What is Product Market Fit?
According to research done by CB Insights, 42% of startups fail because their product doesn’t address a market’s need. This means that in order to thrive in competitive markets, startups and early-stage companies have to gauge how much a product or service resonates with consumer demand. Investing time and research in finding a Product Market fit yields long term benefits for both start-ups and investors by creating a stable market presence and consistent
Product Market fit measures how well a product is received by its market and also reveals the potential for a product’s success in the future. Product Market fit is researched by product managers who evaluate company metrics such as acquisition costs and retention rates. Based on these numbers, product managers create a model to ensure a product is successfully tapping into the market demand. According to research from a global educational institution, Department of Product LTD, Product Market fit can be achieved within 2-3 years of a company’s operation. This time period is long enough for a company to research their product’s market and customer needs. If companies cannot find a fit by this time, they are generally forced to make drastic changes to their product or shut down.
Growing companies like Slack, Dropbox, and Spotify all had to identify and adapt to what makes their product appeal to consumers. This allowed them to achieve Product Market fit within a quick and efficient time frame.
Slack is a business communication platform that offers chat rooms and calling features for corporate use. Slack’s value proposition was centered around the idea that every user counts. The company had a great feedback system, drawing customers to their product over time. By using high responsiveness to focus on product issues, Slack was able to differentiate themselves and develop a competitive edge. With user satisfaction and product adaptation, Slack has achieved Product Market fit to become one of the leading business communication services.
Dropbox offers customers a cloud storage solution, allowing them to access files from remote locations with ease. Dropbox initially couldn’t find a sustainable customer base in the locations they looked at. Instead, they moved product advertising onto Digg, an online newsletter with a young and tech-savvy audience that understood file synchronization. The result was a community of consumers who embraced Dropbox’s capabilities and spread their product’s popularity. Dropbox’s digital communication allowed them to collect important metrics/data to assess their Product Market fit.
Spotify was focused on accessing a gray area of customers who were willing to pay small fees to legally listen to music. Spotify had many factors leading to their Product Market fit coming into place. Music content was thriving, mobile devices became the cost-effective distribution channels, and there was a market of music pirates looking to become legal streamers. Spotify adapted to the problem of illegal streaming and provided a safe way for consumers to listen to their favorite music, which created sustainable, long-term demand.
Questions To See if You Have Product Market Fit
Qualitatively, Product Market fit can be achieved by asking questions about a product’s target market:
Do your customers recommend your product to friends and family?
- If customers are willing to communicate interest in your product via word of mouth, you can capitalize on that opportunity to satisfy more demand in the market. Startups typically measure the spread of their product’s interest with Net Promoter Score (NPS), a simple survey asking customers to rate questions from 1 to 10 (e.g. “How likely are you to recommend ___ to a friend or colleague?”). Usually NPS surveys are sent in emails or receipts. NPS surveys are most effective when the customer has fully experienced a product or service.
Will customers care if you shut down tomorrow?
- Once customers rely on your product on a consistent basis, you’ve achieved Product Market fit and found a market with a sustainable demand.
- A great way to gauge how important your product is to customers is through feedback. If customers are looking for improvements to the product, they are investing in a product’s future. If they receive the improvements they were looking for, they won’t want a company to shut down.
How loyal are your customers to your product?
- Without customers willing to use your product for an extended amount of time, Product Market fit cannot be achieved. Competition could rise to take your place in the market. SEMrush is the ideal tool for competitive analysis research. SEMrush features advertising research, product popularity maps, and insights into what markets competitors are taking advantage of.
How to Measure Product Market Fit
From a quantitative perspective, Product Market fit is measured with consumer metrics and data. These numbers help assess how a company’s product addresses the market’s demand:
Acquisition cost– How much does it cost to acquire a customer?
Startups typically use the customer acquisition cost formula to calculate how many resources need to be dedicated towards acquiring one customer:
Customer Acquisition Cost = (Cost of Sales + Cost of Marketing) / # of Customers Acquired
Retention rate– How efficiently does your product retain customers?
Retention rate is more useful for app-based services, but has uses in every industry.
User Retention Rate = (# of Active Users in Current Period / # of Active Users in Previous Period) * 100
Revenue– Is your company’s annual revenue growing fast? Are you effectively monetizing your customers?
Revenues are a key indicator to a company’s financial health and stability. Revenues rely on price and quantity, and revenue growth in previous years is a key indicator of future performance.
