All early stage entrepreneurs get asked this question at some point in their venture: do you have product market fit? It’s a simple question that investors and advisors use to assess the risk in a business. But unfortunately, it’s also a question too many entrepreneurs feel the reflexive need to answer in the affirmative. Unfortunately the cost of doing this can be high for entrepreneurs, in both failed and struggling startups. So today I’d like to have a frank talk about product market fit: what it is, how you work toward it, and how you know when you have achieved it.
What Is Product Market Fit?
I define product market fit as follows:
The ability to repeatedly market, sell and deliver a value proposition into a target market with predictable success
To better understand, let’s decompose a few of the key phrases:
Market, Sell & Deliver
Many entrepreneurs focus on the word “product” in product market fit at the expense of all else. They believe that by adding additional features, they can achieve this milestone. Unfortunately product alone will never get you to product market fit. Instead, product market fit requires the validation of your entire business strategy - from your ability to drive leads, to your ability to close deals, to your ability to make and retain satisfied customers.
It’s rare for a product to breakthrough with a broad audience, so it’s crucial you carefully direct your efforts toward a specific market. When I started CloudHealth Technologies, my market was any company using the public cloud. But if I had tried to achieve product market fit with such a broad audience, I almost certainly would have run out of time and capital. Instead I learned through experimentation to focus on an initial early adopter market: mid-sized SaaS companies that were spending more than $25K per month on the public cloud. You can open up additional markets post-product market fit, but having a clear target will maximize your chance to achieve this milestone.
By predictability, I am specifically referring to business metrics. The specific metrics will vary based on the nature of your business, but it’s critical that you track and manage to a set of Key Performance Indicators (KPIs) that reflect the overall end-to-end health of your business. We will discuss this in more detail shortly.
So How Do You Drive to Product Market Fit?
There was a time not long ago when most startups were built using a classic waterfall model. The process worked like this: come up with an idea, develop the idea into a fully functioning product, test the product or service, and then launch it with an accompanying marketing blitz. When it worked, it worked well. Unfortunately, more often than not, it didn’t work.
It didn’t take long before thought leaders in entrepreneurship started questioning whether there might be a better way. Steven Blank’s The Four Steps to the Epiphany, first released almost two decades ago based on his Stanford class notes, introduced the concept of “customer development.” At the time, the idea that customer discovery and validation could be an iterative process was revolutionary. This type of thinking would go on to form a de facto scientific method for entrepreneurship: transforming it from an arcane art into something that approximates a repeatable / data-driven process.
One of the key advances in this early thinking was the introduction of the Build-Measure-Learn (BML) loop, which was popularized with Eric Ries’s The Lean Startup. The concept owes homage to an earlier framework developed in the US Air Force in the 1970s called OODA (Observe-Orient-Decide-Act): which postulated that by using a fast and iterative decision-making framework, one could get inside the decision cycle of their enemy and gain an unfair advantage.
Customer Discovery Experimentation
The customer discovery and validation process usually starts with a specific hypothesis around a business strategy. The entrepreneur then rapidly iterates through successive BML loops, running experiments that put different aspects of their strategy to the test. This may start with experiments such as customer interviews, concierge services, or ad campaigns - but over time will eventually result in an MVP. You can complement this approach with a Business Model Canvas, which ensures you are testing critical hypotheses across all facets of your business - not just product.
At the end of each loop through a Build-Measure-Learn process, an entrepreneur is faced with the question: to pivot or persevere. Pivots can involve minor or major changes to the business strategy - from changing the target market, to refocusing the value proposition to an adjacent problem. Hopefully few entrepreneurs are faced with a pivot on the scale of early Odeo: to change from being a podcasting platform to allowing users to share 140 character texts via SMS (a.k.a. Twitter).
