A Blog by Jonathan Low

 

Oct 17, 2017

Startups' Trillion Dollar Numbers Game

Total Addressable Market is latest in a long line of tech fantasy metrics - like clicks, eyeballs and stickiness - that have propelled startups to stratospheric valuations, but which may be more delusional than their ostensible quantifiability would suggest. JL 

Scott Rosenberg reports in Wired:

Total addressable market, or TAM, is a way to gauge the scale of opportunity represented by a startup’s idea—the vastness of the market. If you sum up the TAMs promised by the startups that presented at the last YC Demo Day you get $1.7 trillion.That’s absurd. But that's the point. This jargon is hurting the startups that promote it and the industry that eats it up. Companies that begin throwing around astronomical dollar figures are likely to become serial exaggerators.
The pitches that dozens of startup founders deliver at Y Combinator’s biannual Demo Day events have a ritualistic formality, alternating between change-the-world platitudes and invest-in-us promises. More often than not, those promises culminate in a very large dollar amount.
“We are [startup name].” “We are disrupting [something].” “Our Total Addressable Market is [X] billion dollars.”The first two claims are familiar enough, but if that last one doesn’t ring a bell, maybe you don’t have an MBA. Total addressable market, or TAM, is a way to gauge the scale of opportunity represented by a particular startup’s idea—the vastness of the market space in which this colt of a company will romp, once it has fed on some dollars. At Demo Day, when presenting companies attempt to stand out from their peers in front of a crowd of investors, they roll out the big numbers.
If you sum up the TAMs promised by the 124 startups that presented at the last YC Demo Day —two out of every three companies included the number in their pitches—you get $1.7 trillion. That is more than Canada’s annual gross domestic product.
That’s absurd. But that’s the point. And while it sounds good on Demo Day, this higher-order business jargon is hurting both the startups that promote it and the larger industry that eats it up. Companies that begin life throwing around astronomical dollar figures are likely to grow up to become serial exaggerators. TAM claims can become a kind of starter drug for executives and companies on a downward spiral of overpromising and under-delivering.
Here’s why TAM is such an alluring number for Silicon Valley founders. TAM is a dollar estimate of a company’s potential revenue, if the firm somehow managed to win every possible dollar from every possible customer in its market. Say you’re making a mobile app that helps people buy and sell collectibles. You’re starting with plastic bobblehead dolls. Month one, you’ve got 500 sellers signed up. That sounds just okay. You need something a lot more impressive. So you Google “total collectibles market,” find a number, and declare, “The TAM for collectible toys is $10 billion.” Now you’re in a different league.
Of course, no one really assumes that their startup is going to seize 100 percent of a market. Says Michael Seibel, the CEO of YC’s startup program: “Everyone understands this is a thought exercise. Nobody is thinking to themselves, ‘If I don’t hit that bar, I’m a failure.’”
In other words, the number is the pie; you are at best going to get a slice. But the pie is what dazzles. It’s what people remember, because it’s the biggest number in the slide deck. Yet most of the time it is only going to be relevant in the rare case that you win the lottery—that your startup explodes on a Facebook or Google scale. (My $1.7 trillion collective TAM figure would more than double if I hadn’t screened out a few of the most outrageous such lottery payouts cited at Demo Day—such as the disrupter of small-business loans who noted that the market for such loans totals $500 billion, the dairy disrupter who pointed to a $400 billion global dairy industry, the pharmaceutical disrupter who cited a $450 billion drug market, and the disrupter of Indian retirement plans who noted that by 2025 that market will be worth $600 billion.) In the annals of business jargon, “total addressable market” is a relatively new arrival. It emerged in the mid-’90s during the first dotcom bubble, when expansive vistas of internet-driven scale first captivated investors. But it’s been around forever under other names, like market-segment analysis.
The Lean Startup’s Eric Ries, who has written the book on how to build a startup, believes TAMs have a reasonable role to play in the always-iffy game of establishing the value of a new company when an investment gets made.The easiest way for founders to impress potential investors, Ries says, “is to show them that the magnitude of the eventual opportunity is large. So that even after they discount it with some healthy skepticism, and even after they take the probability of your success down to near zero, the denominator is just so large that people say, ‘Oh, you know, the company is still worth $10 million right now—so let’s invest.’”
But TAM can also be treacherous, Ries argues, because it suggests that business school tools can bring predictability to the quantum-scale craziness of startups. Talking about a “total addressable market” presupposes that you can state with confidence exactly in which market a startup is playing. But a lot of startups are exciting precisely because they are inventing new businesses and markets, and “pivoting” is the norm, anyway. Ultimately, TAM draws everyone’s attention away from the hard realities of building a business, and toward a fantasy future in which the startup has already made it big.
Seibel says that YC encourages founders to favor a “bottom-up” market analysis—one based on credible counts of identifiable customers and product prices—over the “top-down” TAM figure. When I ran the $1.7 trillion figure past Seibel, he was unfazed: He said it’s a sign that YC founders have their eyes on a wide range of new business opportunities. “If that number were small, that would really concern me, because that would mean our companies were focusing on a very narrow set of industries,” he says. “I think there's still a little bit of this feeling that YC funds 22-year-olds who just graduated from college who want to build mobile consumer apps. It’s much broader. Founders now believe that any industry is open to a tech startup.”
He’s right about that: Today, startup thinking is rapidly being transformed into an all-purpose ideology offered as a model for every variety of human enterprise. All the more reason to bring a little more rigor to the startup numbers game.
Right now, the overuse of “total addressable market” numbers in the rites of early-stage investment encourages hand-waving and hyperbole over actual insight. Metrics that incentivize honesty and even a little humility might work better all around. Investors would make smarter choices, founders would gain credibility, and the public would have more reason to trust that Silicon Valley’s startup game is more than a winner-take-all lottery.
Meanwhile, my TAM for this story is a billion English-speaking internet users. But I’ll be content with a tenth of that.

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