I.The problem, solution and market
The one and only goal of a startup should be to solve a problem that satisfies a need in the market.
The problem, its solution and the related market should be well defined in the beginning. Product/market fit as a concept seems relatively straightforward – why would anyone ever build something that no one wants? Yet, according to an analysis by CB Insights, the lack of market need is why 42% of startups fail. The same report also lists many of the other reasons why startups fail, which also can be seen (at least partly) as a result of lack of market need – things like lack of cash (29%), too much competition (19%), and pricing issues (18%).
In basic economics, you often hear the terms “value creation” or the “key value proposition”, which articulate why a customer would consider trying and continuing to use your product. To us, this equals a product/market fit. We like to think that the idea for your value proposition is a balance between two parts: the value your product creates for the customer, and the effort required from your customers to start and continue using it.
An age-old saying in the startup world is that your product needs to be ten times better than what’s already out there. When you combine that with the idea of your value proposition, you get the result that the value created needs to outbalance the effort required for use by a multiple of ten.
So, even if a startup has created a solution that solves the customer’s problem, it doesn’t mean the startup has reached product/market fit. It can be called more like problem/solution fit (which means the startup has done something right). But there is still a lot of work to reach product/market fit.
Startups can be easily divided into two groups: those who have product/market fit and those who don’t. If a startup hasn’t reached product/market fit, your only task is to reach it. After reaching product/market fit, the most important task for a startup is to scale.
Entrepreneurs find new solutions to problems (creating innovations) and turn these innovations into businesses. For a startup to move from problem/solution fit to product/market fit, you have to figure out the fundamentals of your business. This includes the following:
1) Who is the customer?
Most early-stage startups fail because they can’t find customers. To achieve product/market fit, a startup has to know who their customers are. The more precisely you can define your customers, the better. It’s also important to define the “entry market” – the customers you can serve best in the beginning to reach product/market fit with them first.
For business-to-business (B2B) startups, you should be able to name every customer in your entry market (that’s how well a startup should know their customers). In a B2B context it’s also vital to know who you are selling to inside an organization. Understanding the different stakeholders in the customer’s organization significantly improves the chances of success. A great tool to describe this is the “pain chain.”
2) How will you reach your customers?
“We will do some social media, try to get inbound sales with blogs and do some outbound sales” is a bad answer. A startup should have a clear idea of the best and most cost-efficient ways to reach customers. Finding the best channels should also be an iterative process. How to reach customers might differ in different stages of the startup. For example, at first you can “do things that don’t scale” but the best long-term way to reach customers might be different. In the long term, the key question is how to scale your product or service – that is, how can it be made available to a huge customer base once its effectiveness has been proven? Often the hottest startup products have found a super effective way to reach customers.
3) Market and competition
Based on who your customers are, a startup can define what market they are in. It’s essential to define a small entry market at first, but a startup should also understand what is the total addressable market (TAM). The TAM represents the full business potential that is available. The current market size matters, but it is more important to know how the market is developing. Growing markets are always easier to do business in compared to stagnating markets. In stagnating markets there is often fierce competition, while in growing markets there is “room for everybody”.
A startup should understand the competitors in the market and have a plan for how to differentiate from them. And let’s make one thing clear – there is always competition. Competition can be other companies with similar products or some sort of substitute for your product, or the main competitor might be the customer’s option of “not doing anything”.
4) Value proposition
Startups solve problems for their customers. Your solution produces value, and someone pays for it. That means the value proposition should summarize the produced value. In its simplest form, this can be something like “we solve problem X”. However, the situation is often more complicated as the customer is probably already solving that particular problem in some way. In that case, the value proposition has to be more concrete to describe how the startup is solving the problem better than all other options.
A useful concept in this situation is a unique selling proposition (USP). In essence, this means what does your product do so well, uniquely or differently than other products? The USP could be things like better or continuous improvement of quality, the price, a technological advantage, an entirely new type of technology, the design, the brand, the manufacturing methods, development and production schedules, or quality of customer service. The USP is part of the value proposition.
Value proposition or USP?
