Know Your (Operational) TAM

For VSaaS companies, understanding your "Operational TAM" can be the difference between sustained growth and hitting an unexpected wall.

Founders tend to think about their TAM at exactly two points in their company’s journey: when they are in the midst of a funding round and when they hit the saturation point.

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One minute, you’re pounding out locations, adding sales reps, and winning more locations—rinse and repeat. The next minute, the number of at-bats (opportunities to win deals) begins to decline, and your CAC (customer acquisition cost) skyrockets as you exhaust your market. You may need to stop hiring sales reps in your core market. You may even need to reduce reps. More broadly, you need to start thinking about your core business differently.

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As we’ve argued previously, your market structure drives your strategy. TAM is relative to your scale; thus, TAM headroom is one of the biggest drivers of market structure. When your location TAM starts to run out, you need to focus on expanding (e.g., increasing ARPU) to sustain growth while you try to find the next S-curve of location growth in a segment, an adjacency, an overseas market, or extending into other stakeholders.

You must also get operating leverage from your core business to fund this new S-curve. This transition can be painful. Your core business goes from the hero who gets all the resources to the savior who needs to contribute all the profits. You may need to slow down to speed up. By knowing your market structure, you know when you will likely hit saturation and can work backwards to prepare for these pivots.

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It’s a combination of balancing your growth story with the hard realities of your spreadsheet. Those new initiatives are no longer fun, optional projects when you hit that wall. They need to deliver real, meaningful revenue that can keep up your growth rate. This is a fundamental evolution in a company’s capabilities and is never, ever easy.

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A company must maintain an early-stage approach to picking the correct initiatives. You can’t move 100 things an inch, so you need to select one or two things to run hard at. This simultaneously means that you’ll have to defund or cull all the other good but not great things. Your company will likely struggle to accept these changes as the change from a growth-at-all-costs mentality to a more measured approach to management stretches the culture.

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And keep in mind this is all because of your TAM.

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If you’ve done your math properly, you’ll move from hand-wavy PowerPoint TAM to something we call “operational TAM.”

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What Can We Learn From Public Companies?

This is not just theory but grounded in our public company research. We did a longitudinal study of 21 public companies that represent the best examples of Vertical SaaS platforms. What we observed is what theory would predict. Below $250M ARR, growth comes almost evenly from logo and ARPU growth. For those that managed to scale above $250M ARR and were between $250M-$500M ARR, they had to lean more heavily on ARPU growth. However, those that scaled above $500M ARR managed to sustain logo growth, either reflecting large TAMs or the ability to find new, adjacent markets.

This is even more stark if you isolate the five public Vertical SaaS companies that exceeded $500M ARR. We see that these five superlative companies aggressively leaned on ARPU increases to sustain growth as they saw logo saturation between $250-500M ARR. However, as these five surpassed $500M ARR, they were able to reinvest successfully in finding new TAM and adjacencies to reaccelerate logo growth from 8-13%!

If you’re looking to learn more from our public benchmarking, reach out to knowledge@tidemarkcap.com, and we’ll talk you through other cuts of the data (SMB vs. enterprise) and what else we learned.

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Operational TAM

Operational TAM will tell you how many opportunities to sell per year you’ll have and how fast you’ll grow. Here’s how:

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Ideal Customer Profile (“ICP”)

Not all TAM is created equal. You should select your market based on location count and fragmentation (see this piece for more). Once these two variables are understood, you focus on your ideal customer profile (ICP). A common mistake with the ICP in relation to TAM is that founders only focus on product ICP. They find customers whose problems can be solved by their products and who have high revenue potential, but the nitty-gritty of GTM economics is not heavily considered. However, in the long run, that is only half the battle! You also need to focus on a GTM ICP. These are segments where the GTM economics make sense.

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At-Bats

TAM is only a very rough measure of opportunity. As you get deeper into a market, you need to understand the annual opportunity. Most merchants aren’t in the market all the time. While some markets are big, they don’t turn over very often, dramatically reducing the chance a Vertical SaaS Vendor (VSV) has to sell. For example, while there are many dentists in the U.S., they very rarely upgrade their software suites. This is true of the healthcare industry in general—too many founders get distracted by dollar signs when they should be focusing on how many customers are actually shopping for software.

