‘Decoding’ Starting Up with Vani Kola: Chapter 2 – Market Size & Key Terms

“We are building a solution that has a TAM of $10B” – I am sure if you’re in the world of startups, whether an investor or an entrepreneur, you’d have heard similar statements from peer entrepreneurs in your network or even on public platforms like Shark Tank.?

There are many myths surrounding the VC industry, and one in particular is about the size of the potential market for a startup idea. Often, entrepreneurs feel pressured to project an enormous market size—not based on their conviction, but because they believe a larger market makes the investment more appealing to VCs. This isn't entirely accurate.?

Now, what exactly is TAM? Is it just a term to show a rosy picture to attract VCs for funding? Or does it have some relevance as you plan out your entrepreneurial journey? This is the second blog on ‘Decoding Starting Up’, where we try to break down key terminologies that will not only help you perfect your pitch for VC funding aspirations, but also give you a realistic picture of how large an opportunity can be when you plan to start a company.

To clarify, TAM (total addressable market), is not about finding your maximum domination of the universe - it approximates the opportunity, basis your initial customer profile and their propensity to pay. You make opportunities to further expand your product and customer base, but the more tenuous this is, the less credible your TAM projections become.?

I always suggest founders, find the TAM for the next 3-5 years. Invariably, every successful company, expands their product and customer base eventually.?

So, let’s breakdown key terminologies to understand Market Size:

1. Total Addressable Market (TAM): The total revenue opportunity available if your product or service achieved 100% market share. This means that it’s the biggest possible market size for your product or service. But this must be defined every couple of years by the current product offerings and not through unproven products that have not even been built yet.?

How is this calculated – Total number of potential customers for your product or service x Potential revenue per customer.? Now let’s address another acronym - SAM.

2. Serviceable Available Market (SAM): The portion of the TAM targeted by your products and services which is within your geographical reach and your initial distribution / GTM strategy.

How is this calculated – From the TAM that you’ve arrived at, take further assumptions on how many customers you’ll be able to target. And profile of early adopters. SAM should be calculated for the next 12-36 months. For example, you’re a luxury handbag company in India with an average selling price per SKU of INR 7,000. Now, how many people in India can afford to buy this handbag? Maybe 10%? – so your entire TAM gets down to 10% - this is how you achieve your SAM.

But wait, what if there are 4 more companies that are producing similar handbags with similar pricing? Why would all customers choose you over others? For this, we further get down to SOM – which gives a much clear picture of what your actual revenue potential is.?

3. Serviceable Obtainable Market (SOM): The portion of your SAM that you can realistically capture, considering competition. This usually is to see if you are a leader or a follower in the market. While #1 is good, it is not always the leader that will be lucrative to an investor. Despite competition, if your product or service can create a large SOM – it demonstrates your deep understanding of the market constraints and competition.

How is this calculated – Your SAM gets further reduced to 1/5th, assuming all other 4 companies are catering to similar audience with similar purchasing powers in similar geographies.?

What are VCs looking for when they ask for Market Opportunity?

- Does not always need to be a $1B or more. Especially in emerging sectors, VCs do understand that establishing an early lead and success can provide newer opportunities to continue to grow and perhaps capture that $1B, credibility of early market success is weighed more than a huge future projection that is tenuous. - Every VC is unique in terms of how they approach the TAM. While few will look for what the market is today and how it is supposed to grow in the next 5-10 years, others may look for what becomes your right to win in a relative smaller market as well. We at Kalaari look at what fundamental inherent gaps in the market are you solving for? And how is the market going to evolve in the future.

VCs have a limited time window to liquidate (say 5-10 years) – can the market opportunity become substantial in this given time or can you as a founder build a core right to win in a relatively smaller market.

A core example of this philosophy is the e-commerce market in India. Being one of the earliest e-commerce investors in India, I remember the market was barely $20-50M, but we saw the potential of what it could become in the next decade. And that is what exactly happened. However, if you look at the e-commerce market today, surprisingly it is still growing at a rapid pace! Early incumbents didn’t capture the entire market – leaving opportunities in several whitespaces for entrepreneurs to build in.

Now, having covered key terms for market size and potential revenue opportunity for a startup – let us also cover other important aspects that investors like to see in a startup pitch include but not necessarily limited to the following:

1. Value Proposition: Core value of your product or service. Why is there a need of what you’re building. Have very clear statements that explain how your product solves a problem, provides a benefit, or improves a situation for your customers.
2. Business Model: How are you generating revenue? Or atleast what are your plans to generate money from the product or service you’re selling. Explain your revenue streams and pricing strategies.
3. Go-To-Market Strategy: The plan for how you will sell and market your product to your target customers. Talk about distribution, network effects, channels to grow the business and your target audience. Investors like clarity! The clearer understanding you have, better the chances of getting an investor interested.
4. Competitive Analysis: An assessment of your competitors' strengths and weaknesses, and how you differentiate from them. Long term product differentiation helps you strengthen your case in front of investors. What exactly is your right to win or become the #1 in your category?
5. Usage of funds: How will the capital be utilized? While it’s good to have sufficient capital to experiment, sometimes having too much capital and less understanding on how efficiently you can use the capital can backfire. Understand how much capital you’ll need before generating positive cash flow and becoming profitable.
6. Runway & Milestones: The amount of time your startup can operate before it runs out of cash with the capital you’re raising. And talk about where this capital will take you in terms of milestones.
7. Team: The most important part for early-stage companies. Why is this team the one investor should back? What makes you unique? What is your right to win.

The last thing we’ll cover in this edition is what an entrepreneur needs to maintain in the company MIS and breakdown terms for easy understanding. Majority of founders who are doing this for the first time, struggle to answer questions when asked about things like Margins, EBIDTA etc.

Now do keep in mind that the explanations given below for different terms can differ slightly based on the product or service you’re building. Eg. A Consumer brand MIS will be a lot different than a B2B Commerce company.

• Revenue: Sales!
• COGS: Cost of goods sold. If you did sales worth of Rs.100, if the product you built costs you Rs.60 to make – that’s your COGS.
• Gross Margin: Measures the percentage of revenue that exceeds the cost of goods sold (COGS), reflecting the efficiency of production processes. In the example earlier, your Gross Margins will be Rs.100-Rs.60 = Rs.40 (or 40% in this case)
• CM1: Basic contribution margin considering only direct variable costs. These direct variables costs can include Payment Gateway charges, logistics / fulfilment costs, even commissions you pay to a third-party reseller (can be marketplaces, quick commerce, offline agents etc.)
• CM2: Includes additional variable costs related to selling and distribution. Mainly includes costs incurred by you to acquire a customer through marketing.
• EBITDA: Focuses on operational profitability including salaries paid to team, tech costs for building / maintaining a website or an app etc., but excluding non-operational costs like interest, taxes, depreciation, and amortization.

These metrics help businesses understand various aspects of profitability and cost management, crucial for strategic decision-making and financial analysis. Having seen founders in my 15+ years of VC journey, keeping a tab of company performance and having the right format becomes highly critical. Build credibility with investors. It’s never only about numbers – what matters most is the understanding of what is beneath the numbers.