Niches Make Riches

Total Addressable Market or ‘TAM’ is one of the primary metrics that private equity investors use to assess the potential of a company.

The prevailing wisdom suggests that bigger is better, and a sizable, large TAM is a necessary ingredient for a great investment, while small markets are often dismissed as un-investable.

Topline Strategy often works with investors seeking to invest in businesses with as little as $10 million in revenue, who grow them to $50 million, $100 million, or more.

This conventional wisdom holds that to reach these revenue targets and still have enough upside at the end to attract the next buyer, TAM needs to be at least $500 million and ideally over $1 billion.

That is not always the case.

Private equity investors risk missing out on great opportunities by not taking a closer look at companies with smaller TAMs.

At Topline we have looked at companies that had small TAMs and corresponding limited prospects. But, in other cases, we uncovered great opportunities for our clients and demonstrated that it’s not the size of the market that matters most; rather, the ability for the company to achieve market dominance.

Very Large Slice of a Smaller Pie

Winners in small-TAM markets can emerge as significant beneficiaries for investors by walking away with a very large slice of a smaller pie.

They do this by:

  • Realizing Market Dominance: In niche markets, leaders frequently achieve staggering market penetration rates, often surpassing 40 percent, 50 percent, or even 70 percent.
  • Exercising Pricing Power: Dominant vendors can exercise significant pricing power. Market size estimates often underestimate the potential because these vendors can progressively raise prices.
  • Expanding The Market: Good relationships with clients, and close proximity to the industries they serve, allows dominant vendors to benefit from customers who bring new ideas and challenges. This, in turn, opens fresh opportunities for expansion.

The bottom line is that when a company starts with a $100 million total addressable market, grows it to $200 million, and then achieves a 50% share, it becomes a $100 million business – one that might have been overlooked by private equity early on.

Can a Company Get a Large Slice

The key to identifying small but great markets lies in assessing specific critical factors rather than fixating solely on market size.

To distinguish a small market with substantial potential, consider the following criteria:

  • Protection: Evaluate whether the market possesses barriers to entry, such as regulatory hurdles or complex technological requirements. Protected niches can create environments where a dominant player can thrive.
  • Maturity: Look at where the market stands in its adoption cycle. If it’s still in the early stages, there’s room for significant growth, indicating untapped potential far beyond the current TAM estimates.
  • Concentration: Investigate whether the market shows signs of a single dominant player emerging as it matures. Monopolistic tendencies can lead to market dominance and pricing power.

Investing in markets that meet any or all of these criteria can often be a wise choice. These companies tend to be undervalued due to the prevailing bias against small TAMs.

Additionally, they offer substantial opportunities for superior returns on investment, making them attractive options for astute investors.

Understanding your company’s potential goes beyond straight market sizing.

Learn more about Topline’s New Opportunity Validation and  Investment Due Diligence services here, or contact us here.