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“At-Bats” is the most important concept for investors. They are the key to underwriting markets. TAM is the number of potential customers. At-bats are the number of customers you can sell to that year—or, put differently, the number of chances a company has to try and win new business. These chances or “at-bats” do not come out of thin air. Rather, they’re a function of questions like “How often does the average business in the industry evaluate new software?” or “What are the switching cycles in the industry for software?”

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You can bucket these markets/customers into the following categories:

Brownfield Switchers: These are customers who already have a solution. Their at-bats are inversely proportional to how long they tend to use that software before switching. If merchants generally use software for ten years, then one-tenth of switchers are in market every year.
Greenfield Switchers: These are customers who have yet to adopt software. Their evaluation frequency aligns with business catalysts, generational turnover, new revenue cycles, etc.
New to the Industry: These customers may have just started a business or entered the field. For this category, the math is the industry's growth plus the failure rates for the net new businesses created each year. More dynamic industries offer much more growth potential because of buyer turnover.

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If you’re building in an industry where the average business rarely evaluates new software (i.e., every seven or more years), the number of opportunities you have to grow your customer base is smaller. However, you may also experience less churn from your existing customers since they will be slow to switch to competitors. Meanwhile, if you’re building in an industry where the average business regularly evaluates other software, you’ll have many opportunities to win new customers. On the flip side, you may experience higher churn.

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The fact that this math is complicated and nuanced is the point! The at-bats concept is the reason for those annoying questions VCs ask, like: “Why now?” “Are there any catalysts that bring greenfield and brownfield to the table?” “Is there a dramatic growth event happening in the industry that you can take advantage of?”

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A strong answer to the why now question shows why you’ll have many chances and at-bats to win new contracts. However, even once you have enough data to know your yearly at-bats, operational TAM can go deeper.

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Conversion Rate

How a software company converts at-bats to new customers is a conversion rate. Two factors drive this:

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What is your coverage rate? How many of the industry at-bats/sales cycles do you participate in?
What is your win rate? How often do you win the at-bats in which you participate?

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The size and effectiveness of your GTM efforts determine your coverage rate. Your ability to scale these efforts is determined by your cash balance, your CAC payback, and your ability to fund internally or through fundraising additional GTM resources.

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The strength of your product, packaging, pricing, and sales positioning drives your win rate.

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Once you understand TAM at an operational level, you’ll understand the number of at-bats out there, your own coverage rate, and your win rate. With that knowledge, you'll know how to balance investment between go-to-market and product.

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But what does it look like over time?

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Operational TAM Over Time

When you really start tipping the market, you face an unanticipated headwind. You can’t switch your own customers, so as you become a larger part of the market, you start crowding yourself out—meaning you have fewer at-bats. At some point in your company's journey, you start hitting the ceiling of the location count in your TAM, and growth slows. As you saturate your segment, you’ll start to see increases in CAC and close times.

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Another failure mode that sometimes reveals itself through this mental framework is “the TAM is not big enough or structurally advantaged enough to support the number of at-bats needed for the company to reach $X in revenue in Y years given their current win rate, even at full at-bats coverage.”

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If your investors are forecasting that you'll reach a level of revenue by a certain date, they’ve gotten to this assumption by using at-bats. Ask yourself if your growth is plausible given what you know about the at-bats per year available in your category and the batting average of your company. This math tells an investor whether the TAM is big enough to support the amount they are looking to invest and the scale the company needs to achieve for the investor to make a successful return. Likewise, it gives a founder a sense of how much money they should raise given the achievable outcomes, which the TAM partly dictates.

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TAM feels like a vague fundraising concept that might only be relevant in the world of PowerPoint and spreadsheets. However, when understood on an operational level, TAM is one of the most critical inputs to long-term company strategy and growth. Mastering your operational TAM is necessary to scale to hundreds of millions in ARR. By closely monitoring your at-bats, win rates, and sales efficiency, you can make informed decisions about when to double down on your core business and explore new opportunities.

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