Ready, Set, Product-Market Fit!

“Before product-market fit, your only job that matters is to build a great product” Sam Altman, President of Y Combinator

Twitter, a microblogging and social media company where users post and interact with messages up to 280 characters known as “tweets”, was originally a product of the podcast company called Odeo. Following the launch of the iPhone in 2006, which already included a podcast product, the founders of Odeo decided to organize hackathons in search of a product relevant to the market. Twitter was born out of Jack Dorsey’s mind as a result of these initiatives, which then took advantage of the development of the podcast platform, launching the prototype as an internal service for Odeo’s employees in March 2006 and then, in July of that year, the full version to the market. In April 2007 Twitter was launched as an independent company and began to gain popularity, making its official presentation at the music festival, South by Southwest (SXSW).

It can be said that Twitter reached its Product-Market Fit quickly by offering a platform that created a more efficient way to communicate. The Product-Market Fit is defined as the stage when a startup solves a problem that matches the needs of the current market and for which product or service users are willing to pay.

Product-Market Fit: From idea to growth

The growth process of a startup searching for Product-Market Fit can be exemplified with the relationship between its Unit Economics and Net Contribution Margin through time as shown in the following graph:

The stages that Twitter and any other startup face in the development of its product are as follows:

a. Idea: Initial stage in which the entrepreneur visualizes a problem and its solution through technology and a disruptive business model. It is not yet well defined in what will the product be converted. Originally, Odeo launched a podcast platform and subsequently pivoted to an instant messaging app, Twitter. It’s important that you marry the problem and not the idea. On many occasions we create solutions without even understanding the original problem.

b. Prototype / MVP: Stage in which you create, develop and launch a product. It is advisable, just like Twitter did, to start the prototype with a controlled group of users, encouraging them to provide feedback regarding the product and its features. It is important to keep improving the product as many times as necessary (ie. incremental, disruptive, breakthrough innovation).

c. Launch: At this stage you have come up with your MVP, next, you should look for an “aha!”moment, when users have found the value in your product. For example, in 2006, the impact of Twitter following the San Francisco earthquake was an “aha!” moment for the company, as the event quickly spread through this platform.

d. Traction: The startup accelerates its growth through the acquisition and retention of users, offering a unique and differentiated value proposition. Twitter experienced rapid growth, going from 400,000 tweets per quarter posted in 2007, to 100 million tweets per quarter in 2008.

e. Monetization: At this point, startup is very clear about how it will generate revenue and profitability for its shareholders (Revenue Models article: medium). For example, Twitter began its monetization process in 2010 through advertising.

f. Growth: The startup have a path of solid and sustainable growth, capturing a relevant market share. Today, Twitter is used by millions of people globally, from politicians, entrepreneurs, athletes, artists and other public figures. In 2013 Twitter launched its IPO, and today has a market capitalization of more than USD$36bn.

Metrics to measure Product-Market Fit (PMF)

A product aligned with the market usually focuses on users and customers, where users interact with the product extracting value from it, and customers are willing to pay for the use of the product. A relevant metric for measuring user satisfaction and the value you are generating is the Net Promoter Score (NPS). It measures customer experience and predicts business growth. Consider business promoters such as those who want the product extremely (9 and 10), passive users (7 and 8), and detractors, those who are neutral or do not like the product at all (less than 7).

To know the product-market fit development status of a startup, it is also necessary to contrast the NPS against the Willingness to Pay, which refers to the willingness that a user has to pay a price for the value of a product.

Other metrics that may be useful are NPS / Sales. (When you start to grow exponentially without spending on marketing, you have reached the PMF), and the Quick Ratio (New customers + Resurrected) / Churn.

The following matrix shows the relationship between customer loyalty to purchase the product and refer it to others (NPS), and the company’s ability to monetize the customer’s willingness to pay.

Quadrant I: The Star

This stage reflects when the startup has already reached a Product-Market Fit. It is the point where the perfect balance between the value generated to the user and the monetization capacity of the startup has been achieved. Such is the case of Uber, where user loyalty, the “word of mouth” and the value provided to the different stakeholders, have allowed the company to monetize, reaching a Product-Market Fit, and capturing a large slice of the market. Despite reaching the Product-Market Fit, the dynamics of the market force the startups to always improve and reinvent themselves in a continuous way.

Quadrant II: Incumbent Market Dominant

This is the typical quadrant where innovation can cause a major disruption in some economic sectors. It is useful to consider the large number of traditional companies that exist in any economy, providing basic services for the population; for example, traditional financial services, which generated a poor value proposition to the users, who in the absence of competition, had no other choice than paying for those services. Today companies such as Nubank in Latin America, Chime in the United States, Revolut in Europe, and PayTM in India, are disrupting this sector with tangible value propositions.

Quadrant III: Pivot

In this quadrant, neither the users find value in your product or there is a willingness to pay for it, it is at this point that it is recommended to pivot the business model. This can be done in two ways:

a) Validation of the product: Shopify, for example, began as an attempt to be an online store selling snowboards. After evaluating (and experimenting) the real needs of the market, it became a white label online store platform for other merchants, which has now reached a market capitalization of USD$125bn.

b) Validation of the go-to-market strategy: Cabify, a ride-hailing platform, began by offering transportation to passengers in Latin America before Uber; but when the latter entered into this market, Cabify saw a need to change its business model given the strength of resources and strategy Uber had; focusing then mainly on establishing contracts with corporates for employee ride-hailing partnerships, allowing it to maintain a market share in its geographies.

Quadrant IV: Re-think business model and generate value for stakeholders

Sometimes your business model provides value to the right user; however, your revenue model doesn’t meet the customer expectations. In this quadrant, you must understand the flaws in your revenue model and modify it. For example, streaming platforms like Spotify or cloud storage services like Google and iCloud have developed family plans to incentivize users to pay for the product. Sometimes, failed or unprofitable business models can develop a dependence on VC funds to sustain their activities (Business Model VC-2-C), e.g. through aggressive discount promotions such as Rappi or Cornershop. However, this model is not sustainable, ideally, you must find a way to have one customer refer you to another customer (C2).

Bonus Points

The Product-Market Fit is a necessary condition to be able to scale and succeed in any startup. Let’s learn from Odeo’s decisions and Twitter’s strategies. Understand the current state of your startup and prioritize your strategy to find the right alignment with the market.

“The life of any startup can be divided into two parts — before product-market fit and after product-market fit”. — Marc Andreessen, Andreessen Horowitz General Partner, and Serial Entrepreneur

Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.

Ricardo Latournerie. Investment analyst at ACV.

Ana Maury Aguilar. Investment analyst at ACV.

Gonzalo Soriano. Investment analyst at ACV.

ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.

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ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.