Achieving Product-Market Fit is the first sign of you are onto something big. It's the cornerstone of all successful startups. It comes through testing the value hypothesis of your product. Many startups try to gain traction by burning marketing dollars before testing whether consumers want their product or not. Avoid that because that is a guaranteed recipe of misery and eventual failure.
Let’s start with a pleasant hypothetical scenario. You are a smart founder with a brilliant idea. You did your industry research, identified your target market, calculated your costs and decided a price for a healthy Return on Investment (ROI). What do you do next? You launch the product and try to sell it. Bravo! You have taken the big leap. You have become an entrepreneur.
But like most people, your objective is not to become an entrepreneur. You want to become a successful entrepreneur. I am sure you are aware of the statistic that 90% of businesses fail within a few years. What does that mean? It means you need to sell enough to build a successful business. And you need capital to achieve that scale. So unless you have saved a million bucks and don’t need external money, you approach an investor.
Most investors are tough nuts to crack. The best ones, especially those with deep pockets, ask difficult questions. They receive thousands of business ideas, and they fund a select few of them. So your goal is to make your business stand out amongst the thousands that approach Venture Capitalists (VCs). One good way to do that is to show you have achieved Product-Market Fit (PMF).
Why do VCs believe PMF is a big deal?
You might be thinking, hey why do VCs care about PMF? I have a wonderful idea, and VCs invest in brilliant ideas. If you already have launched the product, it’s no longer an idea, right? What more does an investor need? You are right, at least partially right. VCs do back ideas, at least they used to in the halcyon days of Venture Capitalism. Alas, those days are long gone. Some VCs still invest in companies at the idea stage. We can call them seed-stage VCs. Their strategy is to back excellent founders in the hope that these founders will create something worthwhile. But all these founders come with an excellent pedigree and a track record of creating awesome companies. Unfortunately, there are few such VCs in India. If you want venture investment at an idea stage, angel investors are your best bet. Most premier venture capitalists have outsourced seed-stage investing to angel investors.
So if you are a first-time founder, the chances are you won’t get external capital when your business is just an idea. You will need to create a product before you can go out to raise equity. And if you are lucky to find a VC who shows interest in your product and business, he or she will like to see evidence of PMF. The question is what is a PMF for a VC, and how can you demonstrate you have achieved it?
Before we get deep into the PMF discussion, let’s see the things that don’t denote PMF. Charlie Munger calls this approach the principle of Inversion.
The product launch is not an indicator of PMF.
Neither does traction denote PMF, nor does exponential growth.
Exponential growth in some cases is a sign of scaling before achieving PMF.
PMF doesn’t require a complete or final product.
And most importantly, PMF is always evolving – it is not a fixed state that once achieved stays with you. Think of it as the opposite of inertia.
There is a popular saying in the startup universe. When a bad market meets a good idea or a product, the market wins. What it means is you need to pick the right market before deciding on the product. VCs always invest in companies that operate in huge markets. That is non-negotiable. If you are building something for a niche audience, seeking venture capital is not the best strategy for you. You might have an awesome product, but if the target market is 100 users, even a 100% penetration won’t excite a VC. And we are not even talking about frequency and consumption. You might want to produce and sell the best food for pet snakes and you should if you believe snakes deserve to eat better than rats. But in this case, we suggest not bothering with a VC unless you love wasting your time.
Huge market, then what?
What do you do next once you have ascertained the market is big enough for one or several billion-dollar businesses? You start with a hypothesis and check whether it is correct or not. By hypothesis, we mean a product or a service that will solve a pressing problem. You don’t need to be the first one to see this problem. Early movers advantage is a myth in startups. Most successful companies were not the first ones to identify a big problem.
So how do you test your hypothesis? MVP is your friend here.
