PAM TAM SAM SOM Increase CEO Speak
CEOs need to speak many business languages. For instance, they should readily know financial terms like EBITDA, 10K, 10Q, Audit, Capital Expenditures, Capitalization, and differences between Cash Flow and Working Capital. Just like they should readily know operational terms like CIP, JIT, Cycle-Time, Bottleneck, Operations Management, Flow Charting, Swimlane Diagram, CIP, and TQM. CEOs have to speak sales and marketing just as good as anyone in the company. Surprisingly, there is a set of terms that I commonly find CEOs failing to grasp in the business development arena, which hurts their business immensely. Relying on “the experts” of a specific department or set of skills in your business is absolutely necessary. However, not knowing the details of various aspects that govern the success of each aspect of one’s business is reprehensible. The specific terms I am talking about CEOs commonly failing to grasp impacts Engine Component #2 in the Revenue Engine that Renaissance Methodology develops to help leaders identify their buyer’s potential and substantially grow sales and profits.
Let’s zero in on PAM, TAM, SAM, and SOM, and no, I am not referring to a Dr. Seuss rhyme. These terms are often thought of as marketing terminology, yet considered to be sales speak too. So, let’s think of these terms as business development speak. Better yet, think of these three terms as critical growth concepts that impact strategy and tactics.
When doing market analysis startups often refer to PAM, TAM, SAM, and SOM. Savvy businesses refer to these terms often because they are critical no matter what stage of development a company is in; Launch, Growth, Shakeout, Maturity, or Decline. So, what do these acronyms mean, and why are they useful to investors when assessing an investment opportunity and CEO’s with their strategies and tactics for surviving and thriving?
PAM, TAM, SAM, and SOM are acronyms that represent different subsets of a market.
- PAM or Potential Available Market represents the global market of these goods and services without any restrictions of geography and other factors. It is largely dependent on the company’s “view of the world.” The PAM is always greater than the TAM (PAM > TAM)
- TAMor Total Available Market or Total Addressable Market is the total market demand for a product or service. This shows how many customers in the core market need your goods or services (They may not necessarily be able to afford these products but need them) in the same category of goods and services that you sell. The TAM never equals the PAM (TAM < PAM).
- SAM or Serviceable Available Market is the segment of the TAM targeted by your products and services that are within your geographical reach; it means this index shows the volume of customers who are ready to buy goods or services in the same category as yours. The SAM is never greater than the TAM and may be equal to the TAM (SAM = or < TAM).
- SOM or Serviceable Obtainable Market is the portion of SAM that you can capture, taking into consideration the strategic development of this market and competitor’s actions. The SOM is never greater than the SAM and may be equal to the SAM (SOM = or < SAM).
Confused about PAM, TAM, SAM, and SOM? Let’s take the example of a fast-food business.
Let’s say you are starting a vegan fast-food chain called Veganators. Your PAM would be the worldwide vegan fast-food restaurant market. Potentially, if you were present in every country, assumed everyone wanted your products and had no competition you would generate TAM as revenues.
Sorry, but that is nearly impossible.
Let’s look more at the total global market with some realistic restrictions. Your TAM would be the worldwide vegan fast-food restaurant market. Potentially, if you were present in every country and had no competition you would generate TAM as revenues.
This is getting closer to being more valuable and should be identified, but having no competition is unlikely.
Let’s be more realistic. You are starting your vegan restaurant chain in two cities where the demand for vegan fast-food can be estimated based on the population, their food habits, and the revenues generated by similar fast-food restaurants or estimated based on vegan demand not being serviced in other cities having similar demographics.
That is your Serviceable Available Market: the demand for your type of products within your reach. In other words, if you were the only vegan fast-food in town you would generate revenues of SAM.
Now, you have to consider the odds that you are the only vegan fast-food in town.
Look at the reality that you can capture only a fraction of your SAM. Most likely you will attract vegan fast-food lovers and some fast-food aficionados living or working close to your restaurants and a fraction of the people located further away that are willing to give your chain a try for the sake of fast-food diversity. This is your SOM.
