Hit By A Truck

Don't leave your family -- or your shareholders -- with the debts of your company.

Yesterday Josh D. (an attorney) wrote in to thank me for my advice on taking out a business loan.  In particular, Josh noted that I recommend a life insurance policy be in place before taking out a business loan.  He was surprised by that, and I think its worth a bit more discussion.

In yesterday’s post “7 Secrets Your Banker Wishes You Knew”, I described life insurance as a way that banks minimize their risk.  In other words, if you borrow their money and then get hit by a truck, how will the bank get their money back?

And there are some other excellent business reasons for your business to buy a life insurance policy on you, which I’ll get to in a minute.

The entrepreneurs I work with report that banks are requiring a life policy valued at 2 to 3 times the value of the loan.  The policy names the company as the beneficiary (not the bank), but the terms of the loan make it clear that  the policy will pay back the debt on your death.  That’s only fair.

But man, that could get expensive, right?  Right. Don’t forget to add the cost of the insurance policy to your monthly expenses.  Its possible that your loan payment may be $1,000 a month and your insurance bill (depending on your age and health) could add another $300 to $500 dollars.

In fact, if you have a revolving loan like I do, in many months my life insurance payment is much larger than my loan payment!  Suddenly that loan is starting to look very expensive!

But hang on.  Here’s the thing.  Were you really going to run your business without a life insurance policy on yourself?  Would you sign a 3-year office lease or buy a new company truck without knowing that it could be paid for after your death?

No way you want to leave a stack of bills as your legacy to your spouse, your children or your stockholders.

Which brings me to the third reason to have a big juicy life policy in your business… other stockholders.

When you get into business with a partner or investor, its important to have a clear written agreement between all parties.  This is especially true if one of you kicks the bucket.  If you die, who owns the company?  If your spouse inherits your ownership, will (s)he really want to work with your other partners?  Can your spouse even do the job you are doing now?

This brings us to the concept called “Key Man Insurance”… which is a fancy way of saying a life insurance policy that pays the company on your death.  It could be used to pay back loans or leases, but more likely it is used to purchase your stock from your spouse.

That sounds tricky, right?  Let’s try again.  When you die, your spouse inherits your ownership of the company.  Then the company takes the cash from the life insurance policy and “buys” that stock back from her.

The result?  Your partners can carry on without you, and your spouse has something more valuable than stock in a floundering company. (Because without you, it will flounder for a while!)  If the policy is rich enough, there might even be enough for the company to hire your replacement.  That would be ideal.

DO THE MATH:  Every time you make an obligation for your company, be sure its backed up by a way to pay it off.  Add up all your debts and leases, and get a policy that can cover them in case of your death.

THE BOTTOM LINE:  Don’t leave your family OR your partners (shareholders, employees, etc.) out in the cold.  When you die, leave a policy made out to your company that can cover the debts and help the company carry on.

Dedicated to your profits *(before and after death!)

7 Loan Secrets Your Bank Wishes You Knew

Open the Vault with these 7 Secrets of Bank Loans

If you want to borrow money today, there are 7 things you must know before you go to the bank.

Most entrepreneurs want to use “OPM” – other people’s money – to start or grow their business.  With good personal credit, borrowing is almost always the best way to go: rates are low, community lenders are eager to create jobs, and there are a growing number of government programs like the SBA loan guarantees.
Still, actually closing a loan can be difficult.  Banks expect a business plan, financial forecasts to justify the loan amount, and even your home as collateral. The prepared entrepreneur, however, knows the 7 secrets to winning the respect of the bank, and the loan of your dreams.

These 7 lending secrets make borrowing easier and will give you an edge when negotiating with any lender: the kind of edge that can save you thousands in the long run. Here’s what you should know to keep your edge when negotiating with bankers

1. Build a Personal Relationship

It’s true that people do business with people they know.  It’s no less so in banking – bankers lend money to people they know and trust.  The best loan negotiation starts when you begin building a strong personal relationship with a banker. Long before you put in a loan application, invite a banker to lunch. Give them a look at your current business, your home, your life.  Gently let them know how serious you are about building the business of your dreams.

