What Is Product Market Fit?

Every startup dreams of becoming famous and successful. A significant milestone in this journey is achieving ‘product market fit’. Product market fit is one of those terms which may mean different things to different people. Many industry experts define it differently. Yet broadly it means that the startup has found its way in the market and from hereon will find it easier to grow if the startup gets adequate resources.

Product market fit is generally defined as the stage in which the startup creates a product that is being pulled by the market at such a rapid pace that the startup has a difficult time fulfilling demand. At this point, the product starts resonating with the customer.

Before achieving the product market fit generally, the startup has a hard time pushing the product in the market. One or more issues are there which stop the startup from being able to sell the product at a rapid pace. Once the startup finds the sweet spot in the market through multiple iterations in the product or through changes in the market dynamics the startup suddenly sees a spurt in demand. At this point, the startup starts to see so much demand that the startup finds it hard to match the supply.

I have been part of Paytm (India’s highest valued startup in 2019 & 2020), which achieved product market fit in 2016. At that time the Indian government startup promoting digital payments to curb black money in India and suddenly people started using digital payments. Many of them started liking the convenience of Paytm’s payment products and Paytm saw 100x growth in registered users within a few years. In fact in 2020 Paytm had more registered users than the population of the USA which is the third most populous country in the world!

We all have seen this with Uber, Facebook, WhatsApp, etc in the past. I personally remember how difficult it was to travel outside the home city before Uber. Even in my home city, Uber did add to convenience a lot.

After studying the product market fit from various angles and personally observing it in Paytm, I would like to define it as a point in a startup’s lifecycle when there are 3 things going for a startup:

  1. High demand
  2. High customer retention
  3. Positive unit economics

High Demand

High demand means that the startup starts seeing a lot of demand from the customers in the market. This may be due to updates in the product or changes in the market or both. The startup should focus on creating the best user experience and customer satisfaction from the day it introduces the minimum viable product (MVP) in the market. Every iteration of the product should bring a startup closer to this goal.

High customer retention

High customer retention should also be a focus area for every startup. If the customer retention is low then fulfilling demand growth would be like pouring water in a leaking bucket. If you want the bucket to fill up then you have to stop leakage. Similarly, a good startup tries to minimize customer usage drop at every interaction point.

Customer retention can easily be measured through cohort analysis. If the customers who start their journey on any given day keep coming back to use the product even after many weeks or months have passed then we can say that the startup has a sticky product and it has high retention.

If you plot a graph of the percentage of people coming back after every week or month you can analyze the retention graphically. In the case of good product retention, the graph falls initially a bit but then stabilizes and flattens out. Good companies like Uber and Paytm have people coming back again and again to use their products.

Positive Unit Economics

I also believe that a startup should be able to recover at least its variable cost on each transaction to reach the milestone of the product market fit. Startups need to spend heavily on product development and marketing and thus the fixed cost of startups is quite high. These costs may be recovered in multiple years. Also, product market fit is the starting point of the high demand phase. Recovering full fixed costs will take time.

For a startup to achieve product market fit transactions with the customer should be able to recover the variable costs involved. Otherwise if the startup is losing money on every transaction then doing more transactions overall will just increase the losses at a very high rate. On the other hand, if the variable costs are being recovered fully then every transaction will bring the company closer to overall profit. Beyond a certain scale of transactions, the startup will turn profitable.

Product market fit is a very important milestone in a startup’s journey from multiple points of view. Till this point, the startup would be iterating the product to find the sweet spot in the market. Beyond this point, the focus will be to retain this sweet spot and continue growing.

The venture capitalists also focus a lot on the startup having product market fit before funding it. If the startup has not reached the sweet spot in the market where it can grow rapidly the venture capitalists are generally apprehensive about investing in that startup. Thus reaching the product market fit becomes critical in order to attract big VCs. Thus every startup needs to focus on achieving product market fit as soon as possible in its journey.

Author: Saurabh Jain (Follow him on Twitter : @skjsaurabh)


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