Does ‘TAM’ Matter?

Traditional wisdom suggests you need to target a large market if you want to build a large business. Yet quite a few entrepreneurs and venture capital investors have challenged this line of thinking, suggesting that market size – often referred to as the total addressable market (TAM) – should essentially be ignored. Focus on solving a real problem, solve it well and the TAM will take care of itself, or so this logic goes. After all, some of the largest tech companies today focused on small, nascent markets in their early days.

We’ve had a lot of healthy debate on this topic at Vocap. In the dynamic world of emerging technology markets, it can be dangerously easy to overlook a great opportunity by falling victim to small market bias.  We do believe it’s important to have a data-backed theory on the current and future TAM for an opportunity (we like to see line of sight to $1B+), but it’s also critical to guard against unfairly boxing it in.

Take, for example, one of our portfolio companies, XOi Technologies. At the time of our investment, XOi was focused on the Mechanical, Electrical, and Plumbing sector of field service (MEP).  They had strong proof of adoption and value delivery for commercial clients in the US with 20+ technicians. If we had applied a strict bottoms-up TAM analysis to this one segment (commercial MEP companies with 20+ techs), it would have looked like a fairly niche market.  But as time has shown, this frames the opportunity too narrowly. More on this below.

Avoiding the Trap – A Mental Checklist

Matt Heiman outlined a good framework for considering TAM in one of his Techcruch posts a few years ago, which we’ve outlined and expanded upon below.  We like to revisit this as a mental checklist as we consider whether an opportunity is big enough. Entrepreneurs and early stage tech investors might benefit from doing the same.

  • Can the TAM Expand?
    • The product is so useful and unique that people outside of the initial customer profile will use/buy
    • Example #1: Uber completely transformed the intra-town transportation experience, to the point where new use cases naturally emerged (think: rental car replacement, couple’s night out, transporting kids / older parents, and ultimately, car replacement). Early naysayers – with whom we can all empathize – capped the addressable market at the total value of the black car industry. What started as an alternative to a black car chauffeur now applies to all short-trip transportation and delivery. Read Bill Gurley’s great piece on this.
    • (Non-tech) Example #2: Starbucks was initially pegged as a niche product for coffee snobs, a relatively small market in the US at the time. It’s success in achieving mass adoption is largely attributable to two things: it pioneered the concept of using coffee shops as public meeting spaces in the US (there were few alternatives at the time) and it made high quality coffee feel accessible and worth it.
  • Are there credible adjacencies?
    • Initial “wedge” opens opportunity for product expansion
    • Example #1: Atlassian started in 2002 with a simple but kickass issue tracker app for small software support teams. Now, they offer a full suite of software development and collaboration tools, which collectively generate nearly $1B in annual revenue.
    • Example #2 (per Fred Wilson): When Henry Ward, founder and CEO of Carta (then known as eShares) wrote about their Series A round, he said: “I used to try explaining that $20 stock certificates were an entry point into something bigger. It never worked”… Most investors looked at the business of selling $20 electronically issued stock certificates and missed that it was simply the entry point to moving the entire private securities market to the cloud… now Carta is one of the fastest growing SAAS companies out there.
  • Is there nascent market potential?
    • Ride the wave of a rapidly emerging market
    • Example: Apple is Apple because it capitalized on not just one but two tidal waves before they were obvious: the personal computer and the smartphone (people forget that smartphone penetration was sub-10% when the first I-phone was announced).
  • Is there a big latent problem waiting to be solved?
    • Look at the problem value instead of the current market spend (another tact that can protect you from small market bias). Is the company tapping into a “secret”, or a belief system about the world that the rest of the world doesn’t really appreciate?
    • Example (per Keith Rabois): Opendoor, the real estate unicorn, is predicated on the “secret” that homes can be bought and sold much more like a commodity than people commonly assume. It would’ve been easy to overlook this opportunity given the proportion of homeowners that sell directly without engaging an agent or listing on the market has historically been exceedingly small.
  • Do proxy/upstream markets signal opportunity?
    • Study similar supply and demand drivers in other contexts. Or, look upstream: often emerging sectors are sequential (initial market creates new markets).
    • Example: Sequoia made its name on this methodology. Their investment in Apple helped the firm appreciate the need for connected machines and internetworking. This led to investments in 3Com and then Cisco. Once computers were connected on the internet, they recognized the need to organize the world’s information, and invested in both Yahoo! and Google (naturally).
  • Can you answer: why now?
    • List the 3-5 key reasons why the market is inflecting
    • Example: We believe the commercial drone market is in the early stages of a massive growth period due to i) growing proof points, ii) decreasing input costs, iii) regulatory clarity and iv) a tipping point in training data.

So, let’s revisit the market opportunity for XOi using part of this framework.  Despite a smaller TAM size within their initial segment, we saw a few key things that got us excited. First, the founders had identified a huge problem to be solved: veteran techs are retiring in significant numbers and fewer young techs are entering the field, creating a significant labor and knowledge shortage. This problem was hitting all sectors of field service, not just the commercial segment of MEP.  There was a clear answer for ‘why now’, and it was also clear their unique solution would be useful to a broader set of field service customers.  Looking at the scope of this problem with this lens suggested a $20B+ global opportunity. Second, the founders had a clear vision for how their solution would evolve as an intelligent conversational assistant with access to a massive store of helpful digital content that would help newer techs perform like veteran techs. Their initial workflow solution was the wedge into a much broader and more powerful AI-enabled solution.  By applying our framework, we moved past some of the conventional thinking that this might be just a small niche vertical to understanding this had the potential to be a must-have application used by every field service technician on the planet. ~18 months later, we are happy to report that the XOi team is executing quite well on this vision.  The latest generation of their technology is applying artificial intelligence to help thousands of field techs do their job better, quicker, at lower cost and with higher sell-through to end customers.  The demand for their product has been overwhelming, and they have already expanded beyond their initial target market. We are sure the XOi team will face many challenges as they continue to scale, but it appears a small TAM will not be one of them!

If a small TAM is a primary concern surrounding your strategic path or investment decision, take some more time to understand what the ultimate customer base could be. The future might look a lot different than the current market and you just might save yourself from missing a massive opportunity.