Plan to stay in touch with your banker(s) at least once a month.  Since most loans will have terms beyond repayment (called loan covenants), you want your banker to know what is going on in your business and how you are using (or planning to use) his money.

2. Know the Secret Code

Every banker will tell you that approving a business loan depends on how well your company compares to other similar businesses.  The bank looks primarily at your financial operating results. Be sure you check out the banker’s bible for these business metrics: Robert Morris Associates’ Annual Statement Studies, or “RMA” for short.

The RMA includes example operating results from more than 360 industries and can tell you what your banker expects to see on your financial statement or plan.

The RMA is available at your local library or bank – asking the banker to make a copy of the appropriate page is a great way to show them that you know what you’re talking about. Meeting key ratios from the RMA should be your goal as you qualify for, and keep, a business loan.

3. Give More Than You Get

If you want to get a great loan, it never hurts to offer to open several other accounts at the same bank. Bankers love to have your “depository accounts” (checking and savings) and to help you with other fee generating services like credit cards and wire transfers. If you are only interested in the bank for the money it can lend, you’re not going to impress anyone.

Shifting accounts to your new partner bank can be a great negotiating tactic, and might even clip the interest rate you’ll pay on the loan.

4. Plan for Failure

It sounds backwards, but you will gain a banker’s trust by telling him all the ways that your business could fail – and how you have planned to meet those challenges. This shows that you know your business and helps your banker defend your ideas to his loan review committee. [Remember, one banker cannot guarantee you a loan – all loan applications are reviewed by the bank’s underwriting committee.]

One key to helping the committee say yes is to discuss “key person risk”. If you die tomorrow, how would the bank get its money back? Every bank wants to know that you – and your business – have some life insurance set aside for this purpose. It’s morbid. It’s expensive. But it shows that you are thinking through all possibilities and helping the bank cut its exposure to risk.

5. Plan the Work, Work the Plan

Loans are granted based on your projections and plans.  In some cases, the lender will want to be sure you spend the money exactly as you planned.

Of course, no business plan can perfectly predict the future.  You may have to explain each variance from your original budget and show the bank why the costs were necessary.  Be prepared to present receipts for each purchase, and keep an eye on the calendar – your loan may very well have a deadline, after which it will no longer be available to pay expenses.

One key to making it work is to ask for a bit more than you think you’ll need.  A “worst case” plan is always better than a wildly optimistic one.  Bankers don’t like surprises unless they are happy ones!

6. Negotiate Smartly

Careful planning and good relationships can get you a great rate and reasonable terms that might save you thousands of dollars in the long run.  But communicating what you need – and negotiating what is most important to you – will be even more important.

If you need to protect your home and retirement savings, make it clear that those things are off-limits as collateral.  If you know that your business will need extra cash in 6 months, get those facts out in the open.
Don’t expect the bank to blindly accept your terms, but be sure you communicate all your ideas up front.   You’ll get some of what you want, and at least the bank will understand your position on the rest.
Remember, for a well-prepared borrower, everything is negotiable.

7. Keep Your Eyes Open

Most business loans have covenants that can change every quarter or year, and almost all commercial loans are reviewed annually. Getting a loan is no guarantee that you can keep the loan.  If you can’t meet the terms, be prepared to have the bank ask for their money back (“call the loan”) early.

Remember, to keep the loans you need, stay ahead of the game by using all the above strategies. Keep your banker informed. Keep the risk as low as possible.  Plan ahead.  And when all else fails, keep building relationships with other banks…just in case!

Dedicated to your Profits!

PS:  Do you have a bank loan story?  Good or bad, I want to hear it.  Add a comment below and I’ll send you a free Loan Amortization table.

Warning: Angel Investors can be Bad for your Health

Not all Angel Investors are Saints... choose carefully and prepare for the worst

Last week we discussed using Angel capital in your business.   Taking money from individual investors is a great way to fund your business. But beware… angels have their downside too!

