One of the most frustrating metrics in payments is Total Addressable Market, or TAM. TAM measures the market size that a company can target. In my consulting career, I calculated a lot of TAMs – in particular for Private Equity firms looking to invest in payments targets. TAM is also highlighted in investor reporting when companies try to show investors they still have plenty of growth left in their model.
So what is the issue? For one thing, many companies claim a giant TAM, like “B2B payments” or “Health Care Payments” and then show they have only scratched the surface of that market. The Shark Tank cast disparages this tactic, but it is rife in payments.
TAM faces challenges across each dimension: “Total”, “Addressable” & “Market”.
“Total”
The issue here is what metric is used to measure market size. Either revenue pool or profit pool would be ideal, but in payments, a volume metric is often used instead. Typically, this is abbreviated as TPV (total payments volume), GPV (gross payments volume), TMV (total merchandise value) or similar three-letter acronyms with a “V”. They all mean roughly the same thing: The dollar value that flows among trading partners.
Translating dollar value to payments revenue is not straightforward. Many payments businesses don’t charge for their services as a percentage of dollar value but instead via transaction volume. This is true in Treasury Services and Enterprise Merchant Acquiring. Even in payment methods where revenues are a fraction of spend (e.g., SB Acquiring and Cards) the translation from volume to revenue is not straightforward:
In fee per transaction businesses, getting to transaction volume requires dividing GPV by average ticket size. In Treasury Services, the revenue for a $1B transaction may be less than a dollar. In enterprise acquiring, even big ticket transactions may yield less than 1 penny in revenue. Basically, GPV tells you almost nothing useful about revenue in these businesses
In % of volume businesses, revenue per $ is often shown as gross rather than net. The problem is that the cost of that revenue may be more than 50% of the gross. For example, Fintechs in acquiring-style businesses often claim gross revenue of roughly 3% but 2%+ of that are direct costs like interchange and network fees. Revenue sharing with distribution partners should also be netted out. Incumbents treat these as contra-revenue while the insurgents treat them as a “cost of revenue”. At the end of the day net revenue may be as little as ~50bp (one-sixth of gross). As a result, two competitors with identical GPV may show wildly different revenue, but similar net profit.
A volume metric on its own tells you nothing about the real economic opportunity as it doesn’t translate to revenue or profit without knowing more. That is where “Addressable” comes in.
“Addressable”
“Addressable” should indicate what share of the total market can actually be served by the company. For example, some ISVs largely service single-unit restaurants up to small chains, so to get to “addressable”, you should exclude the GPV from big chains. Despite the inclusion of the “A” in TAM, this adjustment is often neglected, so the reported TAM is exaggerated. Similarly, the TAM might be stated as a global figure rather than limited to geographies’ actually served.
This confounds the usefulness of TAM because different markets and segments translate GPV to revenue in different ways. Large retailers pay acquirers a penny or less per transaction under what is known as IC+ pricing (interchange+, where the plus is a small, per transaction acsquiring fee); In contrast, single-location businesses pay 50-100bp of dollar value. Once a merchant grows large enough to get IC+ pricing, their revenue per transactions drops off a cliff. Further, larger companies buy fewer Value-Added Services (VAS) – like lending or payroll – so their ARPU drops alongside their payments revenue. Including Enterprise volume in TAM radically distorts revenue and profit potential. In many cases, the solution itself isn’t fit-for-purpose in Enterprise which leaves that segment unaddressable anyway.
Two examples illustrate the point, both of them from companies I deeply admire.
Square once processed for Starbucks, which instantly magnified their GPV but not their revenue and margins. To their credit, Square later exposed the Starbucks impact on their investor relations page in a handy spreadsheet
Ironically, Marqeta has the same challenge with its Square volume. At one point, Square accounted for 75%+ of Marqeta GPV but only a fraction of their net revenue. Marqeta, to their credit, later accounted for Square’s volume and revenue under a separate financial treatment
Both these examples show that moving up market inflates GPV far more than it does revenue, and it shrinks margin. Therefore, including Enterprise volumes in GPV-based TAM distorts earnings potential. These moves may still be worth doing as they provide credibility for an insurgent and help build scale. But their impact on GPV far outweighs their impact on revenue.
Going global has a similar impact. Other countries have different margin expectations that may make GPV conversions meaningless across borders.
Another use case with an “addressability” problem is the emerging Accounts Payable automation space where many insurgents monetize via Virtual Cards (VCs). They often show an aggregate B2B TAM where the real addressable market is a fraction of that.
Virtual Cards are used to pay suppliers at a gross cost to the supplier of ~3%. Big trading partners usually refuse to accept them, so the addressable space is usually when a big buyer pays a smaller supplier. Smaller businesses may get paid faster if they accept a VC, so the float value partially offsets the cost. VCs also save some reconciliation costs. However, not all Small Businesses are good targets for VCs as they may be one-off payments or the supplier does not have a merchant account (e.g., professional services). So, the truly addressable market is a small fraction of total B2B spend – excluding most large trading partners and many smaller ones. Most published TAMs do not make these adjustments.
“Market”
Even a TAM that uses a good metric and makes a good faith effort to limit the addressable market, simply assumes that market is there for the taking as if it is white space. TAM does not account for the strength of incumbents and associated barriers to entry. Nor does it account for competing insurgents.
Something that drives me nuts is when an insurgent declares a “TAM-expansion” strategy by entering an adjacent market and commenters immediately reward them with a higher valuation – before even one client has been booked! During the boom some Fintechs specialized in TAM-expansion press releases. This also happens when an insurgent starts globalizing since their TAM now includes whole new countries before they have shown any evidence of traction. Stretch ambitions are admirable, proof is better.
Better metrics on the way
Sophisticated investors, like PE firms, recognize the flaws in conventional TAM and have refocused on new metrics called SAM & SOM:
SAM (Serviceable Addressable Market) is the total sales volume that can be sold by all vendors within a specific territory
SOM (Serviceable Obtainable Market) is the subset of SAM that the firm can realistically capture within a few years
SAM fixes most of the “Total” problem by focusing on revenue, but doesn’t fix the inflated revenues in the Gross Revenue/Cost of Revenue model. SAM also solves part of the “Addressable” issue by limiting geography. SOM improves “Market” by assessing how much share of the SAM a firm can capture from the competition.
Both measures are still subject to non-disclosed assumptions that may or may not be reasonable. And neither metric is typically available to the public.
Key insights
TAM is a useful concept whose implementation lacks rigor. Be cautious about giant TAM claims or TAM expansion press releases. They may contain more heat than light
TAMs are often stated as the value transacted, which doesn’t translate cleanly into revenue potential, let alone profits. Revenue potential per transaction is usually lower in enterprise than in small business, so moving up-market usually means declining margins
TAMs may not distinguish whether the company’s products serve the full market being measured. The products often target just a fraction of the market
TAMs do not measure how competitive the market is. A big TAM does not mean that the company’s proposition will resonate. This is a particularly true when domestic competitors enter foreign markets
Newer metrics like SAM and SOM address many of these gaps, but they are hard to create and usually not available to the public. Their accuracy is often dependent on undisclosed assumptions