🎰 Every new product launch is a bit of a gamble. Here's how to improve your odds.
As founders and PMs, we know that finding product/market fit (PMF) is not just important—it's the single most important factor that determines the success or failure of a new business or product. The truth is, despite our best efforts, there's no single solution that will find it 100% of the time... but we can improve our odds by measuring the things that matter.
The Backstory
Recently, I had a vulnerable conversation with a founder while we sipped happy-hour Manhattans and reflected on the state of his 28-month-old bootstrapped SaaS startup. He confessed he found himself scrolling endlessly through his favorite subreddits in the evening, unconsciously searching for ideas to fix his business. Revenue growth was stuck. They had some happy customers, and the marketing team was easily attracting new prospects to their product on a daily basis, but they were running out of cash.
Sound Familiar?
If this story sounds quite familiar, it’s because failures like this happen more often than we would all wish to believe. In 2020, McKinsey reported that 92% of slow growing software companies fail within 3 years. The reality is that competition is fast and fierce within SaaS - the threat of new entrants to a market is constant and unrelenting because the next copycat product to yours is just a few hundred thousand lines of code around the corner.
Research by CB Insights in 2017 and 2021 stated that the top 2 reasons startups and startup products fail was that they “had no market need” or “ran out of cash”. One could easily argue that these two reasons are directly related to each other - that many of these companies run out of cash because they just don’t drive sufficient revenue to scale as quickly as they need to in order to survive against their competition.
[ CB Insights Report 2017 & 2021 ]
When internal teams are candidly asked why revenue is lagging, there are often several different, yet common, perceptions of root cause depending on the department the answer comes from. Here are a few of the more common ones:
- This product just doesn’t sell. (Outbound Sales Team)
- If we just had a feature XYZ our product would be more attractive. (Marketing Team)
- Our sales & marketing team just doesn’t sell it well enough. (Product Team)
- We would have sold more if the marketing team would just get us better leads. (Inbound Sales Team)
- If we had time to apply the latest UI/Framework/Tech stack we’d have a better product that people would actually want to buy. (DevOps/Engineering)
Each of these candid complaints have one thing in common: They are rooted in a failure of the organization to properly find Product-Market fit. As famously quoted by a16z’s Marc Andreesen in his classic 2007 blog post:
“The only thing that matters is getting to product/market fit. - You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of “blah”, the sales cycle takes too long, and lots of deals never close.”
Sound familiar? PMF is the number one critical item that every Founder and every PM should be focused on when preparing to launch a new product. Without it, a business will not grow faster than its competitors in a new or expanding market, it will struggle to acquire market share in a mature market, and it will often get stuck at a revenue level much lower than what is necessary to survive long-term.
So what is Product/Market fit?
With PMF being the critical item we should all be focused on, it's important that we have a solid definition of what it actually is. Marc Andreesen simply defined it as:
“ [ PMF is ] being in a good market with a product that can satisfy that market.”
Although deceptively straightforward, there are two key concepts in this quote that form the beginning of a killer PMF search framework. The real PMF magic lies in finding a good market and knowing it loves your product.
FINDING A GOOD MARKET
It is notable that Marc puts the market before the product in this simple 2-part formula. Marc is really making it clear that there is often no point in building an amazing product if the market for it is too small, too immature, shrinking, growing too slowly, too competitive, or just plain unattractive.
The search for PMF, and by inheritance the search for your market, should always begin with doing the research and understanding the customer you think you will sell to. Steve Blank and Bob Dorf nail it perfectly in The Startup Owners Handbook with their consistent call to “Get outside and talk to your customer”. Hunting down and talking to new customers, (not existing ones that may have purchased your beta product and have inherent biases), is a challenging but ultimately rewarding process that can be simplified by combining experimental landing page testing with structured interviews and focus group activities that start to drill into whether the market really wants your product or not.
But ultimately, to achieve PMF, you need to identify a consumer or business problem common to the group you are researching and create a product that solves that problem better than everyone else.
KNOWING THE MARKET LOVES YOUR PRODUCT
There are several PMF myths that have emerged over the years since Marc Andreesen coined the term PMF. The most common one is that PMF is a 0 to 1 revelatory event in which the founder or team says to themselves “Hey, I think we just got PMF”. Not to say that this does not actually happen for some founders, just that the probability of it is low. That said, there are things you can do to stack the deck in your favor to achieve PMF faster when starting new product development.