Like Getting Married

If you think finding an angel partner can be tough, living with one can be even tougher.  Taking angel money can be like getting married: Before you run to the alter, be sure you know the person pretty well!

Think you’ve got a difficult business now?  Wait until you pick the wrong person to be your angel invesor.  Once you take their money, they may expect you to provide regular reports and to listen when they offer advice.  (And they will offer advice.)  They may even want to play an active role in your company.

The more your company relies on their money, the more closely they will watch your every move.  And when they say ZIG! and instead you ZAG!, the fireworks can fly.  I’ve personally met entrepreneurs who have walked away from their business when the angel investor started throwing his weight around.  Even worse, I’ve seen company founders fired (!) by an angle investor.  It can happen.

Of course, a strong investor can be a curse or a blessing, depending on how you develop the relationship.  Work with your investor(s) to take advantage of their wisdom and support.  Since angels tend to invest in the industries that they know the most about, you should look for angels who can lend their expertise to your particular business challenges.

It’s Payback Time!

Of course, all angels invest for one main reason – to increase their wealth.  Their money is not free, and they will expect a big payback in the long-run.  Some may be willing to wait as long as five years to get their money back, but by then they will expect two or three times their original investment.

Even if it’s not clear to you at the beginning, an angel will always be looking for an “exit strategy”, and it’s your job to provide one.  They may LOAN you the money, or they might BUY STOCK, but either way they want to know that the money will come back to them one day.  (We’ll discuss angel negotiations and loans another time.)

Do the Math: If you want to estimate, figure on keeping an angel’s money for 5 years at an interest rate of 30%.  During those five years, you may not have to make any payments, but at the end of the 5 years, the angel is due more than twice what you borrowed! (drop me a comment below and I’ll send you a simple spreadsheet to show their investment return).

The Bottom Line: Angel capital is flexible but expensive.  Be sure you get to know the person and their goals before taking their money.  Use their expertise to improve your business.  And be clear about what happens if you cannot repay them in the end!

STAY TUNED FOR NEXT TIME:  Negotiating with an Angel — tips and tools to make the process fair and smooth.

Dedicated to your profits!

PS: Be sure to click “JOIN” so you don’t miss my next topic on Angel investing!

Half your customers are dead…

Jigsaw is one of the new tools you can use to improve your database of sales prospects (Image: CrunchBase)

It’s tough to sell anything if you don’t know the name of the buyer.  That’s been the problem with Business to Business sales… “prospect databases” are hard to find and are rarely accurate.  People move around and change jobs so rapidly that yesterday’s prospects are today’s wrong numbers.

In an excellent interview, Ruth Stevens of the Columbia Business School says that more than 4% of your business contacts change jobs every month.  Imagine — fully HALF of your prospect database will be worthless at this time next year. 

That’s a pretty good argument for following up rapidly… and for investing in a new breed of collaborative tools, like www.Jigsaw.com to help you keep your data up to date.

I recently submitted my entire prospect database to Jigsaw — all 17,200 names — and let them score it against their massive reservoir of business names and contact info.  We invest a huge amount of time keeping our list current, so I expected to find out that my data is pretty clean.  I guess hygiene is relative.  According to Jigsaw, fully 10% of my contacts are in their “Graveyard” — people who have died, retired, or other wise moved on, but for whom no forwarding information is available.  And another 10% have changed their phone numbers since I last contacted them!

I’m now in the process of letting Jigsaw beef up my numbers.  Its unlikely that we’ll ever get 100% perfect, but we will continue to make regular contacts, keep our database current, and seek help from companies like Jigsaw.

Good data is the life blood of sales… And now there is no reason to let your data go bad.  So keep in constant contact with your prospects, or be prepared to pay for someone else to clean up the mess.

Committed to your profits

PS:  Don’t forget to click the “JOIN” button.  It’s the easiest way to keep up with the transformational business ideas you will find here.  It’s 110% secure, and totally free.  I’ll never share your contact info, and you can un-join at any time.  But the best part is, you’ll qualify for my members-only tips and offers.

