The Elusive Product-Market Fit

Jan 23

Iman Olya

23rd January 2021

I. Intro

For something so theoretically simple, product-market fit (PMF) hounds founders. This elusive phenomenon evades entrepreneurs so often that even once attained, founders can’t be sure they’ve actually achieved it.

In this memo, I will elucidate the term, its origins and its theory. I then provide practical principles and metrics to check if you’ve mounted the summit.

II. The Definition and The Origin

Marc Andreessen is an OG of VC. But even he rests on the shoulders of greats.

In 2007, Marc wrote a blog called The Only Thing That Matters. This was a pioneering piece on PMF and questions surrounding it. He articulates 3 points:

Market size is more important than the product or the team in a startup's success. Even with a great product or great team you still can’t scale effectively if the market isn’t big enough
Obsess over finding PMF before you have it (e.g. new staff, rewriting product, moving into a different market, telling customers no when you don't want to, telling customers yes when you don't want to, raising that fourth round of highly dilutive venture capital)
(That last one must be sarcastic...)
The best startups all have PMF. And, critically, even the most operationally efficient startups WILL FAIL if they haven’t found PMF

Marc was building on concepts of OGs: Benchmark co-founder Andy Rachleff and Sequoia founder Don Valentine.

Mr Valentine was in exceptional demand - not just because of his Hollywood name. As Rachleff paraphrases in this podcast, The Don was revered as he believed in the power of market demand: “I’m looking to invest in companies that can screw everything up and still succeed because the customer pulls the product out of their hands.”

Rachleff himself builds on The Don’s articulation: “Identifying a compelling value hypothesis is what I call finding product/market fit. A value hypothesis identifies the features you need to build, the audience that’s likely to care, and the business model required to entice a customer to buy your product.”

He goes on:

“If you address a market that really wants your product — if the dogs are eating the dog food — then you can screw up almost everything in the company and you will succeed.”

Like a dog with a bone ravaging over PMF’s insatiable value, Rachleff gives 4 principles that highlight this phenomenon - two for consumer, two for enterprise:

Consumer (B2C):

Exponential organic growth - customer growth through word of mouth and ensuing network effects
This echoes Michael Seibel’s view that: “The only way you know if you’ve built what customers want is because they are using it in an explosive and destructive way.”
Net promoter score (NPS) - a metric for customer satisfaction. Rachleff conceded this isn’t always the best tool, as Chamath once told him Facebook’s NPS was -14 when they were growing at their fastest rate

Enterprise (B2B):

Sales yield - the contribution margin of a sales team divided by the total cost to field the sales team. A sales yield greater than 1 is a sign of PMF
Trialling - a 30 day proof of concept trial, where you test the stickiness of the product with users. If by the end of the 30 days the users don’t want to pay fo the product, you still haven’t found PMF

As these greats of venture exhibit, PMF is the primary proponent of success. To actually understand how founders can manage this concept though, I outline some further principles below.

III. The Practical Principles

The OGs give valuable insight into what investors look for. However, let’s look at how to track the journey to PMF from a founder’s perspective:

Paying Customers
- I mean, this is obvious. But the ability for a customer to see value in paying for a product is key
- The ultimate signal of PMF viability is actually getting customers to commit to purchase, before you have a product
User Retention
- Plot a retention curve - this charts the proportion of total active users over time. With a flattening curve over a year or beyond, you have customer retention. With customer retention, you have a core component of PMF
- Compare this rate to the nearest product competition. If yours is longer, you’re on the right track
- If customers still use the product even if it’s broken or crashing - you’ve probably got PMF
User Feedback
- Run 30-day surveys to test whether customers get disappointed if you remove the product. If 40% of respondents are “very disappointed”, you have PMF, according to Rahul Vohra
- If you’re getting “literal love letters” as Elad Gil states, you also probably have PMF
Growth

Exponential organic growth - building on The Don and Rachleff’s philosophies, if 50% or more of your user growth is coming from organic means, you have PMF
User excitement or addiction - do people’s “pupils dilate when they use your stuff”? Are they clamouring to take the product from your grasp? Well then, you definitely have PMF (or you’re selling crack…)
Efficient growth - when your Burn Multiple is lower than 1x and your Customer Acquisition Cost is less than the Lifetime Value of the customer

Burn Multiple

The higher this metric, the more it costs to achieve each unit of growth. In other words, how much is the company burning in order to generate each incremental dollar of ARR? Anything lower than 1 is preferred for PMF.

Customer Acquisition Cost and Customer Lifetime Value

The value generated by each user, across their lifetime, should be greater than the cost of bringing them into the product. When you repeatedly acquire customers for less than their cumulative value to you, you have PMF.

IV. Conclusion

Navigation towards PMF is a demanding and never-ending journey. You need direction, but with the right approach you can find a treasure island. True pirates (the most apt analogy for founders) navigate through tough waters and are at the helm to steer towards treasure, using the compass outlined in this memo. Shipwrecks on the other hand don’t track their performance and don’t change course in light of impending failure.

And for those who still aren’t sure, Marc’s words may help elucidate if you’re a pirate on course for gold or you’re doomed to be shipwrecked:

“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.”

— Marc Andreessen