To summarize, if a startup is solving a problem that nobody has solved before, focusing on the value proposition itself is enough. If you’re in a situation where you’re doing something better than the competition, you focus on communicating the USP.
5) Operations and partners
What needs to be done in order for your startup to produce value for customers? Everything that isn’t required to produce value for your customers should be left out.
When figuring this out, one question that will come up is what should your startup do internally and what should be outsourced? The core value producing parts of a startup should be in-house, but some tasks can be outsourced. Outlining the core operations helps to understand what kind of team you need. A good founding team should have the capabilities to do all the core operations in the beginning.
6) Business model
Put simply, your business model answers the question: how do you make money? In order to achieve product/market fit, your startup should be clear (at least roughly) on how your business model works. Even though your product could be great for customers, if your startup has as an unsuitable business model, it might prevent the customer from buying.
The most traditional business model probably doesn’t need any explanation: a company creates a product and sells it to a customer and that’s it. Today, more and more companies are moving to a subscription-based model where the company gives access to the product and the customer pays e.g. a monthly fee.
Many successful startups in recent decades are two or three-sided platforms. For example, Uber connects drivers and passengers, while Facebook connects advertisers and consumers. In these more complicated business models, the user is not always paying for the product.
Sometimes the business model itself can be the main innovation. Some mass B2C products can focus on acquiring users and think about monetization later (think Whatsapp or certain games), but in most cases a working business model needs to be found in the early days, or at least a solid idea of how it’s going to work.
One of the critical elements to reach product/market fit is to get the pricing right. This can often be tricky. Finding the right price should also be an iterative process. One should try to understand the price of the current solution or the cost that the problem is causing the customer.
Sooner or later, a startup needs to get a grip on the economic side of the equation by answering questions like: how much does it cost to acquire a customer, what is their lifetime value (the total revenue a business can reasonably expect from a single customer account during the lifespan of the customer relationship) and how much does it cost to serve each customer? Startups are often unprofitable in the beginning and when scaling the business, but one should have a clear idea how to eventually become profitable.
There are many different tools to summarize the fundamentals of a startup’s business, like Business Model Canvas or Lean Canvas. The important thing to remember is that working on a startup is an iterative process. Founders can’t just create a business plan and think “that’s it, we’re done.'' Achieving product/market fit is about finding a way to make all the business fundamentals work. Of course, the business fundamentals will also be iterated during the journey, but you need to have some validation how they all can work.
Achieving product/market fit
Let’s make one thing clear: growth does not equal product/market fit. Growth is easy to understand — web traffic, pilot projects or subscribers taking advantage of “limited time only” offers. It’s relatively easy to attract interest and gain traction, but that doesn’t tell you if the product will be able to carve out a space for itself in the customers’ minds in the long run. When you see the first signs of growth, it’s easy to start patting yourself on the back and believing that you’ve found your sweet spot, but more often than not the initial growth is just temporary.
Initial traction is addictive, and it’s the number one reason why entrepreneurs get stuck on their original idea and refuse to iterate. Entrepreneurs may feel that “the customer just doesn’t (yet) understand” and continue to feverishly carry out more pilots to find the one customer that “gets it”. Others get discouraged and call it quits. This is often rooted in a misconception of the nature of product/market fit – something that is born in the mind of an isolated genius who understands people better than they do themselves. Yet the reality is much more complex than that and many successful products have needed years of iterative work.
After failed launches and trials, successful entrepreneurs admit that their idea in its current form is broken and that they need to change direction. They seek criticism and learn from it. They’re not afraid of failure, as each rejection gives them valuable information on what the customers are ultimately after and how the product can be altered or enhanced to better fit the market’s needs. Each crack in the product or service identified by a customer is an opportunity to plug the holes and build something stronger and more durable. In the very early stages, a startup needs the market – not the other way around.
Earlier, we defined a startup as “a group of experiments to find a solution to a problem and create a sustainable and scalable business model around it.” This definition is especially true for startups searching for product/market fit. After finding the initial solution that can solve the problem for a group of customers, startups need to learn as fast as possible about how to make all the business fundamentals (discussed above) work.