Related Articles

• Salesforce.com Introduces Jigsaw for Salesforce CRM (thetechscoop.net)
• ZoomInfo Offers Additional Paid Services (arnoldit.com)
• How to Stop Bad Data from Wrecking your Marketing Budget (customerthink.com)
• Salesforce boosts chat options with Activa Live buy (v3.co.uk)

What a Wage…To Pay or Not to Pay

Sam's Club is losing ground to Costco ... could their HR policies be to blame?

When someone says “Our People Make the Difference”… don’t you just want to hurl?

OK, that’s a bit too cynical, even for me.  But I bet you at least scoff!

At any company that hires more than 2 employees, can “people” really make that much difference?

I didn’t use to think so, but I recently read some amazing research that has convinced me that they can.

The study compares two well-known and very similar retailers in the USA:  Costco and Sam’s Club.

The first, Sam’s Club, pays their employees an average of just over $11 per hour and about 21% of their employees quit each year for various reasons.

Costco, however, pays their employees $16 per hour and replaces just 6% of employees each year.

Said another way, Sams Club pays less for salary, but 350% more for recruiting, hiring and training expenses than Costco.

Even more impressive are the differences in sales at the two companies.  At Costco, where higher-paid employees stick around longer (and thus are probably better trained, happier, and more knowledgeable about the store), sales are $795 per square foot.

At Sams Club?  You guessed it — just $516.

That is 50% MORE SALES PER SQUARE FOOT AT COSTCO!

THE BOTTOM LINE: Happy, motivated employees will create a happy, profitable company.

But I think it’s even deeper than that…  If you are cynical and view people as a cost (a place to make budget cuts), then you’ll end up hiring the lowest-cost employees.  Instead, look at people as an investment.  Hire the best you can possibly afford.  Motivate and encourage them.  Train them.  Stretch to your limit to keep them excited to come to work…. then watch as they actually perform!

If a 50% increase in salaries can result in a 50% increase in sales… are you better off?

That’s a math problem, to be sure (more on that in a second), but maybe it is also a human problem.  The study did not discuss this, but I’m willing to wager that paying higher wages is not the only thing that keeps Costco employees happy at their job.  There are probably differences in benefits, training and management attitudes toward people too.  Starbucks does not pay exceedingly well, but their employee loyalty is legendary thanks to healthcare benefits, flexible scheduling options and a culture of caring.

OK, let’s do some math.

If you want to experiment in your business — you could try to improve the culture and work conditions.  Or you could increase wages.  There’s a limit to how much you can increase worker’s pay, of course.  If you think better employees will help you sell more, then the formula is like this:

(increase in total sales $) x (gross margin %) / (all hours worked) > (increase in hourly wage $)

This is simply how you say “how much extra gross profit will better workers make each hour?”

You can’t give away all the excess, so the raise they get must be smaller than that hourly lift in gross profit.  (Note:  Why can’t you give it all back to them?  For one thing, some expenses may rise along with sales, like the cost to order and carry extra inventory.)

So let me know — would you rather invest in culture, benefits or just pass along the cash to employees as higher wages?  If you were the employee, which would make you happier?

Remember, the goal is to keep employees happier longer.  Each time an employee quits, you lose.  You lose a little piece of knowledge, but you also lose the time and money you’ve invested in recruiting, interviewing, hiring and training.

The stakes are higher than you might think.  How will you win the game?  Leave me your thoughts below.  I’d love to hear them.

Dedicated to your profits,
PS… Don’t forget to click “join”.  Its free, and its the best way to have a link to all my content delivered right to your email box.  Don’t miss that one idea that could transform your business and change your life!

The $24 Wrong Number — the cost of phone sales

If you use the phone to make sales... you better know what its costing you!

Quick!  Do you know the TRUE cost of a phone call?

If you are like me, you may have answered smartly, “almost zero — unlimited phone calls are free from most phone companies”.  Well, yes, that’s technically correct, but there’s more to it than that.

