Talking TAM (But NOT Andy’s Aunt Tammy)

We’re diving deep today… and having a bit of fun.

There are just three things a private company needs to get our nod and our money.

We dive into the most important – yet least understood – of them today.

When you’re done watching this segment, you’ll know what I look for… what I tell the folks I share my research with… and the best (and easiest) ways to do this important analysis on your own.

And we might even talk about my long-lost aunt…

Watch the video above.

TRANSCRIPT

Alex Moschina: Hello everyone. Happy Friday and welcome back to Venture Spotlight, the series where we, as the name suggests, look at all things in the venture capital and private equity space. We assess deals, talk about what makes it good and bad opportunity for investors and share what’s most exciting right now. And who are we? I’m Alex Moschina and the associate publisher at Manward Press and, of course, I’m here with Andy Snyder, the founder of Manward and the investing mind behind all that we do here. How are you doing Andy?

Andy Snyder: Pretty good, not bad for the end of the week, I’ll take it.

Alex: Yeah, it’s good that we do these on Fridays, I think there’s a lot more energy than, say, if we were to do these on Monday.

Andy: On Monday morning?

Alex: Yeah. Let’s keep them Friday, we want to help you sail into the weekend, hopefully give you something to ponder before you head off to hopefully do something fun. But before we get started today, I just want to remind everyone, as always, keep sending us comments, keep sending us questions to mailbag@manwardpress.com. That’s where we get a lot of ideas for episodes, by addressing the things that are most important to you, you watching us. And today, I think we’re going to answer a question that’s been on a lot of viewer’s minds, we’re going to talk about TAM. Not your aunt Tammy, TAM, that’s total addressable market. Andy, why don’t you kick us off?

Andy: Shoot, I thought we were talking about my aunt Tammy. I got-

Alex: No, that’s for after we stop recording.

Andy: I brought all the wrong notes. So, TAM, total addressable market, as you said, is one of the three criteria that we look for, it’s number one. So, to review those, just to make sure we keep drilling in, total addressable market, we want to see a young company that’s working in a big market or that has access to a lot of money. We don’t want to invest in a $50 million company that’s in a $50 million industry, there’s not going to be much money there. We want the $50 billion or the $5 trillion industry and with a small company working towards that, that’s pretty obvious. What we’re going to talk about today is how we calculate that, that’s less obvious and it’s much harder to do.

Of course, the second criteria that we’ve been talking about is a unique product. We want something that’s not super, super [inaudible] but it has to be new, different, not a lot of competition, just a novel idea. Here you could say the original, what was it the iPod? Nobody was really doing that, spun into the smartphone, smartphone it turns into that-

Alex: I like how you call it the iPod, I’ve never heard the emphasis put on so hard before. That must be the German pronunciation.

Andy: That’s right. I was trying to remember what it was called, it’s been-

Alex: It’s been so long, there’s no iPods anymore because there’s the iPhone.

Andy: And there’s the iPad, so yeah, don’t make fun of me.

Alex: Sorry, it’s Friday, I’m just getting the sillies out.

Andy: And then there’s the management team. We want to see good leaders, people that have done it before, smart, won awards, and ideally, like we talked about a good bit last week, have done a successful exit. We want to see they took a startup company and made money for their early investors. That’s key.

Alex: Or their cult, as we discussed last week, didn’t mean it to derail you, but I’m still not over the fact that in our last episode we were spending a good amount of time talking about a former cult member, but that’s… You know what? If you haven’t seen it, check that episode out, that’s just a backward advertisement. But, go ahead, sorry, I will stop interrupting you, I swear.

Andy: I bet it’s not the last time we’re going to talk about a cult member, but we’ll see. Total addressable market, so what we’re looking there, again, is essentially it’s the number of customers times the amount of money those customers are willing to give us, right? So we can look at something like the healthcare market, I’m just going to toss a bunch of numbers out there, let’s say the healthcare market is $12 trillion, that’s a big market. But if a company comes to me and says, “Hey, we’re a startup and we’re doing big things in the healthcare industry,” it’s a $12 trillion market, instant red flag, “Something’s not right here.” Unless they tell me they have something that’s going to instantly be the fountain of youth, cure death and push all the competition aside that $12 trillion number is bogus. So, if their next statement is, “Yeah, we have a treatment that temporarily relieves the pain from hangnails.” then we’re getting somewhere, we’re going from a $12 trillion market to probably about a $10 market each year and so we can weigh that accordingly.

