Product-Market Fit is one of those business goals that is easy to understand but that doesn’t come with any clear guidance on how to reach it. Everyone has a playbook for achieving Product-Market Fit and a lot of it is survivorship bias with a pinch of commonsense.
In this article we’re going to give you a quick rundown of a VCs take on Product-Market Fit. The VC is First Round Capital and they’re basing their approach to Product-Market Fit on the experiences of the 500 startups they’ve funded, including several unicorns.
The structure and advice is aimed primarily at sales-led B2B startups. You’ll see that they talk about length of sales cycles and integration times. These aren’t concerns B2C startups need to worry about. Even if your business isn’t B2B there are still some useful insights to gain from their model.
The FRC Product-Market Fit Model
First Round Capital, FRC for short, calls their PMF “extreme Product-Market Fit”. That’s some tasty positioning.
FRC splits their PMF model into 4 levels composed of 3 “dimensions” of fit with 4 “levers” you can tweak to fix your fit.
The levels:
- Nascent: Early days. You have a handful of customers and you’re still getting a handle on your product.
- Developing: You’ve sold to more customers, and they’re paying you, even renewing
- Strong: Customers are finding you instead of you finding them, scaling is your new concern
- Extreme: You’re growing, you’re a household name and you can deliver your product repeatably and efficiently to each customer.
The dimensions:
Satisfaction – How much do your customers like your product? How badly do they need it?
Demand – How long does it take to close a sale? How many of your sales are outbound vs inbound?
Efficiency – This is all those numbers that startups should obsess over:
- efficiency in finding the customer (CAC),
- efficiency in selling and closing the customer (CAC payback),
- efficiency in activating and supporting the customer (length of integration cycle, NRR),
- efficiency in in producing the product (COGS, gross margin), and
- efficiency across the company as a whole (burn multiple)
The levers:
The Persona – This is just Ideal Customer Profile with the numbers filed off. You can tweak this by making it broader or narrower – HR Managers vs HR Managers in Fortune 10,000 Financial services?- or changing it all together.
The Problem – Ideally a pain point that your Persona will do anything to be rid of. You want to look for urgency and huge upside for the client from your solution. If you’ve picked the wrong problem you may need to pivot
The Promise – Your Unique Value Proposition. It’s not your product, it’s how you communicate the benefit your product will deliver. Be prepared to fiddle with this as you learn more about your customers and as your product matures.
The Product – What you’re building. Will it deliver on your promise and are people willing to pay for it?
A deeper look at the levels in FRC’s PMF
FRC have used their experience across their stable of startups to establish clear criteria on what level a startup is at. This is a very VC-focused model, but if you ignore mention of funding rounds and look at the other criteria you’ll be able to see where you fit in.
For each level they provide their take on which of the 3 Dimensions of Satisfaction, Demand and Efficiency you need to be spending your time on, and they are sensible. Though how you shift those dimensions using the 4 Levers or Person, Problem, Promise and Product they leave out.
They like to cover that in person, and, really, the 4 levers are the heart of your business model and aren’t amenable to advice given in a document as broadly applicable as a framework is. There is no generic advice that will help you fix your Product or anybody’s Product. That’s why startups are hard.
Let’s look at their levels.
Level 1 – Nascent
At Level 1 you’re a nobody making promises. You’re relying on your personal network to find customers and your conversion rate is terrible.
Here’s the basic criteria according to FRC Level 1:
- Your team is less than 10 people.
- You’re at the pre-seed or seed-stage.
- Demand source is mostly friends and network, some cold outreach.
- Sales conversions: 1 out of every 10-20 warm intros converts to a customer.
- 3-5 customers.
- No renewals yet (too early). No regretted churn (some non-regretted).
- You don’t even know what your gross margin and burn multiple are (N/A for each).
To make it to the next level they suggest you focus on Satisfaction. Getting to 5 customers who really need your product because it solves a problem puts you on the path to doing the same for 50.
Level 2 – Developing
At this stage you should start to feel like you’re on the path to PMF. You’re landing customers from outside your network. Organic growth is kicking in.
Here’s FRC’s criteria for Level 2. Note the low customer count. FRC’s PMF model is very much targeted at products with a 5 to 6 figure+ Annual Contract Value (ACV):
- Team size: Up to 20 people.
- You’re either a Seed or Series A company.
- Demand source: Early signs of a scalable channel that doesn’t depend on warm intros from your VCs or your friends.
- Without a warm intro, your first call to closed-won percentage is approaching 10%.
- 5-25 customers.
- Some renewals, 10-20% regretted churn, NRR at least 100%.
- Not less than 50% gross margin.
- Not worse than 5X burn multiple.
To make it to the next level you really need to work on Demand and how to generate it. You can grind your way to 20 customers, but you can’t 5-10x that effort and simply keep grinding your way to 100 or 20 customers.
You need something generating Demand on your behalf.
The most helpful Levers for pushing on Demand are typically fine-tuning your product positioning and finding scalable channels, whether that’s outbound sales, SEO, paid marketing, referral or a combination of these.
Level 3 – Strong
When you’re at Level 3 you’ve basically made it. Demand is inbound and growing. Customers know your name. You’re able to onboard customers with minimal or no customisation while still delivering value they are happy to pay your contract for.
Here’s the criteria for Level 3:
- Team size: 30-100 people.
- Stage: Series A/B/C company.
- Demand source: 1+ scalable channels (you’ve cracked marketing and sales). >10% of your inbound is coming from referrals/WoM.
- 1st call to closed sale is 10-15%.
- Magic number >.75 and CAC payback <18 months.
- 25-100 customers.
- $5-25M ARR.
- >110% NRR.
- <10% regretted churn.
- 60-70%+ gross margin.
- Burn multiple in 1-3X range.
The business is working. To reach the next level you need to focus on Efficiency. Some numbers need to go up – work on getting your LTV:CAC ratio over 3. Other numbers need to go down – reduce your CAC payback time below 18 months. You’re a mature business with processes that work. Optimise them to get to the next level.
Level 4 – Extreme
Everyone knows who you are. Your efforts are spent scaling and streamlining. You’ve found PMF and you’re getting close to addressing your Total Addressable Market (TAM).
Guess what? That thing you did – create a product and drive it to PMF? Now you need to do that again. And again.
Here are the criteria for Level 4:
- Team size: 100+ people.
- Company is at Series C or beyond.
- Demand Source: 2+ scalable demand channels.
- 1st call to closed sale is >15%.
- Magic number >1, CAC payback <12 months.
- 100+ customers.
- $25M+ ARR.
- >120% NRR.
- <10% churn.
- 80+% gross margin.
- Burn multiple 0-1X.
There’s no moving beyond Level 4 of PMF. To keep growing you simply need to repeat the process. There are four ways to do this that leverage everything you’ve learned and built:
- New features: Add functionality to create fresh use cases.
- New product: Sell something different to the same market and buyer.
- New market: Take your product to a different sector or market segment.
- New buyer: Same product, same market, different decision-maker.
Where to find more
This was a condensed version of First Round Capital’s approach to PMF. You can read the full 13,000 word version here. You probably should. It goes into greater detail, has great examples and interesting interviews with founders on their journey to Product-Market Fit.
As we said, it is tailored to B2B startups with $$$ Annual Contracts, but there’s a lot of quality experience and insight packed into it that everyone looking to found a startup can learn from.