Alright, let me be more specific.  What’s the total cost of a phone call to your company? Would you believe almost $24.00 per call?  I’m not suggesting that every time you speak to someone it costs $24… Its much worse than that.   I’m saying, “Every time your sales person TOUCHES the phone it costs you $24.”  How can that be?

Within our sales organization, we have about a dozen people making sales calls day in and day out.  These are professionals.  They know their industry and their customers.  They can talk the talk.  In short, they are GREAT sales people, and we wouldn’t hire any other kind.  But even though phone calls are free, great sales people are not free.

If each great sales person in your organization has a phone line, a computer, a desk, a salary, some insurance, and maybe even a manager (or two!), the real cost of that employee can be well over $12,000 per month.  (See this great post on the average pay for a sales person in the USA.)

Now, if that same sales person takes a few minutes to prepare for each phone call, researches and rehearses a clear value proposition for the client, and correctly documents his actions in the CRM system, he will make about 25 calls a day.  Let me do the math for you…. that’s about 500 calls a month, or $24.00 each time he touches the phone.

Knowing this, are phone calls really the best way to spend $24?  Don’t forget, about 90% of phone calls are not even answered! That makes the cost of one conversation almost $250.00!

(1) Your sales people should be well prepared and well-armed to justify a $250 conversation. They should know what to say, have specific evidence and documents to back it up, and be ready to ask the right questions to move the sale along.

(2) If you are NOT ready to support your sales people, spend your money on something more effective. Take the first month’s $12,000 and build an amazing website.  Hire an experienced agency to re-write your brochures.  Take a video of your facility.  Build a trade-show booth.  Do whatever you can to PREPARE to have an expensive sales person representing you.

Everybody wants a sale.  But in the rush to hire a sales person, I see too many companies ill-prepared to start selling.  Take a deep breath.  Evaluate your position in the market.  Look hard at your value proposition.  Create the documentation you need to support your position.  Build a database of prospects.  In short, lay the foundation for success.

…And then, go out and start making $24 phone calls!  When you do, you will be “ready to succeed” and those phone calls will be the best investment you’ve ever made.

Dedicated to your profits!

PS: How much are YOU spending on phone calls?  Leave me a comment and let me know!

Related Articles

• A Fool Proof Guide To Setting Up A Sale (smallbizbee.com)

The (OTHER) Colors of Money

When banks say “NO” try these 3 options for raising capital.

Your personal retirement savings can now be used to finance your company's startup or growth

Finding enough money to launch or grow a company is tough… even when you’re not in the middle of a great recession.  We all look to banks to help out when we can, but bankers are not the most imaginative bunch.

If banks are not giving it up for you these days, try these 3 other sources of capital:

1. Hidden Personal Wealth

If you really believe in your business – and you should – then it’s natural that you should try to bankroll your own business growth.

Before you apply for a wallet full of new credit cards or a second mortgage however, look for other hidden sources of personal wealth.  Life insurance policies, 401(k) plans, IRAs and stock portfolios are among the most commonly overlooked sources of business capital.

Start with your life insurance policy.  If you have a whole life policy, you may have the option of withdrawing its cash value (before you die, I mean!).   Even better, you can pay the balance back (to yourself) at a flexible rate – or not at all if you chose.  In some cases, any unpaid balance will simply be deducted from the death benefit when you die.  You can’t take it with you anyway, so why not use it to grow your business?

Retirement accounts are the next logical place to look for hidden wealth. A 401(k) may have cash value that can be either withdrawn or used as collateral for a loan.  IRA accounts, including SEP and SIMPLE plans, typically have stricter limitations on borrowing or investing.

But wait, there’s something even better than borrowing against your retirement accounts.

Did you know you can actually invest your own retirement account into a company you own?   Doing so requires the cooperation of  your plan administrator or personal financial planner, but you can move your account to a firm that will coordinate this for you.  If you have questions on this, call your personal financial planner… or leave me a comment!  I’ll be happy to provide references.

Finally, don’t forget about your stock accounts.  Most brokerages offer “margin” loans, but your local bank or savings and loan may offer better interest rates.

2. Angel Investors

If your personal resources are tapped out, don’t despair.  The next best source of small-business capital may live right next door.