Revenue = Product Price * Quantity of Products Sold
Revenue Growth Rate = [(Revenuey2 – Revenuey1) / Revenuey1 ] * 100
Market Share– What percentage of your product’s market do you own? Is it significant enough to maintain a profit?
Market share is one of the most important factors to determine the success of a particular product. Companies track market share to determine how their product is doing relative to their competitors’ products.
% Market Share (by value) = Company’s Total Revenue/Total Market Revenue100
How is Product Market Fit Achieved?
Product Market fit is crucial to maintaining presence in a market of many competitors. Until Product Market fit is achieved, a company can’t be sure its product has viable use in a large enough market. Simply launching and prematurely expanding without a tight grasp on the market leads to a majority of startup failures.
A good example of Product Market fit failure is Quibi, an app whose main value proposition is high quality TV shows. Quibi wanted to attract a target market that was interested in movie-quality streaming. The primary problems leading to Quibi’s downfall were the extremely competitive streaming landscape and the product’s failure to address a problem. Quibi tried to solve a problem that didn’t need solving because their market targeted the exact same individuals that used Netflix, Hulu, HBO, etc. Quibi failed to achieve Product Market fit because Quibi’s services had poor market share, acquisition rates, and low demand. On top of that, Quibi failed to recognize their market’s demand was changing, and didn’t change their platform as a result. In December 2020, Quibi shut down and officially became unavailable on the app store.
A company will know Product Market fit has been achieved when the market positively reacts to a product with increased demand. Customers are getting significant value out of the product, word of mouth is spreading, press reviews are positive, and deals are closing. Product Market fit acts as a very important indicator towards future success. If companies can determine which of their products don’t have Product Market fit, they can avoid costly investments towards future failing projects.
Companies make revisions and additions to their products and services in hopes of maintaining this Product Market fit. Innovation and adaptation to society’s wants and needs helps startups maintain and take market share.
What Do Investors Look For in Product Market Fit?
Product Market fit wins investments. This is because achieving Product Market fit over a long period of time requires achieving the qualifying metrics that investors look for: Monthly Recurring Revenue (MRR), high gross margin, low churn, and strong lifetime value.
Monthly Recurring Revenue (MRR)– A 90-day snapshot of a startup’s MRR shows investors how well a company’s product is gaining traction in the market. Investors look for upward trends with growing week-over-week gains.
High Gross Margin – In an investor’s eyes, the importance of gross margin lies in the profitability of a product. A high gross margin means that a product’s revenues exceed its expenses, meaning the total yield for a product exceeds the cost to supply that product. This is a sustainable model in the long-term, drawing the interest of VCs.
Low Churn– Churn tells an investor how well a product retains its customers, and how often customers choose to stop using a product. A high churn rate is a red flag for investors looking for reliable products that maintain demand in the market.
Strong Lifetime Value– Lifetime value shows how much value one customer brings to a business. For example, if a customer purchases a 1-year subscription for $10 per month, their lifetime value is $120. This value reinforces the viability of a company’s product in the market. A high lifetime value appeals to investors because it means a product is successfully satisfying customers’ demand.
Sources:
1 Carmicheal, Kayla. “5 Ways to Increase Your Market Share.” HubSpot Blog, June 9, 2021. https://blog.hubspot.com/marketing/how-to-increase-market-share.
2 Clark, Bill. “Invest in Startups: Equity Crowdfunding: Microventures.” MicroVentures Blog, August 17, 2017. https://microventures.com/what-investors-look-for-beyond-financials-product-market-fit.
3 Griffin, Tren, Chris Dixon, a16z editorial and Marc Andreessen, and Ben Horowitz. “12 Things about Product-Market Fit.” Andreessen Horowitz, April 15, 2019. https://a16z.com/2017/02/18/12-things-about-product-market-fit/.
4 Root, Adam. “VCs Want to See Product-Market FIT: Here’s How to Prove It.” Entrepreneur. Entrepreneur, December 19, 2016. https://www.entrepreneur.com/article/284890
5 “SEMrush Competitive RESEARCH TOOLS: YOUR Rivals’ Strategies Uncovered.” Semrush. Accessed July 30, 2021. https://www.semrush.com/competitive-research/.
6 Spangler, Todd. “Quibi Is Officially Dead.” Variety. Variety, December 1, 2020. https://variety.com/2020/digital/news/quibi-officially-shuts-down-1234842926/.