Gartner states the … market is $4B and growing at a 30% CAGR. Unsupported by other facts this is the worst possible market slide you can use in your pitch deck and we see it a lot.
The fact your company addresses a problem, and provides a sought after solution is the basis for your business, your roadmap, your go-to-market strategy, your pricing strategy and so on. It should also be the basis for your pitch deck. Every investor wants to see proof that you, as an entrepreneur seeking funding, knows your customer and therefore your market. Understanding your customers' problems will make or break your search for capital.
One method for showing your market is a TAM/SAM/SOM analysis done properly it will give your investor the confidence you know your stuff.
TAM stands for Total Addressable Market. It is the maximum turnover that your company can achieve in the ideal circumstances, as a kind of monopolist. This TAM is very important when you go to an investor. In venture capital, we look for companies that can scale to several hundreds of millions, and the TAM is an indication of that.
But just throwing a big TAM in your pitch deck is not nearly enough. Example: you sell bottles of water. Everyone drinks water, so your number of potential buyers is close to 8 billion. Multiply that by the price of your bottle. Not realistic - but you get the idea.
That's why you also calculate a SAM and a SOM. SAM means Serviceable Available Market. This is the revenue you can generate in a medium-term time frame and where you limit yourself to a certain geography, sector, achievable feature set, or something else. Simple example: you roll out in the Netherlands initially. Then your SAM is 17 million times the price of your bottle, times how many times a year such a bottle is bought.
With your SOM - the Serviceable Obtainable Market - you go one step further. Here you look at who you can realistically serve in the short term. There are countless brands of water and many Dutch people drink water from the tap, so the SOM for your product is only a fraction of your SAM.
Roughly speaking, we see two methods: top-down and bottom-up.
The top-down method is, unfortunately, the one we see most often in pitch decks and is the least valuable variant. The worst version is what we call the China syndrome: simple statements like '2% of the Chinese...'. Or it says: according to Gartner the TAM worldwide is 12.3 billion for the kind of software we offer.
Some pitches already stop there. That's pretty meaningless. The real market for a specific solution is often not even close to that amount. Others distillate a SAM and a SOM from the global TAM, a bit like the example of the water bottles. That's better, but it remains based on basic assumptions that are difficult to verify. It remains a theoretical exercise that does not really excite us as investors.
At Volta we prefer the bottom-up method. The basis for the bottom-up method stems from known data points: start with an estimate of the number of possible prospects within your target group (e.g. all production companies with a turnover of more than 100 million euro). You multiply this by the price they would be willing to pay annually for your product or service (e.g. 50,000 euros per year). This is your SOM, or the market you can approach at this moment.
What growth choices will you make next? For example, do you expand into other markets, or develop new products or features so you can expand into other types of businesses? This is how you calculate your SAM. Do that exercise again for the longer term and you'll arrive at your TAM.
Bottom-up is much more realistic. Here you take a potential investor with you in a story that starts from a realistic viewpoint and guides him or her along the possibilities.
A TAM calculation tells us as investors how much market potential there is, but also that you understand the market and have already seriously thought about how you're going to conquer it step by step. You'd be surprised how few startups do that thinking exercise.
If you show in your market analysis which adjacent markets you can also serve by developing an additional product or feature, that will be the basis for your roadmap. Or perhaps you can show that you can address an additional market segment without development. Incorporate that into the go-to-market analysis. Do you want to expand to a new geography? Use it as input for your business plan and go-to-market, and share where you will open an new office and when you are going to hire sales people.
A market may well be relatively small if you can extract a lot of value from it. Conversely, a large market does not automatically mean that a startup can extract a lot of value from it. What you also need to take into account is the number of customers. Recently, we saw a startup that was only able to address the states of Germany as a direct customer base. The market was really huge, but with only 16 potential customers, who are also in close contact with each other, the risk is huge.
We also evaluate the market bottom-up: what is the readily accessible market, and how much time and expense does the company have to incur to address a large market? That ultimate goal must be large enough to create 'venture like returns' (returns our investors are looking for).
We would like to make the following comment on this. If your TAM turns out to be smaller, you can still have a very nice company. But we won't be stepping in.
For example, we were introduced to a company that serves a customer base representing more than 500 million euros in turnover, including a number of big names. That's a nice TAM slide, they thought. Unfortunately, the revenue per customer was low and this was not going to change much. Moreover, they already serve about 70% of that market and only generate 1.7 million euros in turnover. The company was in itself a successful business, but it does not have the potential scale towards an attractive size for VCs.
You understand: that TAM is far too important to pass up quickly. For two reasons: 1) your TAM determines whether you are a candidate for venture capital in the first place, and 2) a good TAM calculation significantly increases your chances of funding when you come to pitch.
Well thought through decision making, based on a good understanding of the market, is essential. Even if it turns out to be wrong, your analytical analyses of the market, your ability to discuss it and be challenged on it will tell us all we need to know. (Also because we realise we might be wrong and we want to find out together with you).
