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How to Identify and Find Product-Market Fit

MELINDA ELMBORG FEB 5, 2019

You have all heard of the mythical moment in a startup’s process, Product-Market Fit. Very few startups make it there and those who do can’t concretely explain how they got there. On top of this, experts have different definitions and claim that it is unique for every startup. One thing that we all agree on anyhow — is that if you reach it, you’ll magically know. So how the hell do you find something that you don’t know what it looks like and no one seems to be able to provide a map?

It is indeed very hard to go from idea to traction on the road to product-market fit, there tends to be a lot of detours and many never make it to their destination. Because of this, I wanted to enlighten the subject and make it a little easier for tech entrepreneurs struggling in this phase by defining what you’re looking for and the road to take to get there.

Definition

The concept of Product-Market Fit was first introduced by VC veteran Andy Rachleff. He defined it as when a startup with a certain technology manages to find the right market. When that happens, the product gets torn from the hands of the startup by desperate customers. But since this first definition, many wise people have added their opinions and interpretations.

Next in line was Marc Andeerssen to provide his view on the subject. He said in 2007 that Product-Market Fit is when “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” as he wrote in his famous article called “The Only Thing That Matters”.

In 2009, Sean Ellis, also known as the founder of Growth Hacking, wrote that he identify Product-Market fit with the help of a survey. He asks the users of a product however they would be disappointed if the product would no longer be available. If at least 40 % of users say they would be very disappointed, it probably means that you have Product-Market Fit. Further, he adds that “Admittedly this threshold is a bit arbitrary, but I defined it after comparing results across nearly 100 startups. Those that struggle for traction are always under 40%, while most that gain strong traction exceed 40%.”

A little more recent addition was made by Brian Balfour who is rather describing it in terms of engagement metrics. First, he says that when you have a retention curve that flattens out, rather than falling down to zero after a certain time, it probably means Product-Market Fit. Second, the metrics also need to prove that you have top-line growth for example in terms of revenue or the number of active users. Third, Brian Balfour looks for a metric that shows meaningful usage, as the users repeatedly perform the relevant task, for example, multiple times daily or monthly.

Measure

Well, thanks for the input you great experts, but how exactly should I know if I’ve made it or not? To make the concept of Product-Market Fit a reachable goal, I think you should measure a combination of 2–3 metrics to identify however you’ve reached it or to know exactly how far away you are. Precisely which ones to choose depends on your business and its model, but it should be in any of these three areas.

1. The first measure that is relevant for all startups is Sean Ellis’ survey. The exact question should be “How would you feel if you could no longer use this product?” With the alternatives being: Very disappointed, Somewhat disappointed, Not disappointed (it really isn’t that useful) and N/A I no longer use this product.

If you have a product where you expect users to be active at least twice in their first month, you should email users the day after they have used the product a second time. If you don’t expect that high frequency, reach out with this question after their first use. It is easy to start doing this as soon as you’ve launched your product. Certain CRMs can be connected through API or a code snippet so you can automate these emails, such as Zoho CRM, Hubspot, and Intercom.


Further down the road, you will be able to measure engagement metrics, which is an even better indication of Product-Market Fit since only users who truly love your product use it intensely. It is very unique to each startup what measuring engagement means. Try and think about how a perfect user should use the product and benchmark against that. For example: Should they log in once a week? How many of your proposed actions should they take per month? The most important metric here, however, is usually retention. You want to see that the users you add stay users for a considerable amount of time. Your retention curve should look like the green line in the picture, rather than the blue line.

3. If you offer a product that is not frequently used, such as travel services or maybe e-commerce, you should instead consider your LTV/CAC ratio. That ratio can also be used to further confirm your Product-Market Fit if you want to be absolutely sure. It is calculated by dividing the lifetime value of your users by the cost of acquiring them. There are different ways of calculating these two values but try to stick to the rule that:

LTV = expected lifetime (or if your product is bought rarely, use 1 here) in months x average revenue per user per month — direct costs

CAC = cost of ads and sales hours/number of new customers.

