DI

Nailing Product-Market Fit: The Definitive Guide

What product-market fit is, why it matters, how to measure it, and 7 ways to get there.

Sean Johnson

Sean JohnsonPartner at DI and Founder Equity. Kellogg professor. Very pale.

"The only thing that matters is getting to product-market fit." -Marc Andreessen

People throw around the phrase product-market fit, often without really knowing what it is, what it feels like, how to test for it, and how to know when you’ve achieved it.

Some people believe the answer is “when you can sustainably acquire customers for less than the value you extract from them.” 

In SaaS, for instance, they commonly talk about the ratio between acquisition cost (CAC) and lifetime value (LTV), suggesting that benchmarks like 4:1 LTV:CAC are indicative. 

The problem with a definition like this is that, especially in the beginning, you don’t know what your LTV will be, and you don’t really know what CAC is either. 

True, you might have directional data on both. But really calculating LTV takes time, and CAC at your eventual scale will be difficult to estimate.

According to this definition, there are companies have have gone public that don’t technically have product-market fit. Uber and Blue Apron, etc. would be  fantastic examples.

Really any company that has decided to “blitzscale” will probably not fit this definition. In markets that are considered winner take all, the organization will plow tons of money into acquisition to drive market share, and worry about profitability later. (Although, it should be noted, that most proponents of this approach to rapid expansion will strongly argue that you should achieve product-market fit before engaging in such activity.)

While not specific, this is perhaps our favorite description:

“You can always feel product-market fit when it’s 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. You could eat free for a year at Buck’s.”

Tren Griffin

While this doesn’t exactly define it, it does provide a fantastic litmus test. 

Can you honestly say the above about the thing you’re working on? Most people who think they have product-market fit probably can’t say this.

Why does product-market fit matter?

You might be thinking:

“So what? I use products all the time that don’t fit that definition.” 

That’s probably true. There are many good businesses making good products people use that don’t look like that.

It’s helpful to understand that product-market fit is primarily a construct used by the world of venture capital. They want companies to achieve product-market fit because they aren’t looking for “good businesses”.

They are looking for companies that have the potential for explosive, exponential growth. The kind of growth that disrupts huge incumbents, changes markets, and drives meaningful returns for their LPs.

“If you screw almost everything else up, you still can succeed. How else would you explain the success of a 25 year old running a billion dollar company. If the market demands your product and pulls it out of your hand.” - Andy Rachleff

We would argue innovation teams should have the same goals, at least with part of their broader innovation portfolio

Assuming you believe that your industry or organization has the potential to be disrupted, and assuming you agree that disruption often looks like a hyper-growth startup eating your lunch, it makes sense to be measuring your initiatives similar to how their investors would. 

Because after all, you’re effectively the VC of your innovation group.

What is a market?

In order to adequately define product-market fit, you first need to be clear on what you mean by a market.

We like the definition from Bill Aulet. You know you have a market when:

  • The customers within the market all buy similar products.
  • The customers have a similar buying process.
  • The customers expect products to provide value in similar ways. 
  • The customers talk to each other, such that a product meeting their needs can have organic word of mouth.

Market is incredibly important. It’s one of the most critical elements a savvy VC will consider when evaluating a potential opportunity. And for good reason. A big market simply makes everything else you do easier. Again, in the words of Andreessen:

“The #1 company-killer is lack of market. When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.”

Marc Andreessen

So what is product-market fit?

“Product-market fit means being in a good market with a product that can satisfy that market.”

Marc Andreesen

In other words, you’ve answered the questions who, what, and how:

  • Who is your customer and what is their problem
  • What is your solution to their problem
  • How do you solve that problem in a way that creates proven value for you and the customer.

When you can satisfactorily answer those questions, you have product-market fit.

What product-market fit is not

If you haven’t launched yet, you don’t have product-market fit.

Many people think they’ve achieved product-market fit by answering the who and what questions.

They’ve done the work of going outside the building and talking to customers to validate that customers have the problem. 

Maybe they make a “smoke test”, putting up a landing page and testing acquisition channels to validate demand and (obliquely) willingness to pay.

Maybe they’ve gone out and secured letters of intent or made some sales on the basis of a deck and a clickable prototype.

