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Think you reached Product market fit? Break it down to potential investors

Understanding your level of Product market fit level is key to both understanding which investors you should target, as well as what to expect at the table

June 29, 2020

Think you reached Product market fit? Break it down to potential investors

Product market fit in fundraising pitch deck

For early-stage startups, "product-market fit" is the elephant in the room at every pitch meeting. It might be addressed heads on by the investor, and it might be touched upon from different angles, but it will never be ignored. I believe it should be tackled head-on by the founders and address in detail as part of the fundraising pitch deck. It will show you understand the gaps and risks you will face in your future journey and have the entrepreneurial mindset and entrepreneurial spirit to handle those challenges.

What is product market fit?

"product-market fit is the degree to which a product satisfies a strong market demand."

Source: Wikipedia.

When looking at this definition, it's clear that product-market fit level is not a binary yes/no, but rather a spectrum, because you can have a high degree of fit, some degree of fit, and even a low degree of fit, which are all higher than no fit.

The entrepreneur MVP product market fit assumption

Here is a story we'll use as an example:

Dave is an aspiring digital entrepreneur who loves to deal with education challenges and math. Dave is eager to develop a product that will help with the inability of math students to remember math formulas. Dave believes he can solve it with music. It's easier to remember songs, so Dave recorded a catchy music track that "sings" the formulas. He plans to sell my "album" to colleague freshmen.

He goes out of the building and to the nearest college and interviews students on their math issues and music taste. Dave fine-tuned his idea and recorded a light Jazz track that should be listened to while sleeping. It's on a non-listed Youtube page, and once the customer pays, they get the access link. Dave called it MathToSong.

The next day, he got back to the same college and pitched his product to a hundred students. Many even asked to get a taste, and he played them a sample on his phone. Ten bought it for the asking price of $9.99, so he got a total of ~$100 selling MathToSong. He also got more feedback, so he recorded a new track - MathToSong2, this time on as a rap track. He pitched MathToSong2 and was able to sell to twenty students, out of a hundred he pitched to.

Now Dave has an MVP with paying customers. His product satisfies what is a strong demand in the market. Did Dave hit product-market fit, and is he ready to raise VC money?

The VC product market fit analysis

VCs that invest in early-stage startups are looking to invest in companies with some level of product-market fit. The highest the product-market fit level, the lowest the risk of never reaching it. The importance of product-market fit becomes critical at Series A funding. Deals before Series A funding such as pre-seed and seed tend to focus on plans that will get the company to product-market fit. Later stage deals such as Series C assume a high level of product-market fit, and it's mostly a question of the market and superb execution. For this reason, the degree of your product-market fit will dictate who you are most likely to partner with.

A high degree of product-market fit shows effective results in all three axes (axes) of the "sales interaction stage":

  • Before the sales interaction
  • At the sales interaction
  • Post-sales interaction

We can assume that a product has three independent product-market fit ranges - each in the "low/medium/high" scale. For example, you might have a product with a high level of product-market fit before the sales interaction, low product-market fit at sales interaction, and medium product-market fit post-sales interaction.

Let's look at each independently.

Product market fit before to the sales interaction

"Before the sales interaction" refers to the marketing of the product or any "broadcast" communication. Given the qualification criteria the company has defined for a customer, can the company reach and qualify enough customers that meet the criteria? Can they do it efficiently, given the state of the market?

The assumption is that the company is communicating with an audience or audiences at this stage, but not a single person.

To achieve a high level of product-market fit before sales interaction, you would be expected to identify your audience's best-performing marketing channel. Those would have attractive costs, scalable reach, and efficiency. In addition, your messaging will be scrutinized as it will anchor your company's position.

To get better at this:

  • Be able to discuss alternative marketing channels and their traits: how many of your targets can you get there? What would be the cost? What is the level of competition on the medium in general and specifically in your market?
  • Monitor your data
  • Test messaging, both copywriting and imaging
  • Show costs per qualified lead are being monitored and decreased over time.

Product market fit at the sales interaction

Let's assume that you are a salesperson for a B2B company, and you just got 100 "qualified leads" (a lead that meets predefined criteria)  from marketing.

Assuming these are indeed qualified leads (the level of lead qualification is a tension point between marketing and sales in many organizations), a product with a high level of product-market fit at sales interaction would be able to:

  • Provide a high level of positive customer conversion
    e.g., at least 10% of the leads will be converted to paying customers.
  • Provide a low level of variance around their prediction, e.g., if sales got 17 batches of 100 leads, and they expected to convert 10% of each, we expect to see results that somewhat resemble 10%. If the first is 70%, the second is 5%, the third is 46%, etc., the results are all over, and it feels lucky or random.

To get better at this:

  • Show implementation of supportive systems such as sales CRM, coordinated pitch decks with version control, reviewed sales calls, etc.
  • Monitor your data and analyze it for improvement.
  • Craft, test, and improve your sales messaging and pitch.
  • Test your sales motion -  when and how you should strive for a deal "close"
  • Have a repetitive, documented, and improved sales process
  • Show good conversion results and improvements.

Product market fit Post-sales interaction

Discussing post-sales product-market fit might be considered blasphemy. You identified an opportunity to sell something people need, we're able to reach those people, and you sold your product. That is the definition of product-market fit. "Crank up the marketing machine, and let's make money."

Could be. Maybe. Maybe not. It depends on your market stage.

Let's assume this is a new market, with the active customers mostly being early adopters and influences. For example,

Let's look at an example of a company that developed an AR set that helps surgeons.

They identified all the relevant conferences and even managed to hit a benefits-driven messaging that had nothing to do with AR, something similar to "lower your risk and insurance policy." Most importantly, their marketing costs were meager because they played in a niche, which got them many qualified leads. They have outstanding sales leadership and processes and can convert many of the leads to paying customers. Overall - a very high level of product-market fit.

What do you expect will happen if they crank up the marketing machine now?

I'd argue it's still unknown.

The first sales will be made to the early adopters. These customers like to be at the forefront and are less sensitive to the risks associated with young offerings. So while they might be bought on the promise, they still structure expectations about the product. Given the product did not meet their expectations, they would be very vocal in expressing their negative opinions.

So in a sense, the level of product-market fit Post-sales interaction is related to how well the product meets the "sold" expectations and the cognitive dissonance gap created for the customer after they bought it.

To get better at this:

  • Show increased usage frequency
  • Show positive feedback
  • Show switching from other solutions to yours
  • Show customers referencing other customers - preferably publicly (customer use case)

The subjectivity of product market fit

If you've made it here, you might be frustrated with the vagueness of many of the statements I made above.

What is a "good sales conversion ratio"? 5%? 20%? 50%?

What is “low cost for qualified lead ratio”? $1, $10, $20,000?

It all depends on the market, industry, echo-system, and hype.

What is important is that you'll build arguments that tell a good story.

For example - "Our marketing is currently focused on google ad worlds with a CPC of $20, but we're already testing a partnership with an industry publication that we tested and at small sale reduced the CPC to $10. Assuming the same conversion rates we saw through our sales process; this would improve our gross margins from 47% to 63%".

The purpose is not to show you remember all the SAAS KPIs but rather to show what you've achieved and acknowledged the gaps you plan to address.

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