“You can always feel product/market fit when it is happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You're hiring sales and customer support staff as fast as you can. Reporters are calling because they've heard about your hot new thing and they want to talk to you about it. You start getting entrepreneur of the year awards from Harvard Business School. Investment bankers are staking out your house.”
Although on the surface Marc's statement appears to be a solely qualitative method of determining PMF, it is really just a call to action advocating measurement of each of the warm and fuzzy symptoms that he lists. Some of these symptoms are lagging indicators, but many if measured early enough can uncover trends that point towards how to find PMF faster.
The true degree of PMF becomes even more evident in symptoms that are less qualitative and more quantitative. Things such as:
- You aren’t seeing much website traffic growth, or it’s slowing down,
- Your churn rate is high,
- Current customers are using your product less and less,
- You aren’t generating much (if any) revenue,
- You aren’t getting much feedback from users.
I like using these symptoms because they are anchored in things that can be measured. It’s wonderful to have investment bankers staking out your house and receive entrepreneurship awards, However, these types of lagging indicators are not measurable and dependable extrapolations cannot be made from them.
How do I know if I have Product/Market fit?
A founder’s best PMF indicators are ones that can be quantitatively measured and monitored. Famous statistician and management consultant W. Edwards Deming hit the nail on the head when he said, "You can't manage what you can't measure." Whether your team uses KPIs, OKRs, Balanced Scorecards, or a different methodology to manage your product development, it is critically important that you know how to measure product/market fit if you want to move faster.
You know you have achieved product-market fit when your data tells you that you have it. If your organization centers itself around the core tenet that user/customer data is king, and implements data collection infrastructure early - and I mean really early - in the development cycle, then you become much more able to create and monitor meaningful metrics that will tell you the market loves your product.
How to Measure Product/Market Fit
Over the years, several ways of measuring Product-Market fit have emerged from some great minds in the field. I’ve collected them below and added a new one that has emerged with the rise of Social Media.
These are 6 of the best ways to measure product-market fit:
- The 40% Disappointed Rule
- LTV: CAC Ratio
- Retention / Churn Rate Trends
- SaaS Rule of 40
- Burn Multiple
- Referral Source Trends
The 40% Disappointed Rule
In 2013, Sean Ellis found a leading indicator of PMF. Just ask users: “how would you feel if you could no longer use the product?” and then measure the percentage that answer “very disappointed.” This is a particularly clever way of not only identifying how many of your customers really love your product, but also providing insight into the characteristics of the users that love your product.
Measurement #1
Greater than 40% of users are disappointed if they could no longer use your product
Amongst other things, this survey framework outlines that the best indicator of PMF is if more than 40% of your current customers would be disappointed if they could not use your product tomorrow. The beautiful part about applying this framework is that you can dig deeper into the survey data by assigning personas and segmenting a subset of customers that would be most disappointed.
Careful analysis of the survey responses in this loyal segment can be used to narrow down the most valuable aspect of your offering, unearth other features this segment wishes they had, inform your actual SAM, and guide your product and marketing efforts going forward.
By asking “What would make our product even better” of those that would be disappointed to lose your product, you are able to start looking to the future with greater certainty and use this group of diehards to find the NEXT thing that will drive growth after you’ve tapped out growth from the things they currently find most valuable. It is the incremental discovery of new features this group wants that will ultimately drive your ability to push them into higher priced offerings while simultaneously expanding the user base to parallel groups that may not have originally been within this circle.
LTV : CAC Ratio
LTV represents the total amount of revenue a business can expect to generate from a single customer over the course of their lifetime, whereas CAC represents the total cost incurred to acquire a single customer. A healthy LTV to CAC ratio is typically considered to be at least 3:1.
Measurement #2
LTV : CAC Ratio > 3
Generally, when a business exceeds this healthy LTV to CAC ratio, it is an excellent indicator that customers are willing to pay for your product at the pricing you have chosen without your organization breaking the bank on Sales & Marketing. It is always a strong indication that the business has achieved product-market fit, as customers are willing to pay more for the product than it costs you to acquire them. When coupled with a low churn rate it is a doubly good indicator.
Churn & Retention Rate Trends
No matter which term your team prefers to use, churn rate, or its more positive embodiment retention rate, this metric is a very useful indicator of progress towards product/market fit. It is always normal to have some customers that stop using your product, but if your retention rate is low, or it is decreasing, it is a clear signal that your team still has some work to do to find PMF.