Those are all extremely valuable activities. And they directionally point to the potential of achieving product-market fit. We use these strategies ourselves on a regular basis to validate concepts and hone in on our MVP.

But don’t confuse them for the real thing. 

You haven’t validated the how yet. The how requires that your product is live. It requires demonstrating you can acquire customers, adequately solve their problem, and do so in a way they are willing to part with their money on an ongoing basis (and ideally tell their friends).

If you can’t say that, you aren’t there yet.

Raising money doesn’t necessarily mean you have product-market fit

Sometimes people make the mistake of confusing successful fundraising with achieving product-market fit.

You might have product-investor fit (meaning investors buy into your vision sufficient to write you the check). But investors vary in their level of sophistication in all sorts of ways. Some don’t have good frameworks for assessing product-market fit themselves. Others, in spite of their best efforts, will let internal biases color their perspective and chase deals they otherwise shouldn’t.

Raising money is useful – as long as you have cash in hand you have a fighting chance of getting to product-market fit. But don’t assume that they are equivalent.

Qualitative measurements of product-market fit

There have been many ways over the years people have attempted to measure product-market fit.

For a long time, these were largely subjective measurements. Because of the lack of clarity on what constitutes product-market fit, people used qualitative proxies.

Sean Ellis was one of the first to attempt it. He used a single question:

“How would you feel if you could no longer use this product?” 

The potential answers were: 

  • Very disappointed
  • Somewhat disappointed
  • Not disappointed. 

Ellis argued that when you achieved 40% of respondents saying very disappointed, you probably have product-market fit.

This qualitative approach continues to this day. Superhuman uses a four question survey, starting with Ellis’ question and augmenting it with additional details to help them clarify positioning:

  • How would you feel if you could no longer use product?
  • What type of people do you think would most benefit from product?
  • What is the main benefit you receive from product?
  • How can we improve product for you?

Quantitative measures of product-market fit – the importance of retention

In the last few years, especially amongst VCs, there has been a push to quantify product-market fit.

For a while now, VCs have recognized that the most important metric worth measuring for most products is one related to engagement or retention. 

“Every improvement that you make to retention also improves all of these other things — virality, LTV, payback period. It is literally the foundation to all of growth, and that’s really why retention is the king." - Brian Balfour

They rightly understood that things like total users, total revenue, etc. are meaningless numbers easily manipulated.

Many have expressed engagement and retention using some measurement of active users – monthly active users, monthly recurring revenue, or something similar. 

There have been a variety of benchmarks folks have used to assess whether these numbers are good or not. 

Andrew Chen, for example, has suggested measuring Daily Active Users over Monthly Active Users (or DAU/MAU), and suggests that >25% is a solid place to be. 

Chen has also suggested Day 1 retention rates above 30%, as Day 1 retention rates can be predictive of long term retention. 

There are several mechanism folks use for visualizing retention. Triangle charts are perhaps the most common, as they are baked into most event-based analytics platforms like Mixpanel:

Another way of visualizing retention has been through the use of retention curves. Brian Balfour in particular popularized their use. 

A retention curve charts what a single cohort of users do over time. It can be used to measure specific features, or simply broad usage in a product. 

It always goes down and to the right – some percentage of your users end up not using the product over time. But as long as some of those users keep coming back, your curve eventually flattens out. If that happens, then you’ve at least achieved product-market fit for some subset of users.

A final way of thinking about engagement is with Smile Charts, so named because they tend to form a “smile” if they’re good:

These plot the number of days in a month that your users are engaging in the product. While you will almost certainly have plenty of users on the left who’ve used it once or twice, in a healthy product you also have a reasonable % of users on the far right, who use the product every day. 

(note: you can adapt this chart to visualize by the week or month, depending on the metric that most reasonably reflects natural user behavior in your product). 

There is additional nuance here, specifically the idea of  “meaningful use”. 

There have been products that were “viral” in the past that defined engagement as a user going to the site and doing anything. But in many cases the “anything” was simply accepting invites from other users, etc. 

This was an issue, because these users weren’t actually engaging in the core experience of the product. Balfour rightly suggests that such products have a great referral loop, but not necessarily product-market fit.

Advanced methods for calculating product-market fit

A company with aggressive acquisition targets and the budgets to match can mask retention problems for a while. 

