Understanding TAM/SAM/SOM

When I work with investors and companies on market analysis, one the things everyone wants to know is “what is the total addressable market (TAM)?” This is an important question, but is just the tip of the iceberg, especially because many entrepreneurs (and investors!) focus on identifying the biggest number possible.

When a company stays focused on the giant number, it doesn’t give any real strategic guidance – “we’re playing in a $3billion market” doesn’t help much sense when you’re selling $10m worth of software. Instead, it’s important to dive a little deeper and be more rigorous in your analysis.

I usually break this out into a “TAM/SAM/SOM” analysis.

This does a few things:

  1. It gives potential investors a vision for your businesses’ potential.
  2. It gives discerning investors a sense of how rigorous you’ve been in your thinking about your business, your market segmentation, and competitive dynamics.
  3. Smart thinking here will provide guidelines for your team’s product and GTM strategy.

TAM – Your Total Addressable Market.
This is the entire revenue opportunity that exists today for a type of product or service, assuming unencumbered access to it.

For example: I’m selling an amazing $8 espresso drink. My TAM is all coffee drinkers.

It’s nice to have a giant number here – set the vision for your investors and employees. Give yourself something to grow into.

SAM – Serviceable Addressable Market.
Your SAM is the revenue opportunity that exists given your specific product’s current capabilities and your company’s ambitions. What segment of the market are you addressing today?

In our example, not everyone who drinks coffee likes espresso. And not all espresso drinks want to pay $8. And I’m based in San Francisco and don’t plan to expand. My SAM is everyone who would be willing to pay $8 for a cup of amazing espresso in San Francisco.

SOM – Serviceable Obtainable Market.
Finally, your SOM is what you can reasonably expect to achieve given your current operational resources (or the operational resources you expect to get) and the competition.

In our example, I’m competing against the chain stores like Starbucks, Petes, and the little boutiquey coffee places that are all over SF. I’m not going to win all that business, but with proper marketing and sales execution and great operations, I can win 20% of the time (this is where my silly coffee shop example falls apart, but hopefully the point is clear).

Using TAM/SAM/SOM to drive strategic decisions.

The TAM/SAM/SOM analysis doesn’t just exist to look good on an investor pitch deck – done right it should drive strategic decisions about your operations. Pull different levers and you can increase or decrease different numbers:

  • Increase your TAM by adding features or functionality that fundamentally broadens your scope or increases your price. Add pastries to your coffee shop. These are typically cross-sell opportunities, add-on opportunities, or simple price increases. 
  • Increase your SAM by appealing to different segments within your main market. Often this is geography – expanding internationally, for example. But it can also be product-based – by adding a feature or two you can appeal to a new vertical within the same basic market – or sales/marketing-based – depending on the market, you may need to establish key partnerships to effectively service a market.
  • Finally, you can increase your SOM through a variety of execution methods, including organic methods (better marketing and sales execution, better positioning, gaining a market leadership position) or inorganic methods (e.g., acquisitions of key competitors).

A simpler way of thinking about this is:

  • Increase TAM: Can we sell more?
  • Increase SAM: Can we sell to more people/accounts?
  • Increase SOM: Can we win a greater percentage?

Putting it into action.

I like to present the full TAM/SAM/SOM analysis to the Board along with options for expansion that we’ve brainstormed beforehand with the executive team. This gives you an opportunity to enroll your board in the journey with you, solicit new ideas in a structured fashion, and gain useful feedback and guidance. 

Process is about raising floors and removing ceilings

I’ll admit it: I’m obsessed with creating processes. Whenever it looks like I’m going to do something more than once, I start creating a process. It’s nothing big – I just write down what I plan to do before I do it. Viola! A process.

Processes can take many different forms and names: a checklist, a plan, a recipe, a playbook, a workflow, etc. They are all processes. The dictionary defines process as “a series of actions or steps taken in order to achieve a particular end.

Often the very act of writing down the steps highlights a few things I might have missed. Once I’m done, I can update it based on what actually happened, and the next time I do it, I’ll make fewer mistakes and do so in less time.

This is even more the case at a startup.

Some people cringe when they encounter a process. “It’s onerous!” they worry, “it’ll slow us down and we’re moving fast!” It might slow you down a bit. But it shouldn’t slow you down too much — otherwise, it should be reviewed and streamlined — and it might prevent you from making a mistake that will slow you down a lot more. And the next time you do it, you’ll go much faster.

Another way of looking at it is as an easy way to avoid dumb mistakes, especially in high-pressure, rushed situations, which is basically all the time in a startup. An even better way of looking at it is as a way to spend less time thinking about easy things and more time thinking about hard things. When you don’t need to spend time thinking about the little things, because you have a checklist, you can think about the big things. How can we do this better? Is this even something we want to do?