The easiest way is to build a Minimal Viable Product (MVP) and launch it. An MVP is the first iteration of the final product. It might have one or two features of the ten you want to build. It’s good to remember a successful product is always evolving. Personal and business needs change with time. So does a great product. An MVP is just the first of several stepping stones in your journey. But an MVP can also have several key components. For example, you want to start a company that prints and sells customised T-shirts through its website. What is your MVP here? It is not just the T-shirt you are producing. You might want to start with a catalogue of 100 designs and serve maybe one city. That is fine. You can always scale up later. But you need to ensure top-notch printing, reliable packaging, quick delivery, ease of ordering and payment on the website, and awesome customer service. If you want to achieve PMF, your MVP will need all these features because your MVP is not custom-designed T-shirts but the entire process of ordering and getting the T-shirts.
Now we have a fair idea about MVP, let’s see how we can test our MVP to achieve PMF. We have reproduced a matrix that Bessemer Ventures uses to explain PMF.
Source: Bessemer Ventures
The bottom left quadrant is what Adam Fisher, the brain behind this matrix, from Bessemer Ventures calls self-deception. He believes it applies mostly to engineering companies, but we think it’s relevant to all startups. Some founders create a product or a service before studying the market.
They believe in, to borrow an iconic line from a classic film Field of Dreams, if you build, they will come.
Unfortunately, this doesn’t often happen in the real-life except maybe in the real estate industry. Supply creates its demand is a popular saying amongst property developers. We don’t know the veracity of this adage, but it is not true for startups. Most such startups fail because they always build something that no one needs. You might think, hey most people don’t know what they need. Steve Jobs comes to our mind. He famously said he created the iPad because he knew people needed it. Well, if you want to follow his example, all we can say is May the force be with you. You will need the Force because you won’t get venture capital.
The top left quadrant is a combination of a compelling story, a charismatic founder, and little substance. The business attracts enough investors including some marquee ones on the back of a blazing story. If you are one such founder, this might be a good strategy for you. But such businesses fail to create a long-term value for investors. Founders, if they are lucky, make a profitable exit, but they leave a trail of destruction in the process. You don’t need to look further than WeWork to see how such startups end for their investors and clients.
The bottom right quadrant is the sales-driven approach. Many Indian startups who have raised copious amounts of capital (that means all Indian unicorns) fall in this category. They create some traction with a good product in a huge market and raise capital. They use the initial capital to build more traction and raise additional capital based on that traction. This capital followed by traction followed by further capital loop continues until they become too big to fail or someone calls their bluff. These companies ignore the product and burn capital to increase revenue. Oyo Rooms is one such company. They have been lucky to raise hundreds of millions of dollars, but they never achieved PMF. Their fate remains to be seen.
The top right quadrant is where the magic lies. It is the surest way of building a great business. It starts with identifying a big market and a viable hypothesis. Then you check the hypothesis in a sub-section of the market with an MVP. Think of how Mark Zuckerberg launched Facebook for Harvard students. If your product is good, you will receive awesome feedback from your consumers. A high NPS is a good proxy of customer satisfaction. VCs look at NPS while evaluating investments. But nothing speaks louder than organic sales. If you are getting good traction, it need not be exponential, without spending marketing dollars, you have achieved PMF. If not, continue tweaking using the consumer feedback until you achieve PMF. Once you are there, it’s time to hit the road and raise money.
How to find PMF and raise venture capital post that?
Start with a huge market and not the product.
Form a hypothesis and check it by launching an MVP. Use your savings or ask friends and family for capital for building and launching the MVP. If you know some angel investors, it’s a good time to approach them.
Perfect the MVP before you decide to scale. Pay attention to customer feedback. If you are growing organically, you are on the right path.
Maintain detailed MIS and track KPIs. Find out reasons if your KPIs are not improving. Ignore vanity metrics like downloads and visits. High growth is not needed at this stage. Change and tweak your offering if you are not getting organic growth and repeat purchases.
Track "Customer Churn" if you are creating an enterprise business and repeat purchases if you are building a consumer product.
Approach an early-stage VC once you achieved PMF.
Sources:
https://www.bvp.com/atlas/the-product-market-fit-journey
https://a16z.com/2017/02/18/12-things-about-product-market-fit/
https://blog.wealthfront.com/venture-capital-economics-part-2/
https://www.fastcompany.com/3014841/why-you-should-find-product-market-fit-before-sniffing-around-for-venture-money
Comments