Startups and their investors love to talk about big markets and how they are going to go about tackling them. Total addressable market, or TAM, refers to the dollar value of what a startup wants to sell to a certain population. If you make a widget that plugs into a browser, your TAM might be the total number of users of that browser, cut down to the fraction that might use your technology, multiplied by the yearly value of that usage.
For startups chasing a new or burgeoning market, TAM can be a very bullish indicator. A growing market will have plenty of room for upstart companies to attack incumbents; sometimes startups create their own market, but that’s a bit rarer. (Big TAM doesn’t always lead to outsize success, and smaller TAMs can still yield big companies that can yank strong margins from hooked customers.)
All this is to say that TAM matters for startups, how they pitch investors and how investors make investment decisions. It’s super critical. We’ve written about it on TechCrunch a lot over the years. And I think that it is also a bit insufficient today.
I posit that if the macroeconomic environment winds up as bad as some fear, that the TAM question for startups will be more like reading tea leaves than making realistic projections, especially for those busy selling their product instead of merely proving that a market exists for what they are building.
During the go-go years of the last venture capital cycle, it seemed that the global economy was doing just fine or close to it. There were better and worse years during the business cycle, and COVID-19 threw more than one wrench into the mix. But 2022 has an entirely different flavor to it. The foul taste in the back of your mouth that you may have noticed in recent weeks and months is the risk of recession.
During the 2018-2021 period, how much attention did startups pay to the GDP of particular countries, their inflation rates, the price of money attached to their currency or similar? Not that much, I’d hazard. Again, COVID changed things, but it proved to be largely background noise once investors and founders realized that folks were still buying software.
Startups are building for the future and venture capitalists are investing with a 10-year time horizon — so what does it matter if the economy is a bit better or worse?
Venture investors have told me for years that they don’t track the stock market or other macro-related indicators, and I almost believed them. Now we know that that was all hot tosh. Today, investors are acting more conservatively and counseling their startups to follow suit.
Why? Valuations are down due to macro factors impacting the value of comparables, most often sourced from the public markets. But that’s just one part of the story. From the public-company perspective, we are seeing more and more issues crop up at modern software companies. Discussions of how it’s taking longer to close customers, that deal sizes are getting more scrutiny, all sorts of negative business signals. All of it — driven by new and worse economic conditions — will impact startups. Not their TAM, I suppose; if you extend your timescale far enough, that TAM could still materialize, provided that startups are not bullshitting themselves with their calculations. But in the near term, things could get worse for startups in a meaningful way.
This splits along a few axes. One being the focus of the startup in question; given hot inflation, consumers may be strapped for cash. That could impact any B2C startup out there. Businesses are more resilient, perhaps, but as our public-market notes from above make clear, even B2B companies are feeling some pain.
Another way that the macro question could impact startups is around growth. Growth is life to startups; without quick revenue expansion, they’re simply inefficient, very expensive small businesses that are dramatically overstaffed. Cut a startup’s growth rate in half, and it can lose more than half of its value. Meanwhile, macro conditions could impact not only new customer acquisition, but retention as well. A few extra points in the monthly churn column and startups could see their growth materially slip, no matter what their target market is.
Consider the possible impact of a real, whole-cloth recession on startup markets big and small — it’s staggering!
TAM is perhaps the right question when the economy is good. You look to the future, calculate your eventual winnings and discount back to the present. But when the economic and geopolitical outlook is uncertain, the distance between today and TAM can widen.
Venture capitalists agree. They would not counsel sudden financial rigor after preaching the opposite for years if they weren’t worried. I just hope that all the startups that investors told to not fret about macro questions and instead just build are able to raise their gaze enough to not get hit face-first by a freight train marked with, say, rising interest rates or global political instability.