Product market fit is essential for continued growth. But when do you know if you've found a product market fit?
During the first step of the second phase of your startup's life, you'll get to work on product market fit: proving that your product meets a real need. Product market fit is essential for continued growth. But when do you know if you've found a product market fit? Business developer and serial entrepreneur Tim de Kraker explains how to measure and demonstrate this.
When can you say you have product market fit?
While product market fit is essential for continued growth and attracting investors, it is not always clear how to demonstrate you have it. According to Tim, it’s because of this: "Many people have different ideas about it. The general idea is that if they have many interested parties, have attracted funding, or generate a high turnover, that this is enough. But that is not what demonstrates product market fit. Imagine you have a lot of initial sales but your product or service is barely used. Your business is not future-proof.” True product market fit is demonstrated by looking at usage, retention and reference sales. For at least two of the three, you must be able to demonstrate that they are sound. Tim: "Product market fit is a kind of holy grail, which is exactly why many startups pretend to have achieved it." Let’s zoom in on the three different aspects.
1. Usage
The first measuring point for product market fit is usage. Tim: "How often does someone use your product or service? You can have great sales, but do people actually use it?" How high the level of usage should be depends on your product or service, Tim explains. "Imagine a solar charger for your cell phone. A client does not need to use it every day, but it can be very valuable when they go hiking in a remote area once a year, for example. It's different when you are selling a product for everyday use." To determine the balance between use and how valuable your product is to the customer, you need a benchmark. "You can find this by talking to the user," Tim says. "If you know what level of use is valuable in the eyes of your customer, you can measure this against the average amount of time your product or service is actually used. But usage is not always easy to measure. For a bag of potato chips, for example, it is difficult to determine how often it is used. So in that case, you're looking at the second and third measuring points.”
2. Retention
In addition to usage, you can also look at retention to demonstrate whether you have product market fit. In other words, do your customers remain your customers? Tim: "Based on an email address, an e-commerce proposition allows you to easily measure whether there are any repeated purchases. For physical stores, this could include a bonus card or loyalty program. For services, it can be measured even more easily. Is the customer renewing their contract or subscription?" If you want to measure retention specifically, it is helpful to offer shorter-term contracts. "Commercially, annual contracts are attractive because they allow you to generate larger amounts of turnover at once. But if you want to measure retention, an annual contract means you have to wait a full year to see if your customer renews or not. And if they don’t, you've just wasted a whole year. With a monthly contract, you can quickly and easily demonstrate whether people are actually coming back - and make adjustments when necessary." A good guideline for desirable retention levels is that 95% of customers in a given month do not cancel their contracts in the following month. "That cancellation, by the way, is what we call churn," Tim says.
3. Reference Sales
The third point of measuring your product market fit is reference sales. "This is where you look at the extent to which you get new customers through existing customers," Tim explains. "Do your customers refer you to others and do they then make a purchase as well? If you get 5% of your customers from referrals without pushing for it, you are doing great. At 10%, you have convinced me of your product market fit." You do need to set things up properly to measure this. For instance, give your customers a link or discount code they can share. "An example is Tesla's loyalty program," Tim says. "When you buy a Tesla you receive a code. If someone uses your code to order a new Tesla, you both get a certain amount of free supercharging as a gift. Recently, this loyalty program has been further supplemented with even more gifts that stimulate this desirable behavior. You will probably have your own ideas about how you might encourage reference sales of your product or service. But whatever you decide, make sure it fits your startup."
When you can demonstrate that you meet two of these three measuring points, you have product market fit and are ready for the next step in your startup journey. Tim: "That's why it's important to start measuring from day one. Because as cliché as it sounds, measuring is knowing."
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