And so really there’s two, maybe three different ways we can measure total addressable market, and the first one is the most common, this is the top down model, right? I’ll use an example of a client that I’ve been working for, consulting with, she’s in the floral industry, right? And so that industry is pretty big, about $45 billion a year. So, if we use the top down model, we look at all the reports, the industry, we look at that big number and say, “How much of a slice of this do you think you can get?” so we start with the big number and then start working our way down. And so most people when they’re pitching folks like us in the equity crowdfunding space, just say, “We’re in that $45 billion industry, we’re going to kick butt.” So, a little bit of the conversation I had with this lady is, “All right, so how much of that do you think you can address?”

And so, I don’t want to give away her business, but she’s in one of the flyover states in the Midwest, lives in a small town of 4,500 people, there is a college town nearby, but it’s about an hour and 15 minutes, and to get to any of the population centers, you have to drive by other businesses just like hers. So, that puts her market, unless she wants to start online sales and shipping, very small. So we took that $45 billion, and really, how much do those 4,500 people spend on flowers each year? I mean, that’s a much, much, much smaller number. So, it’s not terrible news for her, it means she can probably corner a big chunk of that market, but she still has to fight the FTDs, the online sales, and so she has to get a pretty big niche there. So, that’s one way of looking at it.

Alex: So, the top down that… Oh yeah, you were going to mention coffee and I think that’s a good… I was going to go there, but so, top down, just so I’m picturing it though, so as we’re starting with basically the size of the entire market, and then really drilling down to the niche or the section of the market, the piece of the market that the business could really have. So, I think I know where you’re going with last week’s deal, but go ahead.

Andy: Yeah. So, as investors, we have to be very good at asking the right questions, so, we can’t just be naive and go into Wefunder and say, “This is a coffee company that wants to dominate the $245 billion coffee market.” Because that’s international, are they working international? Do they have what it takes to deal with tariffs and customs and all that? Are they able to get into? These are the questions we asked last week, are they able to get into grocery stores? Out of all the coffee drinkers, how many want a caffeine-free alternative? That gets much smaller. How many want these flavors? And then all the competition, the 200 competitors out there.

Starts to get pretty small, so we have to have a realistic look at total addressable market, most of the time we don’t, and I’m guilty of it, because I’ll say, “It’s going to… ” The iPhone industry, right? They are the cover of my phone, that’s a big industry, but how many people want a cover? How many people want a black cover? How many people want a waterproof cover? And it starts getting much smaller. So, that’s why we tend to look… That’s a good starting spot but you have to be very good at asking those questions to get any sort of accurate results. That’s why it was… When I was talking to this founder other day, we did more of the bottoms up approach, so we talked about tops down, this is bottoms up.

Much simpler, the caveat here is you really should already be in business with some good sales to get these figures. But here, all we’re trying to do is just figure out how much money we make from each customer in a year, and then figure out how many customers are out there in total. So, if we sell… We’ll use the flowers, if we sell, just ease of numbers, 100 bouquets to 10 different buyers each year, so there we have… Let’s do it this way, we have 100 bouquets, we sell at $10 each to 10 buyers each year, what is that? $10,000. So, that’s our total market that we have right now. We’re start up mode so we want to blow that up. But then we look in this area and say, “All right, well, we’ve got 10 people, but out of that 4,500 only another 100 of them are buyers.” So, then we can start doing some math and say, “Okay, well maybe we can 10X our business from here.” “What does that mean?” “Well, that means I probably can’t hire four employees if I was going out to the 4,500 people, but I can do two employees.”

