02. Bottom-up TAM

Estimated Time

  • Reading: ~6 minutes
  • Video: ~41 minutes
  • Activities: to be completed prior to the next week

Insights

  • Most investors do not care about your lazy TAM
  • A more meaningful measure of TAM is bottoms-up based on real customers

Total Addressable Market

  • The Total Addressable Market (TAM) as described by CFI
    • Is the overall revenue opportunity that is available to a product or service if they captured the entire market
    • It helps determine the level of effort and funding that a person or company should put into a new business line
  • There are 3 main ways of calculating TAM
    • Bottom-Up:
      • Jason prefers this method as it is the most accurate and shows that the founder understands who the customers are
      • It evaluates where products can be sold
      • Takes into consideration the sales of comparable products
      • And estimates the market share based on current customers
    • Top-Down:
      • Calculated by determining the total market
      • Then estimating the company's share of that market
    • Value Theory:
      • How much value do consumers receive from your product or service
      • And how much they're willing to pay in the future for it
  • Difference between TAM, SAM, and SOM
  • image

Episode Date: May 7, 2021 -- External Link to video

Jason Calacanis |

|

|

Understanding your Market

  • Are you creating a new market or servicing an existing one—how to tell the difference.
    • Let's use two consumer subscription companies as examples for this:
      • Spotify and Calm
        • The market for Spotify was clear - everyone loves music
          • Consumers would love all the music in the world cataloged and instantly accessible for a small monthly fee
        • The issue with Spotify was figuring out the rights issues that plagued music startups in the past
        • Spotify knew their market existed
          • They knew everyone loves music
          • They had to figure out how to not make the same mistakes as Napster
        • For Calm, their market did not exist
        • They helped create their own market by launching a great product at the perfect time
        • Calm did not know for sure that there was a pot of gold at the end of the rainbow
          • But their product was so good it helped create the market they now exist in
      • Great products can create markets
        • Uber
        • Airbnb
        • Calm
  • Understand the difference between "Lazy TAM" and "Bottom-Up TAM"
    • Early-stage investors typically don't need to see a TAM slide
    • "Lazy TAM" is a term Jason coined after having hundreds of founders show an uncorrelated Gartner number on their TAM slide
  • Episode Date: May 7, 2021 -- External Link to videoJason Calacanis | TWiST | Twitter | LinkedIn
  • Do NOT do this — you instantly lose credibility with investors
  • The great early-stage investors don't care about an insanely huge market size
  • We care about the flywheel:
    • Great product
    • Great team
    • Obsessed customers
  • If you do want to impress an investor with a TAM slide
    • Use a bottom-up approach
    • Why? It shows that the founder is starting with reality and building upwards from there
  • Let's look at a fictional startup example:
    • Acme Corp sells SaaS software to dentist offices
      • They charge $1000/month per office
    • First, let's do a LAZY TAM example:
      • According to an ADA (American Dental Association) report from June 2020, the total projected dental spending for 2021 was between $123.9B and $154B
      • Lazy TAM would be taking the average of these two numbers ($139B) and pitching that as your yearly market size
      • "We can capture 10% of this market, and if we were at scale in 2021 our yearly revenue would have been $13.9B"
      • This calculation would completely miss the mark, and hurt your credibility with investors
    • Bottom-up TAM example:
      • Remember, you're only selling to dentist offices, so find that number first
      • In 2020 there were 201K working dentists in the US, according to the ADA
      • But there are only 187K total dental offices in the US in 2021, according to market research firm IBIS World's projections
        • This makes sense, as some offices have multiple dentists
      • Out of the 187K dental offices, what % can you convert to customers?
      • Let's say you think you can capture 10% of the market in ten years
        • That's $1000/month x 18.7K = $18.7M/month OR $224M/year in revenue
        • $224M in revenue is a great business!
        • And if you walk investors through your TAM bottom-up style, you will look prepared, believable, and credible
    • Make sure to emphasize that you're only going after the customer segment that fits into your business, not the entire market
      • From that example, The Acme Corp selling into dental offices does not care about the total dental revenue of toothbrushes, oral hygiene products, etc.
    • You can also put a "looking ahead slide" where you talk about potential markets you can expand into in the future
      • Expanding into different markets has made great companies go supernova
        • For example,
          • Amazon building AWS
