Companies often make the mistake of looking strictly at TAM to determine which active business opportunities to pursue. It’s in your best interest to evaluate a few more key data points to ensure your senses about the market are spot-on.

In my previous GrowthBit, I highlighted the importance of adopting core market discipline as part of your company’s growth strategy, particularly to avoid the pitfalls of operating on gut instinct alone. Once you have your core market defined and your strategic growth objective established, you’re likely looking for ways to maximize company resources and pursue the most attractive opportunities to help you reach that objective.

Many companies rely too heavily on Total Addressable Market (TAM) to evaluate and prioritize growth opportunities, whether it’s a product extension, new customer segment, or an entirely new market, but there’s a lot that TAM doesn’t tell us on its own. I’ll demystify some of the reasons why TAM alone can be misleading and illuminate additional criteria that you can use to evaluate and prioritize new opportunities in line with your growth strategy.

TAM: Why it’s misleading on its own and what other data points to examine

Companies often make the mistake of looking strictly at total addressable market to determine which active business opportunities to pursue. That’s not to say gut instincts are intrinsically wrong, but rather it’s in your best interest to evaluate a few more key data points to ensure your senses about the market are spot-on. It will help give you – and your board of directors – confidence in the feasibility of your growth plans.

When I work with companies on strategic planning, I urge them to think about these data points in totality. While each serves a critical purpose and can be a valuable consideration, none should be the only decision-making factor when profitable expansion is the goal. And even if you are “low” in one area, but “high” in all the others, the market in question can still be worth pursuing.

If market feedback tells you that the competition is potentially replaceable, then how will you differentiate from them? Identify their weaknesses and your path toward a sustained competitive advantage.

Vended market and annual revenue opportunity
Don’t confuse theoretical market size with the actual dollars being spent in a market today – this is a common error where the TAM figure can be a mirage. If it is a new product or solution that hasn’t been widely adopted by customers, the actual revenue opportunity in the near-term could be low, even if the total addressable market is quite large based on total adoption potential.

You can make a more informed decision about a new space by determining how much revenue is actually “up for grabs” based on how much of the market is currently vended, how often contracts typically come up for renewal and how often customers typically switch vendors. Even a directional understanding of these additional factors through market research or data from your sales team can be highly informative.

Relative profitability
Rather than leap into a new opportunity purely because of its size, figure out whether it will be profitable for you, and by how much. To what extent will the revenue generated through this new opportunity be accretive or dilutive to your current profit margins and how will that compare to your profitability goals?

Customer needs
Determine whether your core competencies align with the needs of customers in this new area of your market. Can you offer something of value–now or in the future–based on what you already do well?

Differentiation & competitive intensity
Another point of insight that TAM doesn’t reveal is the strength of the existing players in a market. How entrenched are they with current customers and will they be difficult to unseat?

If market feedback tells you that the competition is potentially replaceable, then how will you differentiate from them? Leverage market feedback to identify their weaknesses and your path toward a sustained competitive advantage. It could be as fundamental as rethinking your value proposition and sales approach, or as substantial as making an acquisition to offer platform features those competitors do not.

Remember that TAM alone might represent a larger market than is reasonably available if it’s already saturated. So, differentiation will be key to success upon entry as a new player trying to displace the old.

Having a clearly defined “North Star” can help you stay disciplined and enable you to confidently walk away from opportunities that don’t align strategically with your growth objectives.

Ease of entry
Before expanding into a new market, examine the barriers to entry and determine if it’s a buy or build scenario. Ask yourself, “Are we set up to deliver the product or service this market needs today?” If the answer is no, determine if is there a pathway for you to enter and expand in the market organically. Don’t forget to consider how capital-intensive that will be to build the right products or features and to establish the infrastructure to sell and support them.

If you determine that an inorganic approach is better, make sure there are viable acquisition targets available. Start by creating a database of all the companies in a given space, including any publicly available information associated with each, and then, at a high level, narrow the list to the targets that are potentially actionable based on scale, geography, products, past funding or other factors that would influence their viability for you.

Strategic fit
It may sound easy but defining what really matters to you is a critical step in discerning which growth opportunities are the best strategic fit for your business. Having a clearly defined “North Star” can help you stay disciplined and enable you to confidently walk away from opportunities that don’t align strategically with your growth objectives.

Example decision based on more than TAM

I once worked with a manufacturer of glass windows for commercial buildings and skyscrapers that was evaluating new opportunities to accelerate revenue growth. The management team was initially excited about pursuing the residential window market based on the sheer size of the total addressable market (TAM). However, as we looked beyond TAM, that excitement quickly turned to skepticism. The residential window market is extremely competitive with a few large, established and dominant competitors. This meant that market entry, whether organic or inorganic, would be extremely challenging and even if the company was successful, it would be a constant (and expensive) battle to maintain its share. Additionally, customer needs in the residential window market did not align with the company’s differentiators as the degree of quality needed for commercial windows is not needed or valued by residential customers.

Visual aid

In the Opportunity Prioritization guide below, look at the brief information provided at the top for two example growth opportunities, Opp. A and Opp. B. The CAGR values are identical, but based on the TAM and vended market values, Opp. A appears more attractive. However, as you move down the guide and apply more information, Opp. B proves to have lower competitive intensity, easier entry, as well as a better strategic fit.

Opportunity prioritization graphic illustrating role of total addressable market

Here’s the bottom line.

For many growth-stage companies, eagerness to expand into a large market in a short amount of time can be an extension of the entrepreneurial spirit that got you to where you are today. However, when your goal is profitable growth at scale, you must go with more than gut instincts and anecdotes and look beyond TAM to more revealing criteria. Doing so will help you stay aligned with your core business while pursuing opportunities that put goals within reach, instead of putting good money and effort towards opportunities you’re unlikely to win.

By carefully investigating the true growth potential and costs embedded in each potential opportunity, you can find the paths that will deliver the greatest growth to your business while confidently eliminating those that are a poor strategic fit.

Tips for success
People get analysis paralysis. It’s also common to feel like “if I don’t have all of it, I’m not going to do any of it.” Below are two best practices for implementing the recommendations above:

  • Leverage the information you have and acknowledge the gaps – Something is better than nothing. Base decisions on the best available information at the time, rather than being paralyzed in the face of the unknown. Note gaps to inform future processes.
  • Build a process for next time – Knowing what type of information you wish you had at this juncture can help you plan to capture the right details for making more strategic decisions about future opportunities as they arise.

This GrowthBit is featured in LLR’s 2023 Growth Guide, along with other exclusive insights from our portfolio company leaders and Value Creation Team. Download the eBook here.