Measurement #3
Retention Rate is High AND Increasing
But retention rate can be more than just a single metric derived from the collective state of all users. Much deeper insights can be made if your entire user base, both past and present, are subdivided into mutually exclusive groups having characteristics that when measured in aggregate represent corporate goals, but when measured individually can be leveraged for growth insights at a specific step in the customer lifecycle.
[ Duolingo’s User Subgroups & Growth Model ]
When divided into sub-groups, data savvy organizations create a Growth Model that examines the sensitivity of theoretical improvements targeting one subgroup metric on the aggregate growth metric that their industry derives valuation from.
By measuring the rates at which users move between sub-groups, simulating different acquisition and retention experiments, and comparing your actual retention absolutes and trends with that of your competition you can start to get a strong indicator of whether you actually have PMF. Most importantly, if retention rates are below your industry average, or they are decreasing, it is a very clear signal that you still have work to do to find PMF.
The SaaS Rule of 40
The SaaS rule of 40, surfaced by legendary investor Brad Feld, is simply a rule of thumb that analyzes the health of a software/SaaS business in a way that connotes an underlying PMF signal. It utilizes two of the most important metrics for a subscription-based business: revenue growth rate and profit margin.
Measurement #4
Growth Rate + Profit Margin > 40%
It states: Revenue Growth Rate plus Profit Margin must be greater than 40 percent. Meaning, if your revenue growth rate is 30% YoY, then your profit margin should be at least 10%. If your growth rate is 60% YoY, then you could accept a negative profit margin of 20% to fuel that growth.
Notably, Brad applies this rule broadly to all SaaS businesses, likely because startups often initially only sell a single product. But it can just as easily be applied on a per-product basis at companies that sell multiple products or a combination of products and services if revenue generating sales & marketing campaign activities are separated for each product line and attribution data is collected and analyzed along the conversion path.
Ultimately though, if the business, or more specifically the product, is falling short of the 40% threshold, the root cause is often a lack of PMF.
Burn Multiple
In 2020, David Sacks (formerly COO PayPal, Founder Yammer) coined the metric “burn multiple” in this excellent article that examines the importance of capital efficiency during lean times. Growth efficiency is proxied in the burn multiple by dividing the net cash burn over a period of time by the net new annual recurring revenue generated over that same period.
Measurement #5
Burn Multiple < 2
He goes on to indicate that a burn multiple less than 2 is good, and less than 1 is amazing. Although his article really dives into the weeds about how this metric is influenced by operations, there is a true gem hidden within it when he says:
" [ When burn multiple is low ] the market is pulling product out of the startup, whereas [when burn multiple is high], the startup is pushing its product onto the market."
Even though this is a simplistic method of assessing product market fit, it is still extremely useful as a metric that is easily measured using data that probably already exists within your organization. It is an excellent high-level indicator of PMF, and is one that is often used by VCs and investors in early-stage startups according to David.
Referral Source Trends
By examining the referral sources of visitors to your website and new users of your product, you can yield an even more powerful indicator of PMF. Investing in tooling that seamlessly collects this critical data pays huge dividends in the search for PMF.
Measurement #6a
Organic Social Media Referral Traffic is Increasing
Organic referrals from social media beyond that which you are driving with your paid advertising are an excellent indicator that customers are sharing and recommending your product to their peers. Nothing is a stronger endorsement of the value of your product than a user’s willingness to stake some small part of their reputation within their community.
Measurement #6b
Dark Social Referral Traffic is Increasing
Similarly, referrals from dark social sources such as private messaging apps, personal emails, and other sources that are typically difficult to track, but don’t need to be, are exceptionally powerful too. By leveraging one of several common user profiling techniques, you can identify the rate users are finding your platform through dark channels and create a metric through which you can measure progress towards PMF.
Putting these two source types together, if referrals from organic social media sources are climbing, you are well on your way to finding fit. If your dark social referral contribution is climbing, you are also finding fit. Inversely, if either of these metrics are stagnant or decreasing, there is still work to be done on your journey to PMF.
Wrapping it All Up
As much as we all wish, product market fit is not found by just rolling the dice and hoping our product is the one that is going to defy the odds. It takes methodical product management that wholeheartedly adopts this one core tenet to beat the house and find PMF faster.
By doing the research, understanding the market through metrics, and utilizing the right tools to collect all the data needed to measure progress, you're much better positioned to understand what the market really loves about your products, how they get value from it, and which incremental changes will open up tangential markets beyond initial PMF.
So, if you find yourself awake at 1:30am with a Manhattan in your hand pondering what to do next, consider engaging a growth coach that can help guide your team towards product-market fit faster.