According to the University of New Hampshire’s Center for Venture Research, there are more than 400,000 active individual investors — or “angel investors” — who invest in more than 50,000 companies each year.  Many of the most active join “Angel Investor Clubs”, and there’s a great online resource to locate one near you — check out http://www.angelcapitalassociation.org/directory/.

In addition to these “active” angels, keep an eye out for more opportunistic individual investors. Casual investors – most often people you already know – pour millions of dollars into young businesses with little formality or fanfare.  Like the businesses they invest in, angels come in all shapes and sizes.

3. Commercial Lenders

The more critical your need for cash, the less useful traditional banks become. That’s where a commercial finance company can step in.

Commercial finance companies – also called commercial lenders – are not subject to the same regulations as a bank so they can look at riskier loans and different kinds of collateral. Of course, to make up for the increased risk commercial lenders may charge slightly higher rates of interest.

Collateral for a commercial loan could include things your community banker might not even understand, like accounts receivable, inventory and factory equipment.

And if you don’t have a lot of assets? Look for unsecured, mezzanine or subordinated loans. Rates for these loans are about equivalent to those of a credit card.

Subordinated and unsecured credit is widely available to businesses with solid operating profits, sometimes to the tune of two or three times annual cash flow.

The biggest commercial finance lenders include GE Finance, Textron and CIT. But there are hundreds of smaller shops that specialize in lending against particular types of collateral or to businesses within a particular industry.

So now you know.  When your banker says “NO”, the money hunt is just beginning.  Branch out to Angles, Commercial Lenders and to your own Personal Financial Planner for advice on less traditional (but maybe even more effective!) types of loans.

Got a good story about a banker saying “NO” to your business?  Share it with me in the comments below, and I’ll send you a free copy of my “Perfect Fundraising Kit”… containing everything you need to start a conversation with a bank, an angel, or a commercial lender.

Dedicated to your profits,

PS: If you haven’t already become a member of this site, please sign up today.  All members receive my free report “The Colors of Money” which details 27 other great ways to finance your business.

How Big Can Your Biz Be?

Will your company be too small to succeed?

An average McDonald's unit can't sell more than about $165,000 per month... Where's the limit in your business?

You have a business — or an idea for a business.  But do you have any idea how big your business can grow?

It’s an important question.  From the very first day, a Google-sized business does things very differently than a local retailer or restaurant.  Right?  I mean, a local coffee-shop won’t be investing in Super Bowl advertising the way a giant brand might.

So… How do you decide how much to invest in advertising, inventory, staff… even rent?  It comes back to how BIG can you BECOME, and the answer to that takes some simple math.

Technically, the answer is called your “Total Addressable Market,” or TAM.   That’s a good word to use in front of your banker, but it’s simpler than it sounds.

So, what is a TAM?

It’s easy, really… “TAM is the sales you could make if you had no competition.”

OK, let’s break it down.

• ALL the sales? Right.  If all the people who are already looking for your product bought only from you, how many customers would you have?
• NO competition? Yes.  This is imaginary, remember, so there are no competitors, no substitutions, and no alternatives.  If you have a restaurant, pretend it is the ONLY restaurant in town.

What’s the Catch?

I know you’re getting excited now.  If you own the only restaurant in town, the customers would be lined up at the door all day and all night, right?

Not so fast.  Here’s the catch.

• Your “Potential Customers” are actually fewer than you think. Notice that we said you had the only restaurant IN TOWN.  That means that your customers do NOT include people who live more than 10 or 20 miles away.  It also does NOT include people who regularly cook for themselves.  And if you happen to be a Brazilian Steak House, it probably does not even include vegetarians!  Start carving out the people who are NOT potential customers, and the line outside your door may start looking shorter.
  
• You have other limitations.  Like the number of seats in your restaurant or the hours in a day.  If each person takes an hour to eat a steak, how many total people can you ACTUALLY serve.

Now we’re getting some where. The Total Addressable Market for a restaurant CHAIN might be very big, but the TAM for a single restaurant is probably very small.