Processes are especially helpful even it comes to creative work.

At Loud Dog (the creative agency I ran), we had a process for almost everything. Some things were more logistics than anything, and these are obvious process candidates: launching a website, building a server, collecting client information, etc. But we had a process for creative things as well: creating logos, website designs, videos, developing names.

Often clients were excited about our well-defined processes. These were usually the ones that had been around the block before and seen what not having a process looked like. Other clients were reticent – mostly concerned about time and cost. “Do you really need to take all that time to generate one simple thing? I heard that the Nike logo was created over a weekend by a college student. Can’t you just do the same thing?”

This misunderstands creativity. The process doesn’t guarantee amazing. What it does is protect against downright bad. Without a process, creativity is hit-and-miss. Sometimes inspiration hits and it’s AMAZING. Other times, it’s not. A good process avoids this, grants a higher likelihood of amazing, and ensures good. There’s plenty of bad out there. When you need to generate results, not just the possibility of results, you need a process.

Well-defined processes help organizations scale.

Beyond ensuring good quality, good processes codify and distribute knowledge, ensuring consistent quality as an organization grows.

Every organization engages in repeated activities, from finding and hiring new employees, to designing new features, to marketing, selling, and servicing customers. The more of these repeated activities an organization is able to identify and codify, the more they will maintain quality as they scale, and the faster they’ll be able to scale.

Ad hoc efforts are the enemy of scale.

When a team fails to introduce process to their work, they end up relying on ad hoc efforts – one-time efforts designed specially for the task at hand. Although sometimes ad hoc efforts are necessary, they often rely on the heroic – and siloed – efforts of individuals. And individuals are not scalable. Processes are the opposite of ad hoc efforts.

At the end of the day, processes ensure consistent quality and allow organizations to scale. Creating good process is challenging and hard work, but well worth it in the long run. Relying on ad hoc efforts can create good short-term results, but you end up relying on heroic individual contributions that aren’t always duplicable and are never scalable.

Market confusion – what’s in a word?

Business strategists and marketers throw the word “market” around liberally, using it in different contexts with different definitions without explanation. This can be confusing.

I especially notice the difference moving from an investment perspective to an operational perspective. In the former, the term is often more seller-focused. For example, “who are the players in the market?” In the latter, the term is often more buyer-focused. For example, “our market is automotive companies.”

“The market is $30 billion.” (Overall bazaar, refers to the amount buyers are spending with sellers.)

“We sell to the higher education market.” (Refers to a group of buyers.)

“We can beat anyone in the market when it comes to color choice.” (Refers to a group of sellers.)

“Let’s take this RFP to the market.” (Sellers)

“The market won’t respond well to that message.” (Buyers)

Like I said, this can get confusing, especially if you’re trying to discuss something with precision, like a model for positioning.

For the sake of clarity, here are some definitions.

Market: The overall bazaar, including sellers of a product type and buyers of a product type. Buyers have some (but not all) overlapping problems to be solved (needs), and sellers have solutions with some (but not all) overlapping capabilities. The definition is typically somewhat loose, and different parties may not agree on the specifics. Analyst groups derive a lot of value from time defining and sizing markets.

Market segment: A group of buyers of the product type, filtered by one or more criteria. Needs are very overlapping.

Target market: A market segment the seller has chosen to target.

Product category: Aka Product Type. A group of products that solves a common set of problems. A product category can be broadly defined or narrowly defined (e.g, network security products or firewall products, respectively). Which is used is dependent on the context.

Competitive arena: The vendors competing to sell to a particular buyer. Over time, a company will find itself in the same competitive arena repeatedly, competing with the same sellers to meet similar buyer needs. This is likely a subset of all sellers, with many overlapping capabilities. In aggregate, this is typically a product category.

An important characteristic of these concepts is their semi-organic nature. A market needs both buyers and sellers, and the components are defined by what sellers are offering and what buyers are looking for, and these influence each other. Existing buyer needs (i.e., needs buyers are aware of) are the biggest factor in determining markets, but sellers can introduce new needs and influence the perception and priority of existing needs.

Sellers need to tread a delicate balance: get too far away from what buyers are already looking for and you risk “getting ahead of the market” and failing. Only follow what buyers are already asking for and you risk becoming a me-too product, competing only on price.

Threading this needle correctly is the goal of product strategy and positioning, which I’ll explore in a future post.

Lightbulbs and patent trolls

I’m always searching for good analogies that highlight what’s wrong with software patents. I don’t remember where I saw this, but I like it.

