There is little else that matters to a start-up than product market fit.
Actually… If you are a seed stage company, nothing else matters.
It is so important, that I want to write a blog post dedicated entirely to Product Market Fit.
For those who have never heard of this term, it refers to determining whether there is actually a market for whatever it is a start-up is building — i.e. Is there a market for your product?
I have made the mistake before of building a product with little product market fit (ShopReply). I have also built a start-up that had instant product market fit (Lind Golf). I have also pivoted from a start-up without much product market fit, to a concept that has a lot more* product market fit (CalReply).
Notice I said “a lot more”. I did not imply that CalReply has product market fit. That is because I don’t believe product market fit is not something you either have, or you don’t have. Product market fit is a relative and elastic concept since the extent to which you might have product market fit will vary in accordance to the size of the market you are addressing, and the pain factor of the solution you are solving.
My “back of the napkin” definition of product market fit is:
A product with 10 or more non-related customers that generates $1.5m in annual recurring revenue with 10% annual churn or less, where there is a foreseeable path to $10m in revenue in the next 24 months by scaling andrepeating what got to you to the first $1.5m in revenue.
This will vary depending on your business model, but I’m talking about a B2B SaaS product here. Having a great product and lots of users is not enough. Revenue, or a clear path to revenue is what matters.
Another important factor of product market fit comes down to your expectations as a founder, the expectations of your investors and the type of company you want to build.
You might create a product that solves a problem for a relative niche, however investors are not interested in niches. They want $100m plus valuations post Series A, and the potential for $1bn valuations later.
That said you, as a founder, might be happy serving this niche and building a lifestyle business that generates $1–2m a year in ARR. So in your mind you might have product market fit. If you ask for investment with this mindset, investors will push you to think bigger… 50 x bigger.
So while you might think you have product market fit, investors look at companies like Airbnb, Uber, Google, Amazon and benchmark product market fit based on their products, and the size of the market that these companies address. They want to invest in the next unicorn.
Lets take Twitter as an example. If you started Twitter you’d be pretty sure you had product market fit after the first few million users started using the service on a monthly basis. That is a great achievement… A few million monthly active users. A fraction of start-ups ever achieve this level of traction. Twitter definitely had product market fit at this stage. Fast forward 6 or 7 years, and Twitter is a publicly listed company being compared to Facebook. They have ~300 million active users, however they also have 800 million inactive users. These are people who signed up to Twitter, tried the service, never to return. Twitter is also a public company under a lot of scrutiny
So, does Twitter have product market fit? Of course they do, however what I’m trying to demonstrate here is that product market fit is in the eye of the beholder. The average person doesn’t identify with Twitter like they do with Facebook. Furthermore, Wall St expects the company to live up to its valuation so in Wall St’s mind, perhaps the product is broken if they are meant to be a mass market consumer social network, but there are so many inactive users. This is why I believe there is no “one size fits all” for product market fit.
The more cash you raise, the higher your valuation, the more will be expected of you to deliver deeper, wider and more sustainable levels of product market fit, and ultimately revenue growth.
How do you know if you have product market fit?
The thing with product market fit, is that it can be elusive. You might think you have product market fit but you might be solving a really painful problem in a market that is not sufficiently large enough to ever become huge. This is the elusive part… As a start-up you think you are doing great when you hit $1m in year one, however you now need to get to $10m in the next 24–36 months. There need to be a lot more customers left in the market that got you to the first $1m in ARR. Then you need to get to $20m, $50m etc.
How to get to product market fit
Here are four rules you can follow to help get to product market fit:
1. Money cannot not buy product market fit
One of the biggest misconceptions of start-ups, is the correlation between money raised and future success. Raising a lot of money very early on has almost no correlation to future success. At the seed stage it simply means you are a good sales person, have convinced investors to write a cheque, and have something sufficiently interesting. It does not mean that anyone in the big wide world actually cares about what it is you intend to bring to market.
Many companies have failed raising too much, too soon. Two examples that come to mind are Color and Clinkle. Jet.com seems like they could be on a similar path, however I don’t know any details and am just speculating since they have raised A LOT of money, are far from lean.
I would argue that companies who raise smaller amounts of seed capital actually have a better chance of success because it forces discipline. If forces you to build essential features, get out of the office and make your time count. You don’t have time to get comfortable. You need to figure out if your hypothesis is right and start bringing dollars in. An endless cheque book will only prolong the inevitable if you are on the wrong track.
Remember, Google was profitable on $8m in funding.
What will get you to product market fit is having a visionary open-mindedness around your offering, as well as a product that can be tweaked slightly to open itself up to new markets and verticals if your original ideas don’t stick.
So what does money do for seed stage companies?
Money buys time. In addition to a visionary open-mindedness, time is what you need to get to product market fit. You need time to meet with potential customers and validate your idea. You need time to iterate and change your product and business model based on feedback from customers.
When we raised our $1m seed round for ShopReply we had a couple of customers who used our product but it become obvious very quickly that generating revenue would depend on the platform processing very large amounts of gross merchandise volume. At the time it was tough to admit, however I was realistic with myself and knew that this would be incredibly difficult given the transaction volumes we were seeing from early customers. At that point in time we were still very lean with only three people. To cut a long story short (I’ll save it for another post) we decided to pivot to CalReply.