            • Through the first 9 months of 2021, AWS accounted for ~70% of Amazon's profits ($13B out of $19B)
            • And AWS had only 13% of Amazon's total revenue ($44B out of $332B)
        • Another example,
          • Uber first expanded from black cars into Uber X's, then expanded into delivery
          • The first expansion (offering Uber X) basically created the gig economy on a global scale and kicked Uber's business into hyperdrive
          • The second expansion (delivery) made Uber's business anti-fragile
          • It kept them growing throughout the pandemic as rides shut down for a few months
  • Have investors had success in your market before?
    • Can dozens (or hundreds) of venture-scale businesses be built in your market?
    • Being in enterprise SaaS is much more investable than owning a bunch of laundromats or restaurants
    • Why? The path to creating a $1B company is easier in enterprise SaaS
    • Venture scale means "can your startup can get to $100M in revenue or a $1B valuation in under 10 years"
    • When Calm first started, they were not viewed as a "venture-scale business"
      • Investors were skeptical that Calm's market size was larger than people who were currently into meditating
      • Once Calm added sleep stories, mental recovery for athletes, and other products, the market expanded
        • They did not do this on day one
        • They focused on delighting the customers they had and expanded later
    • Ask yourself: Can you get to $100M in revenue in 10 years in your market?
    • In a February 2017 blog, Elad Gil (Angel S5 E3) described a trick to assess if your market was a good one to be in:
      • Elad calls this "The 2% and $1 Billion Rule"
        • A direct quote from the article: "In general, you want to be in markets where multiple companies could afford to buy you for $1 billion, or where 2% of their market cap is at least in the hundreds of millions of dollars."
        • For Example,
          • If you're a startup that's building tools to help creators monetize, you could be acquired by...
            • Google: ~$2T market cap
            • Facebook: $950B market cap
            • Snapchat: $88B market cap
            • Twitter: $43B market cap
        • Ask yourself: "what are the market caps of the biggest companies in my space"?
      • If the market caps are huge, this will help you in three ways according to Elad:
        • These market caps reflect market opportunity since they're based on total revenue, growth rate, and margin
        • Large incumbents are competitors but they're also potential acquirers (they will create exit opportunities)
        • High market cap and cash-rich companies tend to be great strategic investors at the later stages for a company
  • Do you know who your competitors are?
    • If an investor asks about competition:
      • You should be able to name your top 3-5 competitors
      • And you should also be able to explain how and why what you're offering is better for customers
      • It's also a bonus if you know ballpark revenue numbers
      • This information is typically pretty easy to find through Crunchbase or Pitchbook
    • Here is a scenario that happens often when founders are pitching me:
      • I ask them: "Who are your main competitors"
      • And they say: "We don't have any competitors"
      • You always have competition!
        • If you truly don't have competitors the first question will be:
        • "Is there a market for this — why is no one else doing it?"
      • Even if nobody is going after the same customer segment, there will still be other companies in your vertical
    • If you know the ins and outs of your competition, you will come across more credible to investors
    • And when you're trying to raise money, increasing credibility is key!
  • What are the barriers to entry in your market?
    • For most tech industries, the barriers to entry are pretty low - examples:
      • E-commerce
      • Enterprise software
      • Consumer software
      • Marketplaces
    • Most of the regulations are common sense stuff
      • No lewd content
      • No securities fraud
      • Don't lie to investors or customers
      • etc.
    • In crypto, there are almost zero headwinds right now
    • In enterprise software, some headwinds start to exist around security and compliance once you get to scale
      • Signing contracts worth six figures and up creates additional complications
    • In healthcare, housing, and education, there are massive barriers to entry:
      • Federal regulations for healthcare
      • Zoning and building permits for housing
      • Local regulations for education
    • All of these barriers take time and money to pass
      • That is one reason why VCs are often skeptical about those businesses
    • But keep in mind — the bigger the barriers to entry, the deeper the moat

Additional Resources

Activities

🔲 Recalculate bottom-up TAM

  • You had previously estimated your initial TAM - rework it if necessary with a more bottom-up approach
  • As you get your first paying customers you'll be able to become more accurate with this number

🔲 Create a visualization of TAM

  • You will eventually want a slide in your pitch deck with TAM
  • While the research is fresh put together a visual representation

