Product Market Fit

What is Product Market Fit (PMF) and Why is it so Important?

Product Market Fit was defined by Marc Andreeson as “being in a good market with a product that can satisfy that market.”

Product Market Fit along with Cash-flow are the two most important things for start ups to manage. Unfortunately most Business’s fail before reaching PMF.

According to research by CB Insights, most business fail due to ‘No Market Need’ for the product or to put it another way, the business failed to reach Product Market Fit. In essence what the report tells us is that most start ups fail because they spend time and money building a product that people don’t want or value.

The Real Reasons Why Startups Fail by Heini Zachariassen, Founder of Vivino

Which is more important, Product or Market ………. or is it The Team?

To put it simply, market is the most important, as having the best team or product is no use to you if you are not operating in the right market in terms of size and growth potential. The focus of the company should be to maximize your chances of success by focusing on achieving PMF (Product Market Fit).

What does Product Market Fit Look Like?

Once PMF has been achieved, as in the case of Product A in the chart below, (represented in the blue line below), you will achieve a leveling off in retention. Once a business achieves Product Market Fit (PMF) they can then scale exponentially as demand surges. Without PMF companies waste money on customer acquisition costs, whilst experiencing high levels of churn or low retention. With PMF companies experience high levels of retention as with Product B below and demand soars as word of mouth spreads and people rush to purchase.

How can I measure Product Market Fit?

source uservoice.com PMF Blog

1. Measure Customer Acquisition and Lifetime Value to Calculate Company Health

Your customer acquisition cost (CAC) should be lower than your customer lifetime value (CLV)—otherwise, your company won’t be able to grow profitably . Your CAC equals the cost associated with sales and marketing for your product divided by the number of new customers you’ve acquired. Your CLV equals your customer value multiplied by your average customer lifespan.

You can look at these two metrics together as a ratio:

LTV / CAC = Your ratio

A minimum ratio of 3 is a good indicator that you’re developing enough long-term customers to offset your costs and sustain growth for your product, which suggests you’ve found a comfortable product-market fit.

2. Measure Customer Retention to Check for Product Stickiness

A high customer retention rate goes along with high customer lifetime value. A sticky feature set is a sign of value: you’re serving your customers’ needs well enough they keep coming back to your product.

Customer retention rates vary by industry. The benchmark for B2B SaaS companies should be  between 92% and 97%, or a churn rate between 3% and 8%.

To measure your customer retention rate, follow this formula:

(Total number of customers at the end of a given time period – Number of new customers acquired during that time) / Number of existing customers at the start of your time period x 100

3. How to Measure Net Promoter Score (NPS)

NPS is a measure of how likely your customers are to promote you to a friend and therefore an indicator for product market fit. NPS is calculated by people scoring your business on a rating from 0 to 10. Those that score your company a 9 or 10 are promoters, while those who score your business or product at a score between 0 and 6 are detractors.

NPS highlights your business ability to grow by word of mouth and an ability to retain customers and drive organic growth once they come in contact with your business.

How to calculate NPS:

Percentage of Promoters – Percentage of Detractors = NPS

The higher the score the higher the ability to drive organic growth which indicates a higher level of product market fit. Product Market Fit NPS scores varies by industry, but generally speaking a score of 72 or higher is considered as being product market fit.

4. The 40% Test

Another way to measure product-market fit is the “40% Test,” developed by Sean Ellis to assess your product’s value to users. The 40% Test asks your customers what their response would be if your product left the market? If at least 40% of your customers would be very disappointed in that scenario, that’s a good indicator you’ve found product-market fit. This question is usually asked in a user feedback survey with these possible responses:

• Very disappointed
• Somewhat disappointed
• Not disappointed
• I don’t use this feature

Keep in mind that to satisfy the 40% Test, you’re looking for at least 40% of your users to respond with “very disappointed” and not “somewhat disappointed.” source uservoice.com PMF Blog