The Lesson?

Don’t spend $10 million building and advertising a restaurant if you can only ever serve $1,000 worth of dinners.

In most cases, a quick TAM calculation can put your business into clear perspective.  When doing this, you don’t even have to think about things like profit margin or cost of raw materials…  just use your TAM to get an idea of scope and scale.  Let it guide your total size.

That’s it! You’ve got the basics.  If you’re still awake (and who isn’t after that stimulating discussion!) and you want some more details and examples, keep reading.  I could do this all day long.

…MORE DETAILS

• TAM is not the same as your “industry”… TAM is much smaller.   If you are a restaurant, you are part of the trillion-dollar food service industry, but clearly, you could not sell a trillion dollars worth of steak and sandwiches!
• TAM is not the same as your “market share”… TAM is much bigger.   General Motors may have 30% market share for SUV’s in the USA, but their TAM includes all the people who buy Ford Explorers or Honda CRV’s.
• TAM differs from your “Target Market” (which tends to mean the descriptive demographics of your ultimate customer) and “Market Segment” (which is a description of a subset of your “industry”), since TAM is generally expressed as a value in dollars.

…MORE EXAMPLES

Let’s use the auto industry.  Imagine a “Muffler Co.” that makes specialty mufflers for luxury sedans.  To calculate Muffler Co.’s Total Addressable Market, we need to know how many manufacturers make luxury sedans, and how many cars each one makes.  We can count up all the BMW’s plus all the Cadillacs plus all the Lincolns and Mercedes and so forth.  The total number of mufflers needed for ALL those cars is the Muffler Co.’s TAM.  Usually, we express this in either units (number of mufflers) or dollars (value of selling all those mufflers).

[Note that the muffler company’s TAM is not the trillion-dollar automobile market since they only make mufflers.  Nor is it market for all mufflers on all cars, since their product is only designed for luxury sedans!]

…WARNING!

If adding up all the luxury sedans made in a year seems like too much work, the company might be tempted to find an industry number for all luxury sedan mufflers sold.  Sometimes that’s a good shortcut. But beware – if that number includes the mufflers installed on luxury sedans at repair shops then it’s not a good representation of the true TAM.  Remember, we originally defined our customer only as the auto manufacturers.  To include these after-market sales means we would have to redefine our customer… and that will change our whole business plan!

…EVEN MORE EXAMPLES

Lets try one more example.  A company wants to sell prime filet mignon to all the restaurants in Ohio.  Sounds like a good idea, right?  After all, research shows that there are 10,000 restaurants in Ohio spending over $100 million a year on beef.  That’s a sizeable TAM, and a great opportunity, isn’t it?

Not so fast.  Clearly, by packaging and selling filet mignon, the company can’t serve restaurants like McDonald’s and Pizza Hut.  As it turns out, fast food chains like those represent 60% of the restaurant market.  Ooops!  All of a sudden your $100 million beef market is reduced by products you don’t sell — like ground chuck and pepperoni sausage, not filet mignon.

Perhaps you will find that steaks represent just 30% of the beef market… and filet mignon represents just 10% of the steak market.  Suddenly your Total Addressable Market is just 3% (30% x 10% = 3%) of what you thought it was.

…SO WHAT?

So what does this really mean?  As you figure out how many cows to raise, or how much of your life savings to pour into advertising, it is good to know what your TAM really is.

Clearly, it would make very little sense to pour $10,000 into advertising in a local area that only spends $5,000 a year on filet mignon (or mufflers, or steak restaurants).  Likewise, an investor in the Ohio Filet Mignon Company will want to know how you plan to repay his $5 million investment out of your slice of just a $3 million total market!

Remember: Keep an eye on your true TAM, and let that determine the scope and scale of your business.  Don’t grow out of your TAM until you have your next market already defined!

PS:  Want to define YOUR TAM? I’m available to answer questions and help you with calculations.  All it takes it to become a charter member of this site…  It’s free, painless, and simple (like all my advice).  Just click “JOIN” on the right, and send me a line!