Basic, lesson 1 of 3
Sizing a market like an investor
One TAM number hides the assumptions. Split the market into segments, price each one, and check the price against the value the product creates.
10 min, 3 checks
1Segment, count, price
A founder's TAM slide usually multiplies one big customer count by one price. Real markets are lumpy: small customers pay less and churn more, large ones pay more and buy slowly. Investors rebuild the number by segment, because the segment the company can win first decides how fast it grows.
Worked example
Field service software for US plumbing and HVAC firms
- 1Assume 90,000 firms with 1 to 4 technicians, at 150 dollars a month: 90,000 x 1,800 = 162 million dollars a year.
- 2Assume 25,000 firms with 5 to 19 technicians, at 600 dollars a month: 25,000 x 7,200 = 180 million.
- 3Assume 5,000 firms with 20 or more technicians, at 2,500 dollars a month: 5,000 x 30,000 = 150 million.
- 4Total: 162 + 180 + 150 = 492 million dollars of software spend.
Three segments of similar size but very different sales motions. The 1 to 4 segment has the most firms and the least revenue per sale, so a company starting there needs self serve sign up and low CAC.
Check 1
A product sells to 8,000 small clinics at 3,000 dollars a year and 1,500 large clinics at 20,000 dollars a year. What is the total market, in millions of dollars?
2A price ceiling from value
A count times a price is only as good as the price. Check it against value: what does the product save or earn for the customer each year? Software vendors rarely capture more than a modest share of the value they create, often somewhere around 10 to 25 percent, because the customer needs a clear reason to switch.
Price ceiling = annual value to the customer x share the vendor can capture
The capture share is a judgment, not a law. Use a range and say so.
Worked example
A dispatch tool that saves fuel and overtime
- 1A 10 truck firm saves 30 dollars a truck a day in fuel and overtime, over 250 working days: 10 x 30 x 250 = 75,000 dollars a year.
- 2At 10 to 20 percent capture, the price ceiling is 7,500 to 15,000 dollars a year.
- 3A planned price of 9,600 dollars (800 a month) sits inside that range.
The price is defensible. A planned price of 40,000 would not be, however large the customer count.
Check 2
A tool saves a law firm 120,000 dollars a year. If a vendor can capture 15 percent of that value, what is the price ceiling, in dollars?
Check 3
Why split a market into segments instead of using one count and one price?
Terms in this lesson: Customer acquisition cost.
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