Happy Friday everyone! I’m off to Asheville, NC for the weekend.
But first, the newsletter…
Topic of the Week: TAM & PAM
I realized something this week. I could be the 47th president of the United States.
Sure, I have no political experience, and there are probably incriminating photos of me hiding all over the internet that would wreck my campaign, but in theory, I could be your 47th president.
This same misalignment between potential opportunity and realism tends to present itself in the business world quite frequently. One of the biggest offenders is market opportunity calculation.
For example, the market opportunity for a CPG company selling meal kits is over $1 trillion in the U.S. In theory; you could generate over $1T of revenue if you sold meal kits to every household, seven days a week, at $9 a serving. In practice, this would mean unseating every major grocery store and crushing the restaurant industry. Theoretically, it’s possible, but highly improbable, which leads to an overstatement of the real market opportunity.
The better metrics to calculate market opportunity are total addressable market (“TAM”) and penetrated addressable market (“PAM”).
TAM is the realistically addressable market opportunity when you exclude customers who will never buy from you. It represents the total revenue that your industry can expect to generate at 100% market adoption.
Let’s apply this to the meal kit example: Most U.S. households cannot afford meal delivery services at $9 a serving. Further, most people who can afford it, are never going to cook every meal at home.
When we adjust assumptions to remove lower-income households and realistic order frequency, our total addressable market is closer to $30B.
While TAM reflects 100% customer adoption, most markets, especially innovative sectors, are not at 100% adoption. PAM reflects the revenue opportunity today. There are two ways of getting to PAM: 1) Adding up the revenue of all companies competing in the space (which is impossible to do or 2) Making an educated guess.
For the meal kit company, customers only order a few times a year. If we assume that our customer base has similar purchasing trends as other online grocers, then the penetrated market looks to be under $8B today.
TAM and PAM aren’t nearly as impressive, but they demonstrate a much more realistic take on the market size.