If you divide LTV/CAC you should reach at least 3 to prove a Product-Market Fit. If you reach that number, it means that there is apparently a need for your product since users come cheaper than what you earn on them. If you don’t spend anything on marketing or sales, or do it sporadically, you should not consider this metric as solid proof of Product-Market Fit.

As you can see, growth or new users are not included as metrics that prove Product-Market Fit. If you have lots of new users, it might only be a sign that there is a great need for your service, not that you satisfy it.

How to Reach Product-Market Fit

So, you’ve launched the first version of your product, maybe you call it alpha, beta or MVP (minimum viable product), but how do you take that product to reach the goals stated above? If you are struggling to find Product-Market Fit, here comes the step by step guide on how to reach it.

1. Start by double-checking that you correctly track which user is doing what. This can not be done with only Google Analytics since you cannot see who is doing what activities. You need to track your logged in users in your database, a product analytics tool such as Mixpanel or maybe a CRM connected to your product.

2. Begin with your very first users to start sending out the Sean Ellis’ survey. Preferably, do this automatically so you can be sure that it gets done.

3. When you’ve received a response from a user, no matter their answer, get in touch and ask if you could have a chat so you can learn how to better serve them. Ideally, you get in touch with 5 users who you can talk to for an hour each, either invite them for lunch or head over to their office. Otherwise, opt for 15 min calls as a bare minimum.

4. Based on the feedback you got from the 5 users, rebuild a new version of your product. Maybe you went after the wrong market or maybe you didn’t satisfy your chosen market. Just as your MVP, this should be a non-scalable prototype that is as quickly as possible to build together. The faster you get this version out — the faster you will be able to get new feedback from a new batch of users to build another even better version. Never enter the trap of thinking that “this is the one!” before validating it with real users, always expect that this another crappy version that will need to be improved.


5. When you think you’re ready to relaunch, do 3 UX-testing sessions. This doesn’t have to be done by real users, but rather people who have never seen your product before. While you observe, ask them to sign-up, place an order, or whatever other activity people do on your platform. Do not say a word and only observe (I know, this will be crazy frustrating, but it has to be).

6. Once you’ve fixed and checked that the UX is fine, release your update and measure your new cohort of users.

7. Analyze your data both in terms of the survey and activity on the platform. Would at least 40 % be very disappointed? Are your engagement metrics satisfying? If you achieved both of these milestones and/or the LTV/CAC is above 3 I congratulate you and recommend you head over to the next phase of your startup, Growth Hacking. If you did not reach Product-Market Fit in this iteration, there is really no need to panic, iterate again, and start over from step 3.


You will definitely iterate many more times than you think and redo this loop at least 10 times before you hit the jackpot. Therefore, I can’t encourage you enough to get through this loop as quickly as possible. Indeed, this should be a maximum 1-month loop, but preferably shorter if possible. It is only when you’ve validated your product features with your users that you can start building more robust versions of them that might take more time.

I congratulate all startups who find their Product-Market Fit, but you should know that your job is not done. Now, the next chapter of your startup’s life starts which means to jump on the accelerator and focus on growth!

👉 P.S. It doesn’t end here, for you to get started, I have created free templates and sheets that you can refer to for your startup to grow faster. Click on the link to access all the free resources. So don’t wait and grab these templates and sheets today!

References:

https://nextviewventures.com/blog/man-coined-product-market-fit-shares-mental-models-entrepreneurs-traction-47-andy-rachleff/

https://pmarchive.com/guide_to_startups_part4.html

https://brianbalfour.com/essays/product-market-fit

https://www.youtube.com/watch?v=0LNQxT9LvM0

https://a16z.com/2017/02/18/12-things-about-product-market-fit/

http://www.startup-marketing.com/the-startup-pyramid/

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About the Author: 

Melinda Elmborg was a Venture Capital Investor at the French VC firm Daphni. To help founders build, grow and raise capital to their startups, she switched careers to become a startup coach. In 2018, she started Startup Action. 

Based on her learnings, she has developed The Startup Action Framework that guides startups from launch to exponential growth.

So far, over 400 founders have already joined one of her workshops and thousands of founders have taken advantage of her templates and guides to succeed with their startup.

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