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.

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 prioritise achieving PMF.

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 purhcase.

How can I measure Product Market Fit?

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 ratio of at least 3 is a good sign you’re acquiring 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.

The benchmarks for customer retention rate vary depending on your industry and goals. That said, the average monthly rate for B2B SaaS companies is between 92 and 97% (that’s 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. Measure Net Promoter Score (NPS) for Your Word-of-Mouth Potential

Calculate your NPS to gauge how well your product encourages organic growth through word of mouth. You can find your NPS by surveying your current customers on how likely they are to recommend your product to others. This question is typically rated on a scale of 1 to 10. Those who choose 9 or 10 are “promoters,” while those who choose 0 to 6 are “detractors.” The NPS formula is:

Percentage of Promoters – Percentage of Detractors = NPS

A high score means a higher potential for organic product growth driven by word of mouth, which is an indicator of great product-market fit. The definition of a high NPS depends on your industry, but a score of 72 or higher is a good place to start.

NPS does have some potential issues, however. It’s not specific—the score alone doesn’t explain why your customers are willing to promote your product. It also doesn’t account for different levels of influence among your promoters and detractors. Earning glowing praise from a well-known industry leader has the power to generate a lot of organic buzz, regardless of your NPS.

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