, then making extrapolations using logical parameters. Having identified every customer, multiply the total number of the customers with how much each customer will likely spend on your product per year.
That’s your TAM.
TAM = Revenue Per end user X Number of end users
Clearly, this approach will take time, but it provides the most accurate estimation.
If you are calculating TAM for your patent leather shoe business, using this approach, you will identify customer archetype first.
This is part of the customer discovery process. Say, your end user profile is: a man between 18 and 60 that earns between $5,000 and $30, 000 per month, you will find out how many of them are there in your beachhead market from primary data. You won’t get everyone in your survey, so you are left to make extrapolations from that subset of raw data.
Next, you find out how much each customer is likely to spend on shoes every year. Then, go ahead to multiply the figures to get your TAM.
2. Top-down analysis
This is fairly easier to pull off. You will rely on secondary market research to determine how many end users you got for your service. Because these data don’t exist at a specific level, you will have to work backward from large chunks of population stats.
Armed with the stripped down population figure, do the same as in bottom-up analysis. Multiply the figure with how much an average customer will spend on your product per year. That’s your TAM.
This top-down strategy often leads to an overstated TAM, so it’s good sense to benchmark it against your bottom-up analysis.
A truer TAM is probably somewhere between results from the bottom-up and that from the top-down analysis. So, it’s good sense to settle on an average of both results.
It’s important to know the size of your market. A market too big might put you in the crosshairs of the big boys, You could end up being in a market where you don’t have enough resources to compete. However, your market should be big enough to get you to critical mass, iterate your product based on learning from the market, get to cash-flow positive and give a good return on investment.
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