👋 Hi, it’s CJ Gustafson and welcome to Mostly Metrics, my weekly newsletter where I unpack how the world’s best CFOs and business experts use metrics to make better decisions.
Ever wonder how tech giants like ServiceNow, Datadog, and CrowdStrike come up with those massive TAM numbers to make investors drool? Let's pull back the curtain and dive into the nitty-gritty of how these companies size up their markets.
Spoiler alert: It's not just about pulling a number out of thin air.
The Importance of Bottom-Up Approaches
While top-down approaches using analyst reports like Gartner and Forrester can provide a good starting point, it's the bottom-up calculations that really show us how companies view their market opportunity. These methods allow us to see if they're basing their estimates on:
Number of employees in target companies
Number of potential customer companies
Data consumption rates
Specific industry verticals
Product adoption rates
Understanding these bottom-up TAM calculations gives us a window into how these companies view their growth potential. It's not just about the final number, but about the assumptions and value metrics they're using to get there.
Let's break down how each of our spotlight companies tackles this challenge (formulas included below).
ServiceNow: Segmentation is Key
ServiceNow takes a segmented approach to calculating its TAM, focusing on company size and product adoption. Here's how they break it down:
Company Segmentation:
They use the S&P Capital IQ database to identify global companies with 200+ employees.
These companies are then split into two cohorts:a) Companies with 200-999 employeesb) Companies with 1,000+ employees
Product-Based Calculation:
For each cohort, they calculate the average Annual Recurring Revenue (ARR) per customer for each of their platform products.
TAM Formula:
TAM = (Number of companies in cohort A × Average ARR per customer for cohort A) + (Number of companies in cohort B × Average ARR per customer for cohort B)
This approach allows ServiceNow to account for different adoption rates and pricing tiers based on company size, providing a more nuanced view of their market opportunity.
Key Takeaway: ServiceNow's method hinges on the number of potential customer companies and their likelihood to adopt specific products based on size.
Datadog: A Multi-Faceted Approach
Datadog takes a more complex approach, combining multiple factors to estimate their TAM:
Host-Based Calculation:
They start by estimating the total number of hosts (servers, containers, etc.) in their addressable market.
This is multiplied by their average annual revenue per host.
Application Performance Monitoring (APM):
They estimate the number of applications that could benefit from APM.
This is multiplied by their average annual revenue per application monitored.
Log Management:
They calculate the total volume of log data generated by potential customers.
This is multiplied by their average annual revenue per gigabyte of log data ingested.
User Experience Monitoring:
They estimate the number of end-users whose experience could be monitored.
This is multiplied by their average annual revenue per end-user monitored.
Datadog's TAM is the sum of these individual components, allowing them to capture the multi-product nature of their platform.
Key Takeaway: Datadog's approach is based on usage metrics (hosts, applications, data volume, end-users) rather than just company count, reflecting their consumption-based pricing model.
CrowdStrike: Endpoint-Centric with a Twist
CrowdStrike's TAM calculation focuses heavily on endpoints but also incorporates additional factors:
Endpoint Calculation:
They estimate the total number of endpoints (devices, servers, cloud workloads) in their addressable market.
This is multiplied by their average annual revenue per endpoint protected.
Module Adoption:
They factor in the potential for customers to adopt multiple modules.
Each additional module increases the potential revenue per endpoint.
Industry Vertical Adjustment:
They adjust their estimates based on the specific needs and regulatory requirements of different industries (e.g., financial services, healthcare).
Cloud Workload Expansion:
As more companies move to the cloud, CrowdStrike factors in the growing number of cloud workloads that need protection.
Emerging Threat Landscape:
They incorporate estimates for new market opportunities arising from emerging threats (e.g., IoT security, 5G-related security).
CrowdStrike's approach allows them to capture both their current market and potential expansion areas.
Key Takeaway: CrowdStrike's method is endpoint-centric but incorporates product depth (module adoption) and market breadth (industry verticals and emerging threats). It also takes a more forward leaning approach to what the market could become as new technologies take hold.
Comparing Approaches: What It Tells Us
When we look at these three approaches side-by-side, we can glean (vocab word) some interesting insights:
ServiceNow focuses on company count and size, suggesting they see their growth tied closely to enterprise adoption and expansion within those enterprises. This is the most basic and straightforward of the approaches.
Datadog emphasizes usage metrics, indicating they believe their growth will come from increased data volume and broader adoption of their various monitoring tools within organizations.
CrowdStrike combines endpoint count with module adoption, showing they expect growth both from protecting more devices and from selling additional services to existing customers. This is the most complex of the approaches.
The Bottom Line
Remember, TAM calculations are part art, part science. They're based on assumptions that can change as markets evolve. But by understanding the methodology behind the numbers, we can make more informed decisions about a company's true potential.
For investors and analysts, this deeper understanding can help in:
Assessing the realism of growth projections
Identifying potential areas of market saturation
Spotting new growth vectors the company might pursue
Next time you see a flashy TAM number in an investor presentation, don't just take it at face value. Dig into the assumptions behind it – that's where the real story lies.