Ok, now let’s look at why and when they matter.
Put yourself in investor and CEO shoes. You need to deliver a target return to your investors, and or yourself or the business as a whole so it is sustainable, which implies both de-risking the investment early and being a stronger market player for the long run (I.E. figuring with the minimum possible of capital if the start-up has a market or capital needs to grow a market or into new markets and products/services) and investing in opportunities which offer substantial upside potential (I.E. huge market size).
The SOM and SAM help to de-risk the investment while the TAM enables to assess the upside potential.
The Serviceable Obtainable Market is your short-term target, and therefore the one that matters the most: if you cannot succeed on a fraction of the local market chances are that you will never capture a large part of the global market.
As an investor or a CEO, you are expected to have a realistic objective and will be judged on your ability to deliver that objective.
To be realistic your SOM needs to factor in:
- Your product: people will want to buy your goods
- Your marketing plan and the identified distribution channels: you have a clear plan to reach a large portion of your target customers with both marketing and sales efforts
- Your SAM and the strength of your competition: chances are that you are not going to take a 50% market share within 6 months. Therefore your SOM needs to be a reasonable fraction of your Serviceable Available Market.
For investors and CEOs, the ability to reach their SOM means that he or she will not lose their shirt. In that context, SAM acts as a good sanity check to assess the likelihood of achieving the market share implied by the Serviceable Obtainable Market and as a proxy for the short term upside potential of the business as a whole.
If a business can deliver SOM in time then it is capable and credible and might be able to increase the market share and reach a more important penetration of the SAM, which would deliver a good return on investment and higher potential for sustained profits long-term.
Then comes the Total Available Market.
Once demonstrating the ability to penetrate a local market and de-risked the investment, investors and CEOs can start looking at how to expand and increase the company’s penetration within the TAM.
For example, you come to pitch an investor who has a target return of 10x. You are seeking a $250k investment in exchange for 20% of the startup’s equity.
Based on your market research and business plan we can reasonably assess that:
- PAM = $4B
- TAM = $2B
- SAM = $100M
- SOM = $5M within 2 years and $12M within 4 years
- EBITDA margin = 25%
- Valuation at exit = 8x EBITDA based on the value of listed companies within the sector
What happens if you deliver your plan?
Well, once you deliver $5M in revenues the EBITDA is $5M revenues x 25% margin = $1.25M and the company is worth 8 x $1.25M EBITDA = $10M. The investor return on investment is $10M x 20% ownership / $250k investment = 8.0x.
When you reach $12M of revenues the EBITDA is $12M x 25% = $3M and the company is worth 8 x $3M = $24M. The investor return on investment is $24m x 20% ownership / $250k = 19.2x.
Here if you can capture your SOM the investor will meet his target return and he is then left with a company that has achieved a 12% market share on a segment that represents 5% of the TAM of $2Bn ($100M SAM / $2B TAM).
If you decide to expand the company and scale internationally, the company revenues potential (Assuming you can reach a similar market penetration at scale) becomes 12% market share x $2B TAM = $240M. Which would imply a $60M EBITDA (25% margin) and therefore a potential valuation of $60M x 8 = $480M. The investor could, therefore, offer to invest up to $48M in the company in year 4 to meet his target return on investment of 10x.
As you can see PAM, TAM, SAM, and SOM have different purposes: PAM is more of a pipedream, but is still useful as it can help determine the other market sizes. SOM indicates the short-term sales potential, SOM / SAM the target market share, and TAM the potential at scale. All three play an important role in understanding growth potential, capital expenditure risks, resource allocation, and assessing an investment opportunity and the focus should be on getting the most accurate numbers rather than the biggest possible numbers. They all three greatly impact the strategy and tactics for business. Hence, CEOs need to speak and understand PAM, TAM, SAM, and SOM clearly.