In the early 1980s AT&T asked McKinsey to estimate how many mobile phones would be in use worldwide by the year 2000. Their conclusion was it would be a niche market of around 900,000 subscribers. They were off by 108 million.
The McKinsey error is a result of the challenge with estimating market size. Markets expand and contract. For businesses such as Uber, the market gets created entirely. The taxi market in Australia is significantly smaller since Uber arrived. Yet few could have predicted Uber before it arrived.
There is a heuristic that large TAMs = good, and small TAMs = bad. Except when looking at SaaS businesses, there’s a counter phenomena at play. Often the best SaaS businesses start in very small markets. They then codify best practices, become efficiency drivers for their customers, and move into adjacent segments organically at first, and via acquisitions later on. And this process repeats. So, over time, TAM grows. Salesforce recently raised its TAM from $120B in 2021 to $140B in 2022.
So what does this mean for start-ups and investors? Well, our sense is that TAMs matter a whole lot less than other attributes of a business, such as the quality of the team and product and their ability to scale into an existing and then adjacent markets.