If they do have a retention problem eventually they always tip over, when they can no longer spend the increasing amounts of money they need to on acquisition to hit their growth targets. 

But by then you might be the unlikely VC who invested on the basis of that growth.

Studying your retention curves can help. If the curve tapers, there’s something there. But where it tapers matters as well. And specifically it matters in relationship to growth.

VCs have started working on understanding the relationship between growth and churn. Social Capital developed what they call growth accounting. The idea in a nutshell is to break monthly actives into several buckets:

  • New revenue
  • Retained revenue
  • Expansion revenue
  • Contraction revenue
  • Resurrected revenue
  • Churned revenue

They then developed what they call a “quick ratio,” which effectively measures the sum of those gains in revenue (or users) over the losses. If you have a quick ratio over 1, you’re growing. If it’s less than one, you have a problem.

Other firms have taken this approach and added to it. Tribe Capital uses these metrics and in addition to quick ratio will look at gross retention (retained revenue over total revenue from the previous period).

7 strategies for increasing the likelihood of achieving product-market fit

One of the things you’ll find when you start measuring product-market fit this way – it’s actually really hard. Many companies never make it.

What can you do to increase the odds of success?

Start with a BIG, established market.

A large, existing market that is underserved by competitors is a fantastic place to achieve product-market fit. In most cases, the customer already knows they need what you have to offer. They know how to evaluate you relative to the competition. They are used to talking about products like yours. And as long as you have a clear differentiated value proposition you can be successful.

One of the misconceptions about “disruptive” businesses is they are pursuing green field. But think about the word “disruptive” – it implies the existence of a status quo. 

Disruptive doesn’t mean there is no competition – it means that you attack the competition, usually in ways that are un-economic for for the incumbent to compete.

Many people are terrified of competition. They assume that because someone is actively operating in a market they’re necessarily doomed.

VCs will routinely pass on deals that look like good businesses but operate in markets that are too small. The larger the market, the bigger the impact “success” will represent for you.

But focus on a segment of that market.

This might sound counter-intuitive. Having a large market is ultimately going to be super important. But that doesn’t mean you attempt to talk to all of them at once.

Many startups get their initial toehold by focusing relentlessly on the needs of a small subset of a larger market. Doing so makes everything you do easier. Your value prop is laser focused on their needs. Your marketing channels and creative are designed specifically for them. Your roadmap maps closely to their needs.

This works because usually the features that REALLY matter to these folks will also matter to the larger market. 

A good market segment is typically one full of folks who tend to be open to new things, have a willingness to pay, and like to talk to each other. They also tend to be aspirational to the larger market, making the move from early evangelists to the larger market easier to pull off.

There’s often an advantage to further segmenting your market by constraining to a specific geography. This is the idea of “network compression”. Targeting first time moms is good. Targeting first time moms in Seattle is arguably better, because you increase the likelihood of them talking and spreading the word with each other.

A big pitfall at this stage is failing to keep your eye on the segment long enough. You will see the larger market out of the corner of your eye. You’ll have customer development conversations where they talk about how they’d love to use your product if it just did X. 

Make a note of it. But then ignore them. At least for now.

Truly get in front of your customers.

How do you figure out what they want? You ask them.

Any customer feedback is better than none. But some are better than others.

Strategies like surveys can certainly be helpful. But there is often nuance missing, and requires you crafting the survey really well to maximize the effectiveness of the feedback.

We leverage customer interviews on a regular basis because they’re cheap and you get to ask follow up questions and study body language. It turns out there’s a huge difference between “Sure, I’d use that” and “SURE, I’D USE THAT.” Surveys don’t capture this nuance particularly well.

An even more robust, albeit more time and cost intensive, approach is to shadow your customers. You will ALWAYS get more helpful insights than you can by simply talking to people about what they think.

We’ve shadowed patients and families inside of hospital facilities and learned about limitations of products. 

We’ve discovered things like high contrast screens matter a ton for people doing mechanical integrity rounds at manufacturing facilities, because they have to stand on roofs in the bright sun. 

It’s extremely unlikely people will surface these kinds of insights in an interview alone. And these tiny details are often the difference between a good idea and a product that people actually adopt.

There are many areas where there are diminishing returns. Talking to your customers isn’t one of them, at least not for a long time.

See how hard it is to generate demand.

