Product-market fit is a well-known concept in the startup community. While it is commonly used in discussions about new high-growth companies, it does not appear to have caught on in the rest of the business world. It deserves to be better understood because it is a useful Mental Model for the interaction of a company, its products, and its customers. Understanding product-market fit will help you see the world in a new light and inspire new ways to provide value to your customers while growing your business.
What is Product-Market Fit?
Understanding product-market fit refers to a situation in which a company's target customers buy, use, and tell others about the company's product in sufficient numbers to sustain the product's growth and profitability. According to entrepreneur and investor Marc Andreesen, who is widely credited with developing the concept, product-market fit means finding a good market with a product capable of satisfying that market. Product market fit occurs when your value proposition is true, your product addresses and solves the needs of your target market. You've shared it through the appropriate channels to sustain your business and bring you the success you seek.
How to Find Product-Market Fit?
When evaluating and improving your product, you must consider three factors: conducting research, understanding the market through metrics, and utilizing tools to measure Net Promoter Score and Product-market Fit.
Do your research before delving into the metrics that determine your product's success. It is critical to clearly understand what your target customers want by observing how they react to competing market solutions. Articles, user behavior studies, industry groups, and social media are excellent places to learn about the market and what customers want. Alternatively, try searching for hashtags on Twitter to narrow down the topics that your target customers are most interested in. The market data you discover may reveal gaps between your product-market fit pyramid layers. Perhaps you've found that your target customer doesn't actually have the needs that your product is designed to address, and your messaging could benefit from some tweaking as a result. This research will quickly reveal where changes in your pyramid are required.
Next, think about talking to customers who use your product or the target customer for the product you want to develop. It might be a good idea to include super-users – those who can't live without your product – in the conversation.
Here are some topics to think about for the discussion:
Guide the discussion in such a way that any misalignment in your pyramid's layers is exposed
Check with your clients to see if they understand your value proposition (of course make sure that it is clearly defined)
Ask them if they believe the product lives up to the value proposition and, if not, what changes they would make to make it so
Inquire about how simple it is to use the product
Finally, compile feedback from a large number of conversations to influence future product roadmaps or help develop a new product.
2. Determine the Size of the Market
To measure product-market fit, you must first understand the market you are addressing through actual metrics tied to revenue potential. Even if your product has a market, you must demonstrate that the market demand is strong enough to justify investment:
The first step is to determine your Total Addressable Market (TAM) and the size of the market that you can actually reach. Your TAM should be the users with the underserved needs you want to address. However, your ability to reach those users is influenced by the geography you serve, which is referred to as your Service Addressable Market (SAM).
Your Service Obtainable Market (SOM) – the number of users you can realistically acquire – is contained within your SAM. There is no one way to get this number other than your own guesses and research, so consider it back-of-the-napkin product math.
Next, multiply your SOM by your Average Revenue per User (ARPU), which will give you the total potential revenue for your business. Calculate your potential profit after deducting costs, and use this figure as your compass.
Now that you have your potential revenue number, you must assess how well you are meeting it and track this over time using the SaaS rule of 40. The SaaS rule of 40 is a general principle stating that your growth rate and profit are inversely related and usually total 40. For example, if your year-over-year or month-over-month growth rate is 35%, your profit could be 5%.
Doesn't that make sense? Increase the cost to the consumer, and your profit rises while your growth rate falls as prospects are put off by the price. But what if your combined growth rate and profit are less than 40%? It may be time to rethink your messaging or whether your target customer or their unmet needs are as prevalent as you thought. If you are exceeding a percentage of 40%, congratulate yourself: your product is profitable while continuing to grow. Of course, 40 isn't the only number to consider, and it will depend on your product and the market it serves.
If your combined growth and profit are less than 40%, it's likely that your product hasn't found the right fit. In this case, the Net Promoter Score (NPS) can assist in confirming. Net Promoter Score can be calculated by asking your customers in a survey, "How likely are you to recommend our product to a friend or colleague?" Users can choose a number between 0 and 10, with 0 representing "not at all likely" and 10 representing "highly likely."
Promoters are the most likely users to recommend (9-10). Passives are uninterested users in your product and are vulnerable to competing products (7-8). Those dissatisfied with their lives are classified as Detractors (0-6). The larger your sample size, the more confident you can bet that the percentage of each group represents your SAM. Subtract your Detractors' percentage from your Promoters' percentage. Your NPS is the end result. Because your NPS can range from -100 to 100, you should aim for a positive NPS to demonstrate that you have more Promoters than Detractors. If you are not in the positives, your product requires improvement. If your product has a score between 0 and 50, there may be a few things you can change to increase your NPS by a few points.
Product-market fit (PMF) surveys can also help you determine product-market fit. PMF surveys, also known as the "Sean Ellis test," ask users a simple question: "How would you feel if you couldn't use the product?"Unlike the numbered scale used in the NPS survey, the first PMF research questionnaire employs a 3-point negative scale (Not disappointed, Slightly disappointed, and Highly disappointed). If 40% of users say they are "highly disappointed," you have achieved product-market fit. And the more people who say "highly disappointed," the more appealing your product is, and the closer you are to meeting market demands.
Like all aspects of product development, measuring product-market fit is an iterative process. Conduct your research, develop your hypotheses, construct them, test it, and feed your findings back into the process. No company achieves product-market fit immediately, but with proper planning and intentional research, you can get pretty close and see the success that exceeds the SaaS 40 percent rule and achieves a stellar NPS and PMF.
Why is it Significant?
According to Alex Schultz, Facebook's VP of Growth, the biggest issue he sees with the companies he advises is that they don't have product-market fit even though they believe they do. So, why is achieving it so critical? Why do so many venture capitalists insist on measuring product-market fit before investing in a company? Why does Andreesen believe every startup's life should be divided into two stages: before measuring product-market fit (BPMF) and after product-market fit (APMF)?
The answer is simple: Before you develop a product for which you have confirmed a sufficient number of people are willing to pay, your team cannot afford to focus on other critical strategic objectives such as growth or upselling existing users. In fact, those initiatives may be counterproductive if you haven't first determined that your product has a large enough market to sustain itself and generate a profit.
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Product-market fit is rarely achieved holistically or by chance. Companies are constantly fine-tuning their products, target markets, sales, and marketing strategies to find the optimal combination of needs, demands, and how to satisfy them. Knowledge, research, and efforts ultimately inform, if not drive, product management. Like most things, discovering new demands, changing the market you're targeting, identifying patterns of pain, and adjusting the messaging and communication tactics your company employs to reach new buyers is an ever-evolving journey. Reassessing your product-market fit and relying on benchmarks such as the Rule of 40 ensures that your company does not become complacent and constantly adapt to meet growth targets and defend its position from competitors.