A key concept of customer discovery / validation is that everything is tested directly with customers. You will often hear the phrase “get out of the building” from thought leaders & practitioners. The reality is: there is very little of importance you can learn about your business that does not come from direct engagement with customers / prospective customers. I liked to say at CloudHealth: we subsume all opinions at the altar of the customer - by which I meant that while we can all have competing opinions about what the right thing to do in the business, there is always one right answer: the one that advantages our customers the most.
The Minimum Viable Product
At some point along your journey, you will have sufficiently proven the critical assumptions of your product strategy and exhausted all pre-MVP experiments. At this point, it's time to build your first MVP. My first version of CloudHealth was a crude prototype that very much reflected the famous Reid Hoffman quote: "If you're not embarrassed by the first version of your product, you've launched too late."
It's important to think of your MVP as just a continuation of your iterative BML journey. Once you put your first MVP in the hands of customers, your BML loop will get incorporated into your Agile software development process, where you will use concepts such as A/B testing and Minimum Viable Feature (MVF) to continue to validate and refine your business strategy and value proposition.
So How Do You Know You Have Product Market Fit?
Product market fit occurs when your business can predictably execute within a target market - as proven through business metrics. Let me illustrate with a story:
About 15 months after raising a seed round at CloudHealth Technologies, we'd managed to build our product and acquire a handful of loyal paying customers. But we were also starting to run low on cash and realized our need for an A round was approaching faster than expected. In early VC talks, investors wanted to know if we had achieved product market fit. Like all entrepreneurs, I instinctively wanted to believe the answer was yes. But the more people we talked to - especially those looking closely at our business metrics - the more it seemed clear we were not quite there. After much deliberation we decided to pull back our fundraising efforts and continue operating our business for a few more months before going out for a raise. The result: when we did go to raise the next round, we had multiple competitive term sheets and our choice of investors.
So what was the difference? We originally treated product market fit as a qualitative question, as opposed to one that can be quantified with data. In our case, we had the data and it all told a positive story - but we needed a few more months operating the business to prove the trends.
Using Business Metrics To Quantify Product Market Fit
Product market fit occurs when the metrics you have chosen to reflect the end-to-end health of your business suddenly become predictable. These metrics should at a minimum cover these categories:
- Marketing - the ability to reach and engage a target audience in a sales process. E.g. lead-to-customer conversion rate, CPL, conversion rate, MQL to SQL.
- Sales - the ability to turn leads into qualified prospects, bring them through a predictable sales process with clear entrance / exit criteria, and close your fair share of these deals. E.g. conversion rate, win rate, average deal size, annual recurring revenue, monthly recurring revenue.
- Product / customer success - the ability to deliver a value proposition that customers care about and continue to engage with after initial sale. E.g. customer satisfaction, churn rate, gross/net retention, customer health, renewal rate.
- Business model - the ability to do all of the above with a cost model that shows a path to future profitability. E.g. # customers, ASP, CAC, retention.
Product market fit has been achieved when a business can demonstrate through KPIs over time - e.g. two or more quarters - that their business is predictable within their chosen target market.
I can still point to the exact month in CloudHealth history when we achieve product market fit: February 2014. Prior to this, we were working hard to refine every part of our business strategy. Every week we took another step forward in refining the business - e.g. figuring out how to identify customers in our target market, engaging them in a sales process, turning them into customers, and then making them happy / loyal customers. But after all that work, we were still seeing unpredictable results month over month. As it turned out, we were still missing one piece in the puzzle: a single feature in the product that drove home the core value proposition. Fortunately for us, one of our customer not only told us exactly what we were missing, but worked with us to develop and launch it. The result: the up and to the right MRR stair charts every venture investor seeks. That one feature - after months of hard validation work - would unleash a growth engine that would make us one of the fastest growing SaaS companies in Boston.
Admitting to being pre-product market fit should be a badge of honor among entrepreneurs. It is not a failure, but a statement of intent. It makes clear where you are in your venture, and what you need to do next. Only through continuous testing of your business strategy - iterating in the presence of customers - will you eventually break through.