Estimated Time

  • Reading: ~6 minutes
  • Video: ~41 minutes
  • Activities: to be completed prior to the next week

Insights

  • Most investors do not care about your lazy TAM
  • A more meaningful measure of TAM is bottoms-up based on real customers

Total Addressable Market

  • The Total Addressable Market (TAM) as described by CFI
    • Is the overall revenue opportunity that is available to a product or service if they captured the entire market
    • It helps determine the level of effort and funding that a person or company should put into a new business line
  • There are 3 main ways of calculating TAM
    • Bottom-Up:
      • Jason prefers this method as it is the most accurate and shows that the founder understands who the customers are
      • It evaluates where products can be sold
      • Takes into consideration the sales of comparable products
      • And estimates the market share based on current customers
    • Top-Down:
      • Calculated by determining the total market
      • Then estimating the company's share of that market
    • Value Theory:
      • How much value do consumers receive from your product or service
      • And how much they're willing to pay in the future for it
  • Difference between TAM, SAM, and SOM
  • image

Episode Date: May 7, 2021 -- External Link to video

Jason Calacanis | TWiST | Twitter | LinkedIn

Understanding your Market

  • Are you creating a new market or servicing an existing one—how to tell the difference.
    • Let's use two consumer subscription companies as examples for this:
      • Spotify and Calm
        • The market for Spotify was clear - everyone loves music
          • Consumers would love all the music in the world cataloged and instantly accessible for a small monthly fee
        • The issue with Spotify was figuring out the rights issues that plagued music startups in the past
        • Spotify knew their market existed
          • They knew everyone loves music
          • They had to figure out how to not make the same mistakes as Napster
        • For Calm, their market did not exist
        • They helped create their own market by launching a great product at the perfect time
        • Calm did not know for sure that there was a pot of gold at the end of the rainbow
          • But their product was so good it helped create the market they now exist in
      • Great products can create markets
        • Uber
        • Airbnb
        • Calm
  • Understand the difference between "Lazy TAM" and "Bottom-Up TAM"
    • Early-stage investors typically don't need to see a TAM slide
    • "Lazy TAM" is a term Jason coined after having hundreds of founders show an uncorrelated Gartner number on their TAM slide
  • Episode Date: May 7, 2021 -- External Link to videoJason Calacanis | TWiST | Twitter | LinkedIn
  • Do NOT do this — you instantly lose credibility with investors
  • The great early-stage investors don't care about an insanely huge market size
  • We care about the flywheel:
    • Great product
    • Great team
    • Obsessed customers
  • If you do want to impress an investor with a TAM slide
    • Use a bottom-up approach
    • Why? It shows that the founder is starting with reality and building upwards from there
  • Let's look at a fictional startup example:
    • Acme Corp sells SaaS software to dentist offices
      • They charge $1000/month per office
    • First, let's do a LAZY TAM example:
      • According to an ADA (American Dental Association) report from June 2020, the total projected dental spending for 2021 was between $123.9B and $154B
      • Lazy TAM would be taking the average of these two numbers ($139B) and pitching that as your yearly market size
      • "We can capture 10% of this market, and if we were at scale in 2021 our yearly revenue would have been $13.9B"
      • This calculation would completely miss the mark, and hurt your credibility with investors
    • Bottom-up TAM example:
      • Remember, you're only selling to dentist offices, so find that number first
      • In 2020 there were 201K working dentists in the US, according to the ADA
      • But there are only 187K total dental offices in the US in 2021, according to market research firm IBIS World's projections
        • This makes sense, as some offices have multiple dentists
      • Out of the 187K dental offices, what % can you convert to customers?
      • Let's say you think you can capture 10% of the market in ten years
        • That's $1000/month x 18.7K = $18.7M/month OR $224M/year in revenue
        • $224M in revenue is a great business!
        • And if you walk investors through your TAM bottom-up style, you will look prepared, believable, and credible
    • Make sure to emphasize that you're only going after the customer segment that fits into your business, not the entire market
      • From that example, The Acme Corp selling into dental offices does not care about the total dental revenue of toothbrushes, oral hygiene products, etc.
    • You can also put a "looking ahead slide" where you talk about potential markets you can expand into in the future
      • Expanding into different markets has made great companies go supernova
        • For example,
          • Amazon building AWS
