Problems yearn for solutions, needs long to be met, and markets are waiting to be addressed. This reality beckons startups and established firms to introduce new products that will scratch that itch and deliver satisfaction. Whether the products they offer (and the price they sell them for) match the demand is (part of) where product-market fit comes in.
Knowing when you don’t have product-market fit is simple. If no one wants your product, you don’t have a market. If your product isn’t loved and valued by customers, you haven’t achieved product/market fit. Similarly, knowing when you do have product-market fit is fairly straightforward. If you’re delivering a solution people will pay for, that is (or could realistically become) profitable because there’s enough of those people, and they’re happy enough with it that they’ll keep paying for it every month, you’ve achieved product-market fit.
What isn’t so straightforward is understanding where you stand during your journey to the holy grail of product-market fit. How do you know if you’re moving in the right direction? (or even moving the needle at all?) Today I’ll address a few ways to measure product-market fit and easily quantify your progress toward attaining it.
How to Measure Product-Market Fit
Work backwards from total addressable market.
No product has an unlimited potential market. So, figuring out not only who could try your product but also who might become a loyal subscriber is an essential element of every SaaS strategy. Knowing not only who your potential market is, but also how big that market is, is a useful step in helping you measure product-market fit.
Enter total addressable market (TAM). Total addressable market is a metric you can use to estimate the size of the market (and its potential revenue) that you are targeting. Once you’ve identified your TAM, you can determine what percent of your TAM are customers. Over time, that line in the sand—the percent of TAM you serve—will theoretically increase as you get closer to attaining product-market fit.
Furthermore, if you identify a very small TAM, you have an early indicator that you need to target a broader audience in order to make a worthwhile business case.
How to Estimate Total Addressable Market
Due to its somewhat abstract nature, TAM can be difficult to pinpoint for some products, but it is not impossible. One proven tactic for identifying and isolating this population starts by asking early customers how they would feel if your product went away.
Sean Ellis of “growth hacker” fame says this can be boiled down to a simple survey question: “How would you feel if you could no longer use [product]?” The users who respond “Very Disappointed” (vs. Somewhat Disappointed, Not Disappointed, or Don’t Use It Anymore) represent your actual target market (despite the fact that lots of other people gave it a try).
Once you have your Very Disappointed cohort, you can then look at who those people are (persona-wise) and what it is they value most about your product. From there, you can then extrapolate based on those personas and figure out approximately how many people like that exist, which gives you your Total Addressable Market (TAM).
The tactic may sound a bit abstract right now, so let’s put it in practice. Let’s say you have a hotel recommendation app that has been downloaded by 1,000 people. Of those users, 300 said they’d be Very Disappointed if the app stopped working. Those 300 people represent a snapshot of your target market. Therefore, you can then look at those 300 people and figure out what they have in common persona-wise.
Armed with the knowledge that these 300 people tend to be millennials who travel at least twice per month for business or are wealthy individuals in their 40s that vacation at resorts for at least three weeks per year, you can then calculate a TAM for those two personas.
Apply a targeted focus on serving your target market.
While it may be disappointing to realize that your widget isn’t going to become a necessity for every human being with an Internet connection, trying to satisfy everyone simultaneously is a recipe for failure. Instead, by doubling down on the people that truly value your product you can invest in features and improvements that they appreciate and thereby attract more people similar to those initial fans.
Becoming a vital resource for millions of people is actually a better outcome than being a take-it-or-leave-it option for billions when you’re talking about a SaaS business that needs recurring revenue and happy subscribers to stay afloat and grow.
Superhuman’s founder and CEO Rahul Vohra believes the path to success is focusing on that core group of dedicated users to understand what they love and make it even better combined with addressing what’s holding back on-the-fence users that also fall into your identified personas. Your product roadmap should then be evenly divided between those two objectives.
Measuring the results of these efforts is then simple: is the percent of the TAM you currently serve increasing? If so, that’s a good indicator you’re headed in the right direction.
Toe the line between luxury and necessity.
People buy lots of things, and they buy them for a lot of different reasons. Sometimes it’s because they want it, while other times they need it (or at least feel like they need it). This is what distinguishes a luxury item from a necessity.
A luxury may bring customers joy, happiness, or satisfaction. But without it, life would still be just fine. A necessity, on the other hand, is something a customer either can’t live without or really wouldn’t want to give up. There are plenty of product categories where seemingly similar offerings may fall into either of these camps.
Look at streaming services, for example. While CBS All Access and Netflix both offer exclusive content, very few customers would feel a major hole in their life without the CBS product. Yet Netflix feels like a necessity for many people in the cord-cutting generation—so much so that they can increase their prices without worrying about mass defections to cheaper services. Both products have a market and paying customers, but only one of them knows they’ve achieved a sustainable product/market fit.