And as an investor, that makes me think, “All right, well, if they’re going to 10X and their valuations are here, to scale up, they got to have these costs.” and so you can see we can start asking these much better questions by looking at things that way. So, that really takes us understanding, how many customers do we currently have, that’s easy, how much of those customers are paying us, that’s fairly easy but remember, as we scale up and as we go for the marginal customers, our prices tend to have to come down, the most lucrative customers are the first ones, the easy, the low hanging fruit after that they get more expensive to acquire them to advertise, so that might come down. And then a little bit harder, we have to understand how many potential customers are in our market, but that’s still easier than trying to drill down from that big number, which might not even be accurate, a 12 trillion number, the rounding error on that could be 10 times the size of a successful business, so that’s trouble there.

Alex: Sure. I guess the practical advice that the viewers can really take from this is that if you’re evaluating a company, if you’re looking at a listing on Wefunder or any of the other crowdfunding portals that we would look at, if somebody’s saying, “Hey, we’re seeking to address an issue facing a $13 trillion market.” but they are an alternative coffee company, you can maybe start to think, “Okay, let’s dig into this a little bit.” or make sure that they’re digging into a little bit to give an accurate reflection, because obviously a business is trying to get the highest valuation possible when courting new investors, but you do want them to be realistic. And so, with TAM, TAM essentially allows you to put some numbers to the idea of potential, right? Because TAM is just potential, potential for your investment, potential for the market, but looking either top down or bottoms up, you can start to actually fill in some of the blanks and determine if the company is doing what they purport to be doing.

Andy: Exactly. And then we can leave it with that but add one more caveat to that, because you kind of hit on it, is we have to understand that the market size is different than the size of the problem, right? We see this a lot in the healthcare industry, use cancer, so I don’t know these numbers but cancer is a $5 trillion economic drag or a $5 trillion drag on the economy each year, right? We see that a lot. But, does that company… The company that’s going to tackle that doesn’t get that $5 trillion, it’s not like they’re going to get $5 trillion in revenue for solving that. So, we have to… As we’re doing our evaluations, doing due diligence, we had to look at the problem, and that number gets tossed out all the time, we almost have to just push that aside and say, “Okay, but what’s realistic? How much are people going to pay for?”

And it’s, kind of, the third way of coming to TAM, is looking at the problem, how much people are willing to pay for the solution. That’s a little bit harder to do, you can do it with companies that aren’t… You almost have to do it with companies that aren’t generating revenue yet or very, very early in the very early stages of the startup stage we look at the valuation side. But look at the problem and then, kind of, figure out how much people are going to pay for it. That’s kind of the smaller side, but we can get tripped up on that. But those two things we really want to focus on are the top down and really the bottom up. It just takes a pretty simple spreadsheet and some good solid facts to get us there, but if you get those right, that takes us to that first criteria and we can start saying “Yay or nay.” on the listings that we’re looking for and the deals we’re looking for, that sort of thing,

Alex: And a good company or a good startup is going to, kind of, lead you through that, you’re going to see right away when you’re going through the forms they’ve filed and when you’re going through the information they’re presenting, if they’re maybe incorrectly or embellishing some of the information we’ve discussed. So, if you’re going through a presentation or a pitch and they start to say, “Okay, I know what you’re thinking, it’s a $5 trillion market, we’re not trying to grab the entire thing, we don’t think it’s realistic, but here’s the problem we’re looking to solve, which is priced this way, here’s how we reached that valuation.”, then you’re starting to speak to the investor in a way that we’d like to be spoken to.

Andy: Exactly. If that’s the message you’re getting with that detail, that’s a good company, if you’re getting the opposite where they’re saying, “Oh, this is a $12 trillion and we’re going to dominate it and this product’s going to solve this $50 billion problem.”, start heading the other way and look for those guys that are talking about it in a realistic, real world terms. That’s a great way to sum it up, but it’s a powerful idea for sure.

Alex: Excellent. Well, so we covered TAM today, I’m sure we’re going to be speaking about some of the other metrics that we’ve shared, some of the other key things that you look for in a startup if you’re going to consider at all, but, we’ll save that for another time. For now, I hope everybody watching has a great weekend. Thank you for joining us for Venture Spotlight. As always, please continue, like I said, to send comments, questions to mailbag@manwardpress.com. And we look forward to seeing you next time. Andy, now just let’s go over those papers for your aunt Tammy, let’s take this offline and get into it.

Andy: Let’s do it.

Alex: All right. We’ll see you guys next time.