5-4-3-2-1 Countdown for Entrepreneurs (9/14/22)
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Fallacies about Product-Market Fit that can trigger costly mistakes
“Field of Dreams” delusion
Some startup execs believe that if you build a great product, customers will naturally show up. In most cases the opposite is true. It is extremely rare that a market is enormous due to a strong, unmet need because someone would have built a solution already. So, it’s not just the features of a product that matter, but the realities of a market.
“Early Revenue Proves Fit” fantasy
There are many ways companies can generate meaningful revenue without product-market fit. One can argue, “Who cares if we have product-market fit if we're making money?” But, for a venture that must answer to investors and likely raise additional capital, early revenue that doesn’t scale holds little value.
The Curse of Consulting
This is one example of early revenue that can be misleading. Let’s say a software-as-service startup has a useful product. They get introduced to a prospective customer who heads a big corporation. That new prospect says, “Your product is promising, but you meet only our A, B, and C needs. We also need X, Y, and Z. Add those and we’ll do a deal.” Even with the knowledge that X, Y and Z aren’t core to their product, the startup will likely reply, “OK, we’ll make it happen.”
And I get it: In an early-stage venture, you need to do whatever it takes to generate some initial revenue. But the problem is that most ventures in this scenario believe they just made a sale of their product. They didn’t. What they sold was unscalable custom consulting on top of a product the customer wasn’t buying.
Engaging a marquee customer this way can disguise itself as PMF. But it’s actually the opposite. In these “imposter PMF” cases, the market is telling a venture their core product is NOT a fit at all. Without unique changes that don’t appeal to a broad market, there would be no sale. There’s no fit. Yet startups find this encouraging because they are generating cash and getting good feedback. And the lure of landing a big-ticket client — regardless of the method — is really strong. So, this pattern can easily repeat, and pretty soon you’re not a true product company anymore.
Imposter PMF is dangerous because it not only takes your eyes off the prize, it also fools you into thinking you achieved something you did not achieve. And that becomes a huge problem.
Newness Shine Wears Off
Early sales can be misleading because they are often due to the charisma of the founder or other top-level executives in the early-stage company. Charisma can close deals and help a startup hit a milestone, but that is not scalable or sustainable. It’s not just because you can’t replicate that person in your salesforce; it’s that the appeal of the newness wears off. Plus, early sales can come from prospects who were already receptive to helping you out personally, so that too is not evidence of true product-market fit.
Over-Embrace the Early Adopter
Early-adopter customers are a great asset. They are first in line to buy your product and can become some of your best — and most cost-effective — early marketers. And they tend to be more accepting of blemishes that can accompany an early product release. But it’s a common mistake to assume that eager early adopters are evidence of PMF. In most cases, their enthusiasm is atypical, and they don’t represent a large enough audience to make a product successful over time. Early adopters offer great value by helping a startup know they’ve created a “product” but can that product truly “fit” a market? That’s not a question the early adopter was meant to answer.
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Thoughts to ponder about PMF
• Product-Market Fit is a catalytic concept. It is an evolving goal and a strategic vision. ·
• Startup teams need to achieve it and investors need to see proof of it.
• PMF is crucial because the ability of a venture to generate repeatable sales and predictable scale comes down to its ability to achieve Product-Market Fit.
• PMF is widely misunderstood. If you asked a typical founder of an established startup, “What’s more important for achieving PMF – product or market?” they’d likely weight the P as 90% important and M as 10%. Their assumption is that their product is so novel and valued that the product will find its own market. However, that’s not the reality. While there is no definitive ratio on the importance of P vs. M, it’s best to think of it as inherently balanced. It’s like the law of supply and demand in economics.
3
Books that illuminate the art and science of engaging a market
Crossing the Chasm: Marketing and Selling Disruptive Products to Mainstream Customers by Geoffrey A. Moore
The Innovator’s Dilemma: the revolutionary book that will change the way you do business by Clayton M. Christensen
Hooked: How to build habit-forming products by Nir Eyal
2
Metrics for figuring out Product-Market Fit
The key to figuring out and achieving Product-Market Fit is focusing on the things that matter. Many metrics help reveal what you need to define, calculate, and optimize PMF, but let’s focus on two:
Customer acquisition cost. (CAC) What’s the incremental cost to create one new buyer? The basic formula is simple enough – add all sales and marketing expenditures, then divide by the number of customers acquired. However, determining which costs to include in the CAC formula can be tricky. For example, the cost of pay-per-click ads on Google should clearly be included in CAC, but what about the salary of a team member who spends a fraction of their time helping with marketing?
On the flip side, the software engineering expense to develop an app’s core functionality should not be included in CAC, but what about the cost to build a few non-core features added solely to close some key customers?
For this to be an accurate and revealing calculation, you need to analyze all factors and be honest in assessing what should apply.
Customer lifetime value. (CLV or CLTV) How long does a customer stay with you, and what are they worth? On paper, the calculation seems easy enough – add what customers spend over their lifetime with you and divide by the number of customers. But for most early-stage ventures, calculating “customer spend” requires lots of assumptions. For example:
· For an existing customer, how long will we expect them to pay?
· How will our pricing grow over time? Will existing customers still buy?
· Are a few large buyers making today’s average spend unsustainably high?
· Do we have enough customers to reliably predict the behavior of future buyers?
As a new venture ages, the accuracy of their CLTV calculation will improve. But in the early days — during the heart of the PMF quest — this formula is dominated by estimation and crossed fingers. As with CAC, startup teams need to pay careful attention to how they predict CLTV. An overly optimistic set of assumptions could suggest a market fit that doesn’t exist.
What do these metrics say about PMF?
A “low” CAC suggests a product has really targeted the ideal audience and the promise to that audience meets a very real need for them -- or, hopefully, both. Put another way, you’ve achieved PMF. But founders and startup execs can easily and unwittingly underestimate CAC — and that’s a problem they must avoid.
Similarly, a “high” CLTV indicates that a customer truly values what you have to offer. They are happy to pay, and they are willing to stay. That type of commitment screams “PMF”.
But CAC and CLTV alone don’t tell the whole story. For some products, a CAC of $50 is incredibly cheap, while for others it would put them out of business. What really matters is the ratio of value to cost: CLTV over CAC. To survive and scale, a venture must achieve a CLTV that is substantially greater than its CAC, and sustainably so. And if a venture can’t put itself on that path, they are not achieving PMF.
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Methodology for achieving Product-Market Fit
I’ve developed a methodology for mapping the most effective course of action for entrepreneurs, and it works exceedingly well for achieving Product-Market Fit.
It’s called Market Advantage Proof (M.A.P.). It enables entrepreneurs to identify, test, and improve the best pathways toward profit; pathways to develop new products and ventures; and pathways to achieve market fit.
I won’t get into a detailed explanation of how it is carried out, but basically, when applying the MAP Method, you use tools and skills in phases:
Phase One: Identify your highest priority outcome. In map terms, this is your desired destination.
Phase Two: Define the circumstances of where you start — the specific realities that you’re facing.
Phase Three: Brainstorm possible paths from start to finish.
Phase Four: Select a path that promises the most progress with the least risk.
Phase Five: Capture insight and learning by actualizing that path through testing and action.
The MAP Method brings objectivity, structure, and results to the search for PMF. It helps avoid the mistakes that derail so many ventures, and it drives reliable and actionable metrics — the ones that turn early traction into sustainable success.
Stay safe, stay happy, stay in touch!
Adam
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