            • Through the first 9 months of 2021, AWS accounted for ~70% of Amazon's profits ($13B out of $19B)
            • And AWS had only 13% of Amazon's total revenue ($44B out of $332B)
        • Another example,
          • Uber first expanded from black cars into Uber X's, then expanded into delivery
          • The first expansion (offering Uber X) basically created the gig economy on a global scale and kicked Uber's business into hyperdrive
          • The second expansion (delivery) made Uber's business anti-fragile
          • It kept them growing throughout the pandemic as rides shut down for a few months
  • Have investors had success in your market before?
    • Can dozens (or hundreds) of venture-scale businesses be built in your market?
    • Being in enterprise SaaS is much more investable than owning a bunch of laundromats or restaurants
    • Why? The path to creating a $1B company is easier in enterprise SaaS
    • Venture scale means "can your startup can get to $100M in revenue or a $1B valuation in under 10 years"
    • When Calm first started, they were not viewed as a "venture-scale business"
      • Investors were skeptical that Calm's market size was larger than people who were currently into meditating
      • Once Calm added sleep stories, mental recovery for athletes, and other products, the market expanded
        • They did not do this on day one
        • They focused on delighting the customers they had and expanded later
    • Ask yourself: Can you get to $100M in revenue in 10 years in your market?
    • In a February 2017 blog, Elad Gil (Angel S5 E3) described a trick to assess if your market was a good one to be in:
      • Elad calls this "The 2% and $1 Billion Rule"
        • A direct quote from the article: "In general, you want to be in markets where multiple companies could afford to buy you for $1 billion, or where 2% of their market cap is at least in the hundreds of millions of dollars."
        • For Example,
          • If you're a startup that's building tools to help creators monetize, you could be acquired by...
            • Google: ~$2T market cap
            • Facebook: $950B market cap
            • Snapchat: $88B market cap
            • Twitter: $43B market cap
        • Ask yourself: "what are the market caps of the biggest companies in my space"?
      • If the market caps are huge, this will help you in three ways according to Elad:
        • These market caps reflect market opportunity since they're based on total revenue, growth rate, and margin
        • Large incumbents are competitors but they're also potential acquirers (they will create exit opportunities)
        • High market cap and cash-rich companies tend to be great strategic investors at the later stages for a company
  • Do you know who your competitors are?
    • If an investor asks about competition:
      • You should be able to name your top 3-5 competitors
      • And you should also be able to explain how and why what you're offering is better for customers
      • It's also a bonus if you know ballpark revenue numbers
      • This information is typically pretty easy to find through Crunchbase or Pitchbook
    • Here is a scenario that happens often when founders are pitching me:
      • I ask them: "Who are your main competitors"
      • And they say: "We don't have any competitors"
      • You always have competition!
        • If you truly don't have competitors the first question will be:
        • "Is there a market for this — why is no one else doing it?"
      • Even if nobody is going after the same customer segment, there will still be other companies in your vertical
    • If you know the ins and outs of your competition, you will come across more credible to investors
    • And when you're trying to raise money, increasing credibility is key!
  • What are the barriers to entry in your market?
    • For most tech industries, the barriers to entry are pretty low - examples:
      • E-commerce
      • Enterprise software
      • Consumer software
      • Marketplaces
    • Most of the regulations are common sense stuff
      • No lewd content
      • No securities fraud
      • Don't lie to investors or customers
      • etc.
    • In crypto, there are almost zero headwinds right now
    • In enterprise software, some headwinds start to exist around security and compliance once you get to scale
      • Signing contracts worth six figures and up creates additional complications
    • In healthcare, housing, and education, there are massive barriers to entry:
      • Federal regulations for healthcare
      • Zoning and building permits for housing
      • Local regulations for education
    • All of these barriers take time and money to pass
      • That is one reason why VCs are often skeptical about those businesses
    • But keep in mind — the bigger the barriers to entry, the deeper the moat

Additional Resources

Activities

🔲 Recalculate bottom-up TAM

  • You had previously estimated your initial TAM - rework it if necessary with a more bottom-up approach
  • As you get your first paying customers you'll be able to become more accurate with this number

🔲 Create a visualization of TAM

  • You will eventually want a slide in your pitch deck with TAM
  • While the research is fresh put together a visual representation