Calculating TAM Is About Problem Size, Not Market Size
The size of a market or Total Addressable Market (TAM) is almost always at the top of the list for what VCs are looking for when evaluating startups. Because so many startups fail, it’s essential that each investment has the potential for an exit that can return the fund. However, the primary method for calculating TAM of looking at existing industry data is often very inaccurate. ‘Bottom-Up’ approaches are often not much better as there is significant uncertainty about the inputs.
The problem with looking at industry data is that startups make products that are often much better and cheaper than existing products. This allows many more customers to enter the market than ever before and often renders industry data worthless. For example in the US, the Taxi and Limo industry was a $4.2B market when Uber first started and many investors passed because it was seen as too small of an industry. Today, the ridesharing market alone is almost $50B which would have been impossible to predict when focusing on industry data. Below is a market size slide from Uber’s original pitch deck.