Because we ran lean, we had sufficient funding left over to have a real crack at an entirely new product. Where we were fortunate, is that it only took three weeks to add support for calendars to our platform so we did not have to start from zero on the product side. We did have to start from zero on the customer/sales side. I decided to go all-in on CalReply and within a few months got very lucky (I’ll leave that story for another post).
The lesson here, is that you need to be very conservative during your seed round because it takes time to prove product market fit. Chances are it will take a lot longer than you think so if you don’t listen carefully to market feedback and iterate on your product quickly (or pivot entirely), you will run out of money and die in the trough of sorrow.
In addition to all of this, you need an insanely committed team, a visionary founder, excellent engineers, a heap of luck and excellent timing. So there are about 5 or 6 key variables that are working against you at all times when you are at the seed stage. It’s not easy. Most start-ups fail.
2. Stay Lean
The most important thing you can do in the search for product market fit, is stay lean. When you raise $1m or $2m in your seed round, it is too easy to think you need to create a culture defined by ping pong tables, nice offices, stand-up desks and a large team.
The truth is that you need to keep the team tight, save every penny and be as scrappy as hell.
Here is why…
Lets say you raise $1m in seed funding and you have a team of 4 people (1 founder, 3 product/engineering people) on average salaries of $120k each, fully loaded at $150k each. You will be burning around $650k/yr when you add a few travel expenses, hosting and other costs to the mix. With this money, you need to build the first version of the product, find product market fit AND get to initial traction.
Lets say it takes 9 months to get version 1 out the door (9 months is relatively quick by the way — only a team that has experience in start-ups, is sufficiently product minded, and has strong engineers and designers can do it this quickly). This means you get to the starting line after about 9 months. Once you are at the starting line, your product is ready for paying customers. Over the next 3 months you might be lucky if you meet with 10 customers where your business has a high probability of product market fit. By now it is a year in and you’ve spent $650k. You now have $350k left in the bank.
With the remaining $350k you need to:
- Continue to improve your product
- Get initial traction so you can raise more money!
Now lets assume 3 of the 10 customers love your product, and want to buy it. They ask for pricing and an insertion order. By the time these customers sign off on the terms, you’re probably looking at another 2 months of money burnt. You now have $120k left in the bank. Now lets assume each deal is worth $25k/year and you sign three of these, you’re back to $195k.
You now have three customers who you have convinced to give you some money, however you are still far from initial traction which is around $1.5m ARR run-rate.
The lesson here is that even with a sizeable seed round, start-up economics are stacked against you. You need to be lean, while ensuring you have enough money to find product market fit, and get to initial traction.
3. Don’t get emotionally attached to your product or offering
If your customers are not emotionally attached to your product, you should not be either.
Think long and hard about what you are trying to achieve:
- Do you want the freedom of running your own company?
- Do you enjoy the creative process of going from Zero to One?
- Do you love hustling or coding or selling?
- Do you want to make a lot of money?
- Do you want to build a great culture and team?
All of these desires can be fulfilled with any product even if its totally different to your original vision. If you start selling eCommerce software but end up building a SaaS calendar platform, so be it. What is important is that you end up with something people want and are willing to pay for, while having fun and enjoying the journey.
Not being emotionally attached can be tough. You need to dig deep and be very real with yourself if its not working out.
4. Keep your product simple
I am extremely proud of the ShopReply product, and while nobody uses it today for commerce, it is an insanely awesome platform that became the foundation of CalReply. We built a ton of great features that we thoughtwould get us customers. In hindsight we made it too complex and spent a lot of time on features that were never used. Luckily there were only two salaries being funded at that stage, which goes back to being lean.
The reality is that many of the best platforms such as YouTube, Soundcloud, Airbnb, Instagram, and Twitter are fundamentally simple products. Complexity does not make your product better. It probably makes it worse. So figure out what your core value proposition is and deliver a great experience around that but don’t try and be all things to all people. You shouldn’t have to. Your core offering should offer enough functionality to provide significant value.
How do you know if you have product market fit?
Here are some signs that you might have product market fit:
- You can explain what you do in 30 seconds and pitch your entire product from 1 slide. I can pitch CalReply to any customer from a single slide if I have to (I don’t do this, but I could). It’s a simple product that solves a real problem that is easy to understand.
- Customers that you are pitching for the first time tend to ask for pricing on the first meeting or call. This is a great sign.
- You have 10 or more unrelated customers buy your product for meaningful sums of money — e.g. $15k/yr+
- You’ve closed 10 or more sales where all customers are using the exact same feature set and you did not have to add new features or customize the platform for each new customer
- You can pitch your product via a web-ex demo and sign up a customer who can start using your product almost instantly (I plan to talk about the importance of “instant utility” in a future post)
- You know who your ideal buyer is, whether it’s the CMO, CEO, CFO, social media lead etc
- You confidently believe there are thousands of other companies or customers that would also pay similar amounts of money to use your product
- Customers are responsive to your follow-up emails and don’t disappear after the first meeting
This blog was cross posted to lindventures.com/blog