One of the more overlooked aspects of a good market is the ease with which you can reach them.

I’ve made this mistake personally. We invested in a company at one point that was solving a meaningful problem for a demographically expanding segment of the population.

The problem was there was no easy way to find these people. They couldn’t be targeted demographically or psychographically.

The most cost effective channel ended up being through partnerships with non-profit associations, which was hit or miss depending on the organizations’ sophistication and level of commitment.

In the end, their acquisition cost was too high relative to the average useful life of a customer.

Some markets are simply hard to reach easily. Achieving product-market fit is hard enough as it is – don’t make it harder on yourself.

You can de-risk this somewhat easily by creating a growth model. We’ve talked before about the myriad benefits of modeling growth. One that isn’t immediately obvious is the sense it gives you on the relative difficulty of reaching your market.

Creating the model properly involves doing keyword research to assess the level of potential inbound organic traffic available, as well as the cost of showing up in those searches via paid search. It involves doing research on paid acquisition platforms to assess the size (and cost!) available audience you can effectively target. It involves assessing the potential reach of some of the publications you might want to target to estimate the potential lift from earned media.

And while all of these are estimates and surely will be wrong, they give you sense of where you’re headed. And sometimes you stare at that model and think to yourself, “This is going to be a lot harder than I thought.”

Better to know now.

Ship. Quickly.

While customer development, smoke tests and other strategies can be helpful intermediate steps, it’s not uncommon to still miss the mark when it comes to implementation.

This is okay. What isn’t okay is failing to commit to a cadence of rapid shipping in response to qualitative and quantitative feedback.

You have a limited amount of runway to figure things out. The longer you take to incorporate feedback and iterate on your solution, the less likely you are to achieve product-market fit before running out of money.

This speed of iteration is much more common with startups, partially because for them it’s life and death. In most internal innovation organizations or enterprise environments, speed isn’t as prized. 

It should be.

Make your product a closed beta.

This is a counter-intuitive one.

Many people think closed betas are little more than ways to manufacture scarcity and drum up interest in the product. I want to get behind the velvet rope because it makes me feel cooler. And there are plenty of startups who take this approach.

But a much less discussed but more important reason for doing it is you get to shape your audience. 

One reason why things like NPS and Sean Ellis’ question can backfire is your audience has commingled data. You have some % of people who reflect your ideal customer. But you have a bunch of other folks who are simply kicking the tires, or are competitors, or don’t have budget, or aren’t in the ideal job. 

The product isn’t designed specifically for them, so their feedback isn’t nearly as valuable. But it can be difficult to tease that out.

Enter the closed beta.

Gating your product, followed by some sort of survey or other instrument to qualify your customers, allows you to filter out the noise and maximize the feedback you get from your audience.

Some folks object that doing so artificially constrains growth. But growth in top line users who aren’t in your ideal customer profile and who churn doesn’t really do you any favors.

You can always open it up later.

Concierge your onboarding process.

One of the trickiest things in product design is architecting a good first time user experience. If you have a product that solves my problem, but it’s cumbersome or confusing to get to that point, I’m never going to get to the point where the light bulb goes on for me. 

One of the things that impressed people the most about Superhuman was their extremely hands-on approach to onboarding users. Critics argued that it doesn’t scale well.

But when you’re searching for product-market fit, scaling doesn’t matter. What matters is seeing your product in the hands of customers.

Walking them through it gives you a chance to see how easy or difficult it is to get started. It gives you a chance to find places that are confusing, to surface product improvement opportunities and identify ways to make your eventual first time UX better.

At the same time, you ensure customers get through that first time experience and experience the core of the product, maximizing the chances the light bulb goes on for them.

Concierge MVPs help you figure out whether the product itself sucks, or if it’s just the onboarding experience that needs work.

Product-market fit is hard to achieve. But it’s possible.

Make no mistake – legitimate product-market fit is elusive. But it is possible. By focusing on speed of iteration and staying very close to customers, you can increase your odds of success.

Whatever you do, avoid the temptation to prematurely scale. You will likely get pressure from your investors, or your CEO, or your growth board to scale whether you’re making legitimate progress or not. But it’s a trap, and typically ends poorly.

Stay disciplined. Move quickly. And when you’ve truly achieved product-market fit, you’ll know it.

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