Set attainable goals.
Once you understand your target market and have calculated its size, you then need to apply reality to the situation. While your TAM is X, you’re not going to get 100% of it to buy your product. So, you need to set a realistic goal for what portion of that market you can capture.
TAM is useful, but purely theoretical in terms of what you will actually capture, which is why it’s important to narrow it down first to Serviceable Addressable/Addressable Market (SAM)—which is what’s within your geographical reach—and then from there to determine the Serviceable Obtainable Market (SOM). Your SOM is the portion of the SAM that you can actually achieve, otherwise known as “how much of the pie” you’ll actually get.
Unlike TAM and SAM, SOM is much more of a guesstimate than based on hard, indisputable data. The process for determining your SOM should include how much of the SAM will actually want to buy your product, how much of the SAM can you actually reach via your marketing and distribution plan and channels, and the strength of your competition. Your SOM will also grow over time, since you won’t get 100% of your customers the first day/month/year you’re selling your product.
Perhaps the most important aspect of SOM is that you need to be communicating this internally so expectations aren’t too lofty based on the huge TAM numbers everyone is familiar with. Setting attainable goals early will preempt freakouts and disappointments down the line.
Maintaining Product-Market Fit with the Rule of 40
Once your product is on the market, there are two key levers that help you determine whether your product has achieved—and is continuing to achieve—product-market fit: growth and profit. In short, these two levers come together to create what many call “The SaaS Rule of 40.” The rule of 40 suggests your growth rate plus your profit margin should equal or exceed 40%.
While any combination of those two elements adding up to 40% or more is great, the ratio should match what stage your offering is in. If you’ve only been on the market for a few months and are seeing a profit of 35% with a 5% growth rate, you should still be pretty concerned about your long-term potential. Because, for an early stage product, these figures can indicate your target market is pretty small, your marketing isn’t working very well, or maybe you’re just scaring off potential buyers by pricing your product too high. Meanwhile, a mature business might be thrilled with that ratio.
On the other hand, if it’s still early days and your growth rate is soaring at 40% or more yet you’re not generating a profit or even losing money, it’s not necessarily time to panic. As you grow, you can always dial down your spending or increase pricing to begin generating a profit down the line once the land-grab period of growth cools off.
Of course, 40% is a somewhat arbitrary number and the specifics of your product’s market dynamics and competitive landscape may not fit with that formula. But as a general benchmark, it’s not a bad starting point to see if your company is on the right track.
Getting to Product-Market Fit
Early on, your growth rate is going to be largely driven by your spending and tactics to acquire new users. While products occasionally catch viral wildfire and sell themselves, most businesses actually have to spend money to make money, which in this case means paying for advertising, marketing, and sales initiatives.
Spending money to land new deals can be boiled down to Cost Per Acquisition (CPA). This metric conveys how much you’re spending on sales and marketing divided by how many new customers you’re signing up during the same time period. Growth-oriented companies can quickly become obsessed with CPA, since the common thinking is that the lower the number, the more effective your tactics, plus you can then dial up spending to increase growth.
But few things in life are that simple, and you can’t just keep cranking the same knob up over and over again. Market dynamics change and the low-hanging fruit/cheaper acquisitions get snapped up fairly quickly in the overall lifespan of a product. That means that you have to work harder, try more things, and most likely spend more money to get your ten thousandth customer than it took to land your five hundredth.
The other factor driving up your CPA could be the competition you will face for the marketing channels you’re leveraging. Even if you’re the only company selling travel insurance to mountain climbers, there are other companies bidding for those same eyeballs to pitch them nutritional supplements, shoes, ropes, and helmets. That drives up the cost of the ads you’re relying on to bring them to your landing pages and sign up for your email list.
And, as you move past the early adopters and into the folks that required a little more convincing, there’s much higher risk for churn and unsatisfied customers that weren’t chomping at the bit and proactively seeking your solution. So, the uphill climb just gets steeper… and more expensive. Not to mention that the success of your product in the market may attract even more competition, which can further increase CPA while simultaneously putting you on the defensive to retain the customers you already have.
Product-Market Fit is Product Management’s Holy Grail
Product/market fit rarely happens holistically or by accident. Companies constantly tweak their products, their target markets, and their sales and marketing tactics to hone in on the perfect combination of needs, demands, and how to satisfy them. As a product leader, this ultimately is informed—if not driven—by your knowledge, research, and efforts.
Like most things, it’s also an ever-evolving journey to uncover new demands, modify the market you’re targeting, and adjust the messaging and communication tactics your company uses to reach new buyers. Reassessing your product/market fit and relying on benchmarks such as the Rule of 40 ensure your company doesn’t become complacent and is continually adapting to reach your growth targets and defend your position from competitors.