Everything product-market fit

This post was initially published at Greenhouse’s COO blog where he shares his views on the topic of startups, growth and fast-growth markets: viktor.substack.com

Today, I want to take that chain of thoughts further and describe the second most important event in the lifetime of a new startup – discovering product-market fit (PMF).

While there is a lot of criticism around the buzz and valuations around startups, I think understanding product-market fit helps to justify the hype to an extent.

The term “product-market fit” was coined initially by Andy Rachleff, a legendary figure in Silicon Valley, a founding partner of Benchmark VC, professor at Stanford University, and a founder of Wealthfront. Later the term was further popularized by Sean Ellis (VP of Growth at Dropbox and Eventbrite) and Marc Andreessen (founding partner of a16z and inventor of the browser).

Mainly the term refers to the clear signs from the market that customers genuinely want what you are selling: meaning, the moment when you can efficiently scale your marketing efforts and maintain positive unit economics.

In startup terms, there are two dominant metrics investors pay attention to LTV (lifetime value of a customer) and CAC (customer acquisition cost). The interplay of those two metrics often demonstrates the presence or lack of product-market fit. For example, the lifetime value (in $$) you are getting out of every customer you acquire, over however long they are going to be with you before they churn, divided by how much you spent on marketing to acquire that customer.

The notion that you have built a machine where you can pour money into, and you will know what the multiplier on that will be as it comes out on the other side.

Venture capital investors are most often scouting for startups that have clear signs of product-market fit before investing. Consequently, their advice is usually “do whatever it takes to get the product-market fit and come back to us.”

In the words of Marc Andreessen, startups need to focus obsessively on getting to product/market fit:

“Do whatever is required to get to product/market fit. Including changing out people, rewriting your 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 — whatever is required.”

At the beginning of every startup, it’s fine to have your CAC to be 3, 4, 5x what it needs to be. Because your team will be working towards stacking iterative improvements on top of each other to bring the price down, but if your CAC is, say 20 or 30 times higher, you will never get there.

Hence why experienced founders do everything in their control to discover strong PMF, think of Uber; from the very beginning, they had a clear PMF reaching revenues of $11M one year in their operations, which allowed them to fundraise a ton of money. Along the way they screwed up all kinds of other things, to name a few: allegations of systemic sexual harassment and sexism, losing 400k customers because of the #deleteuber hashtag on Twitter, investors calling the culture “toxic,” a federal lawsuit over the IP theft of self-driving car technology, losing $1B in a mostly unsuccessful bid to compete in China, etc. etc. Despite all that, the company has fundraised about $20B at a valuation of about $70B. That’s the power of a strong PMF. On the other hand, you may run your business really well, HR policies in place, great sales model and team, well-designed marketing plan, top tier team, and VCs onboard and still shut down the company due to never finding PMF.

As Marc Andreessen wrote in his famous essay on PMF:

“You can always feel when product/market fit isn’t happening. The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of “blah,” the sales cycle takes too long, and lots of deals never close.

And 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.”