We all know the story of how Thomas Edison invented the lightbulb. He knew the basics of what he needed to invent: something that would glow consistently when a current was applied to it, but wouldn’t burn up too quickly. The idea for this had been around for fifty years, but no one had been able to make it work practically. He and his assistants tried some 3,000 different ways of making it work, and finally figured out how. And thus the modern lightbulb was born, with Edison as its inventor.

Flash forward to modern software patents. Edison isn’t the inventor, and doesn’t receive the patent or any accolades. Instead, some guy fifty years earlier has the idea for an incandescent lightbulb and describes it without having any practical way of making it work, and just sits back and waits for Edison to come make it a reality. Welcome to the modern patent troll.

Traditional patents are granted for the method by which an invention accomplishes something – the specific filament, for example, or a machine that works in a particular way to do something. Software patents are granted for the concept that the software accomplishes, not the actual code that accomplishes is (that code is still protected by trademark). Amazon’s (in)famous one-click patent doesn’t cover the actual code written to make one-click happen (there are many ways one could write that code), but covers the idea of writing code to make that happen.

If we applied modern patent practices a hundred years ago, Eli Whitney wouldn’t have patented his actual cotton gin, but the idea of using a machine to separate cotton fibers from seeds, regardless of how the machine was designed or built. Edison wouldn’t have had to spend time figuring out how to build a working lightbulb, or patenting the specific method – the vague idea would have been enough.

Edison famously said that invention was 1% inspiration and 99% perspiration. Today’s software (and many hardware) patents are awarded for inspiration, not perspiration.

Kickstart, crowdfunding, and the future of media

If you’ve known me for long enough, we’ve probably had a conversation or two about the future of the music and movie industries. These industries are undergoing massive changes right now, largely driven by changes in technology over the last decade that are rendering existing business models obsolete.

Media industry supporters go crazy over the Internet and piracy, support things like SOPA, and bemoan the “death of music” or the “death of writing” or whatever it is they are involved in, claiming that without robust legal protections against piracy, music, writing, and movies will go away. I don’t buy this argument because these various industries have only existed for 50-100 years, and people have been creating music and writing for far longer (obviously movies are a modern phenomenon, but the point remains).

To explain further, let’s focus on the recording industry. Although they claim they are all about creating music, their business model is actually built on the distribution of music, not its creation. Music itself has been around since the dawn of humanity – the oldest known instrument is the Divje Babe flute, from some 40,000 years ago. Modern recording companies, however, have only been around since the early 21st century. The invention of phonograph in the late 19th century allowed music to be recorded and distributed for the first time in history, and by the 1920’s the technology had been perfected and modern recording companies were born.

Eventually, the record was displaced by the 8-track tape, then by the compact cassette, then by compact discs, but for each of these, the recording industry’s business model has been about the production and distribution of these physical goods. In other words, the recording industry is actually not a creative industry, but a manufacturing industry. It’s not selling music; it’s selling physical tapes, records, or cds.

And this was very valuable: cost effectively manufacturing cds requires a significant capital investment, and getting them physically shipped all over the world requires a lot of logistical expertise and money. Because their manufacturing and distribution expertise was so valuable, the recording industry made a lot of money and was able to align related industries to support it: radio was a key marketing and advertising channel, driving additional sales, as were live concerts.

Record companies like to claim that their business model is really centered around finding new artists to publish, but the only reason for narrow talent acquisition is because of manufacturing cost and scale issues. Sure, a recording session in a studio can be somewhat expensive, but it’s nothing relative to the cost of ramping up manufacturing and distribution of physical media. So their business model required fewer artists to sell more records. Thus the hunt for talent.

Advances in technology and the introduction of the Internet have rendered the two strengths of the music industry worthless. Now that all music is digitally formated, manufacturing expertise is no longer needed, and since the Internet allows digital files to be distributed world-wide at near-zero cost right into consumers’ homes, distribution expertise is no longer needed.

In short, there is no fundamental reason for record companies.

But, they do provide a valuable service. Even if the cost of recording (studio time) is small relative to the cost of manufacturing and distribution, it’s still large relative to most starving artists’ bank accounts. And that’s where Kickstarter and crowdsourcing come in.

This last weekend, two independent artists – a video game creator and a music artist – both posted projects to get community funding for their work. They both raised around $1,000,000 in 24 hours – directly from fans, completely bypassing publishers, and ultimately at a far lower cost than the recording industry model would support.

The recording industry has been buffeted by the winds of change for a decade, but continues to cling to its old business model. That model’s not going to survive another decade. Some of the companies will, but not in their current form.