Using the build-measure-learn cycle
The iterative build-measure-learn cycle also applies when searching for product/market fit. The “build” part can be as simple as coming up with a way to reach customers or some new version of the business model. A startup’s task is to come up with a clear hypothesis for all the business fundamentals, test them as quickly as possible and iterate based on customer feedback. By feedback we mean not only what the customer says directly or answers in a feedback form, but also what a startup can learn from the behaviour of customers. For example, if a startup reaches only 1% of the customers they aimed for, that is a form of customer feedback. Either the value proposition, channel or some other thing is not working. After many iterations if the results just don’t get better one of the fundamental hypotheses is probably wrong and you should rethink the question: “who are my initial customers?”
While iterating to find product/market fit, startups should have a clear focus – after all, the more variables an equation has, the more complex it is to solve. And startups are definitely equations with many variables. That means if your startup is testing tens of hypotheses simultaneously, you can never be sure about the results for one specific variable – it always leaves room for speculation. Instead, the best practice is to focus on validating one or at maximum a few hypotheses at a time.
What counts as “enough” customer feedback?
As discussed earlier, you should probably have a two-digit number of of customers giving feedback. Another good rule of thumb is that you have enough feedback when you start to see a certain pattern of behaviour in your potential customers and aren’t learning anything significant during new customer interactions.
How to measure if a startup has achieved product/market fit
Product/market fit is a quite straightforward concept in theory, but the challenge is how to quantify and measure it in real life. Product/market fit is often described as a feeling that selling your product is much easier than it was before. However, as that’s a rather vague definition, we’ve summarized some metrics below that can make the search for progress more tangible.
In many cases, while searching for product/market fit the number of transactions is so small that using quantitative metrics is hard (or at least the metrics are not statistically significant). However, in some cases a startup already has a large number of customers, making it possible to get useful numbers.
- Customer acquisition cost measures how much money a company has to spend to get one paying customer (or with free products, one user). Being able to decrease the customer acquisition cost also indicates an improvement in product/market fit – and is a good sign that your channels, value proposition and pricing are heading in the right direction.
- Hit rate describes the percentage of customers the startup acquires from the ones they have had contact with. This is a useful metric for B2B startups who make offers for potential customers. For example, this could be the hit rate of how many customers ask for an offer after a meeting or how many offers convert into customers. Note however that the hit rate (and customer acquisition cost) doesn’t yet describe how well the product performs with customers.
- Churn means the percentage of customers that end the customer relationship during a certain time period (often either one month or one year). The metric is applicable for a subscription-type business model and is a key indicator of how well the product is performing.
For many startups searching for product/market fit, it’s not possible to use the metrics described above. In that case, a good metric is to ask your current users the following question:
How would you feel if you couldn’t use product X anymore?
A) Not disappointed
B) Somewhat disappointed
C) Very disappointed
According to Sean Ellis, the above question can be a great indicator of product/market fit. Through multiple case studies, he suggests that when 40% of a startup’s users answer “very disappointed”, the startup has found product/market fit. Using this metric to measure progress can also make the process of reaching product/market fit much more tangible. It can also be a good indicator of which customers you should focus on. The ones who answer “not disappointed” are probably too hard to turn into “very disappointed”, but the startup should listen especially carefully to the feedback of the “somewhat disappointed” group. If you’re interested, here is a case about a startup called Superhuman that used this metric.
In many cases, verbal and written feedback are the only feedback available. Collecting feedback is easy, but asking the right questions and knowing what and whose feedback to listen to is the challenge. As discussed in Chapter 3, asking “do you like the product?” will often lead to the wrong conclusions. That’s why you should ask more concrete questions about how the customers are using the product and what value they get from it.
For B2B startups who do face-to-face sales, a good indicator of product/market fit can be if someone else besides the founders, such as a sales representative, can actually sell the product in a sustainable manner. In the very early days of a startup, the founders should do the sales as they have a lot of hidden knowledge and understand the big picture (or at least they should). When the product is packaged correctly and you are using the best channels to reach customers, it should be pretty straightforward for a hired sales representative to sell your product.
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