– Amit Nath
A helpful mental model that we often incorporate into our research process at Montaka Global is Total Addressable Market (TAM) analysis. Through this process, we attempt to estimate how large the revenue opportunity is for a particular business. However the picture isn’t quite as linear as it sounds.
For example, take the advertising industry as it currently stands. Last year (2019), the world spent US$511 billion on advertising (excluding China), of which US$261 billion (~51%), was spent on TV commercials, print ads, radio, billboards, etc (“offline” advertising) and the balance (US$250 billion) was largely spent Google and Facebook advertising (the pair represent >80% of TAM combined). Now Google and Facebook are two of the highest quality businesses in the world and derive nearly all of their revenue by selling online advertising. Hence a cursory glance at the TAM picture might suggest their revenue opportunity is approaching saturation point and are set for imminent decline. Another thought experiment might be to imagine it is 1999, when Google was pitching its online advertising model and search engine. In 1999 online ads represented ~2% of the market or ~US$4.8 billion, which would represent Google’s TAM. For many this would not be a compelling proposition and what would become one of the greatest investments of all time, would be ruled-out along with the company’s vision of an online future.
Source: Company Filings; Magnaglobal; Bloomberg; MGI
Obviously predicting Google’s violent disruption of the advertising industry 20 years ago would have been near impossible, there is however an interesting lesson here. By using the traditional top-down, TAM framework over the last two decades, an investor would have measured Google’s revenue opportunity at each point-in-time and concluded the business was uninvestible as it had already saturated the market. What we are highlighting here is that TAM can be directionally misleading, not only in the early years of a true disruption, but at practically any point along the path. As disruptive technologies / businesses tend to consume adjacent markets, make others obsolete and create entirely new ones along their journey, it is incredible difficult to determine what is reasonable and what is not when assessing TAM.
While there is no “silver bullet” here, some of the perspectives the team at Montaka Global explores in parallel with the traditional TAM framework to get a better sense of a market include:
- TAM Expansion: The highest quality businesses will often fundamentally alter the markets in which they operate. These companies are often seen as disrupters and may remove friction in legacy systems (e.g. Expedia), increase convenience (e.g. Uber), enable new use cases (e.g. Airbnb), lower price (e.g. Amazon), etc, etc. By innovating in this manner, these businesses can dramatically expand the size of their markets and point-in-time TAM, as Google has been doing for over 20 years.
- Credible Adjacencies: Another powerful mechanism a high quality business may use to expand its TAM is by either creating an entry-wedge (service or product) or leveraging an existing one into a larger opportunity. For example, Amazon started its business selling books because the category had a large number of SKUs, were easy to ship and had broad mass-market appeal. However books were just Amazon’s entry-wedge into selling “everything” online. An example of an existing entry-wedge is Microsoft’s Windows and Office suite. Microsoft is leveraging these legacy offering to open up the cloud computing market via its Azure platform to tremendous effect. The complexity for an investor is judging when a proposed adjacency is real and when it is fiction.
- Nascent Market Potential: With many technology businesses, there is a tremendous competitive advantage in being the first to scale in an emerging category. For instance, Facebook wasn’t the first social network (MySpace, etc came before it), however it was the first to scale its offering, achieve mass appeal and effectively owns the highly profitable category now.
- Frequency of Use: A rule of thumb in consumer technology, is that the frequency with which users interact with a given product or service, tends to correlate with the size of the opportunity. Something that is habit forming and becomes regular behavior with a large part of the population, generally presents an opportunity for a significant TAM. While Ofo and Mobike, the Chinese bike-sharing companies, have had mixed success, they are early examples of this phenomenon. While the point-in-time TAM for bike-sharing remains relatively small, and the businesses only collect cents for each ride, investors see opportunity in something that people use 2-3x per day for the critical task of commuting. So far it has largely proven to be an unprofitable endeavor however.
As can been seen, we can easily underestimate TAM, resulting in excessive conservatism and sustained missed opportunities and by the same token, it is all too easy to become overly optimistic and significantly overestimate opportunities with disastrous results. Unfortunately striking the correct note is not easy, it involves a myriad of insights, perspectives and conclusions, none of which will be immediately obvious. Take for instance the prestigious business consultancy, McKinsey & Co. In 1980, McKinsey carried out a detailed market study that confidently concluded mobile phone penetration in the United States would be less than 1 million by 2000. In reality the number turned out to be ~110 million. Time will tell, but a potential example of overoptimism may be found in Uber’s IPO prospectus. In it, Uber claims its TAM is ~US$6 trillion for rides and ~US$3 trillion for meal delivery. This would imply that every person, in every country Uber is in, forgoes all other means of transportation and just uses Uber, in addition to never eating in a restaurant again and instead, only ordering off Uber Eats!
The team at Montaka Global thinks extremely deeply about the size of the markets companies we own serve and how those markets are moving. This helps us prioritize developments, understand customer segmentation and uncover non-obvious insights on both the long and short side, as we strive to deploy our collective capital in the most productive pursuits possible.
Amit Nath is a Senior Research Analyst with Montaka Global Investments.
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