When counseling clients or judging startup completions, one of the biggest swag figures I see is related to the size of the market they expect to hit. These numbers are often extremely large which too often causes startups to overspend pre-launch based on the overly inflated prospect of future sales.
In an effort to determine your product or services real market potential, it is advisable to follow the three step process many venture capitalists use to determine a product or service’s real market potential.
1. The first step in determining your real market potential is to ascertain the size of the Total Addressable Market (TAM). For example, if you were the Dollar Shave Club, your TAM in the United States would be the total male population less males under 17 that do not yet shave.
2. However, your TAM is an unrealistic target since you would never capture the entire market with no competition. Therefore, you have to also determine the portion of TAM that is the Serviceable Available Market (SAM), in other words, the market portion that you can more realistically reach with your anticipated sales channels such as direct sales, affiliates, or dealer networks.
To understand SAM, let’s look at ROHO Inc., the developer of a medical device for patients seeking relief from pressure sores we talked about in a previous post called “Four Business Lessons from the Sturgis Motorcycle Rally.”
ROHO Inc. knew their product could be extended to other markets, such as relieving sores from motorcycle seats. However, its established sales channels for medical devices was not a good fit for extending its product line to these new markets. Rather than invest heavily in establishing a new sales channel to expand into a potentiality lucrative new market segment of motorcycles, ROHO Inc. decided to sell their technology to HESS LLC. HESS LLC already had a sales channel in place in the motorcycle industry with its Danny Gray Seat Design Division.
Therefore, your SAM is a more realistic target than your TAM. However, the SAM is still an unrealistic real target since you will never have a total monopoly on your SAM.
3. Finally, you have to estimate the percentage of the SAM that you can realistically reach and stimulate to buy from you. This is known as the Serviceable Obtainable Market (SOM) or your realistic target market. Your SOM is the the most realistic fraction of SAM you can hope to gain based on your customer acquisition strategy.
In conclusion, it is not advisable to determine your TAM and then immediately assume you can capture a percentage, such as 1%, without doing further research to determine your SAM and ultimately your SOM.
Are you guilty of just guessing your market potential?
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