Love At First Click: The Product-Market Fit Metrics VCs Fall For

When legal tech startup Atrium declared bankruptcy after raising $65 million from prestigious Venture Capital firms, including a16z, co-Founder Justin Kan went public with the lessons he learned from the failure. One of his major takeaways was that it’s useless to look for funding before knowing what you’re selling, who you’re selling it to, and how you’re going to do it—my personal definition of product-market fit, or PMF. Instead of seeking out VCs, Founders should focus on iterating the build-measure-learn loop. Contrary to popular belief among entrepreneurs, most Investors don’t invest pre-PMF. However, generating revenue or demonstrating proof of customer adoption will attract Investors.

In this post, I explain why Kan’s statement is true. Founders who are primarily focused on raising money to build a product are tackling the problem from the wrong end. Besides, having enough money doesn’t guarantee success; in fact, having too much money too early will almost always end in unnecessary overspending. Iterating and testing ideas is the only way to get to product-market fit.

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Product-Market Fit Is Not What Most Founders Think

Product-market fit is a concept that has been popularized by Venture Capitalists Andy Rachleff (who co-founded Benchmark) and Marc Andreessen (who co-founded a16z). It refers to the degree of success that a product has in meeting the needs of its target market.

Product-market fit is achieved when customers are actively buying, using, and recommending the product to others. Companies must understand their target market and create products that meet their needs in order to achieve product-market fit.

Product-Market Fit Is Measured With Hard Metrics

Many Founders misunderstand this core concept in entrepreneurship and Venture Capital. They wrongly believe that product-market fit is about an adequation between a product and the (supposed) needs of a large customer base.

It’s more than that. VCs measure product-market fit with customer adoption metrics.

Growth Metrics: These include user growth rate and revenue growth rate, reflecting a market interest for the product or service. Since the first cause of startup death is making a product that nobody wants, grow metrics are paramount in a VC’s startup evaluation.

Engagement and Retention Metrics: VCs analyze active users (daily or monthly), churn rate, and retention curves. High engagement and retention indicate that users find value in the product, which is a strong signal of product-market fit.

Market Feedback: This encompasses net promoter score (NPS), customer satisfaction surveys, and qualitative feedback from users. Positive feedback and a high NPS suggest that customers are likely to recommend the product to others, signifying a good fit between the product and its market.

Product-Market Fit Metrics: Why LightSpeed Invested in Snapchat

Lightspeed’s Jeremy Liew, who was the first Investor in Snapchat in 2012, described the early indicators of product-market fit he analyzed when evaluating the startup. Snapchat’s outlier growth and user metrics convinced Jeremy Liew to invest.

His analysis centers on DAU (Daily Active Users), the number of unique users who engage with the product within a 24-hour period. This metric helps gauge how integral the product is to users’ daily routines. A high DAU suggests that the product is consistently used and has become a part of users’ daily lives, which is a strong indicator of product-market fit.

He also mentions MAU (Monthly Active Users), which counts the number of unique users who interact with the product over a 30-day period. The DAU/MAU ratio, often expressed as a percentage, is a key indicator of user engagement and product stickiness. A high DAU/MAU ratio suggests strong user engagement, as a significant portion of the monthly user base is returning to the product every day.

With such high engagement and such high retention, it was clear that Snapchat had become a habit for a lot of their users.

Jeremy Liew – Lightspeed Venture Partners (Source: 20vc)

In his conversation with 20VC’s Harry Stebbings, Jeremy Liew mentions the following metrics that impressed him when he analyzed Snapchat’s growth and engagement metrics:

1. High DAU/Install Ratio: Snapchat had 90,000 users out of an app installed base of 180,000 downloads. This indicates strong initial engagement. For most startups, converting installs to active users is a challenge, and a high ratio suggests that the product meets a clear user need or interest right from the start.
2. Month-on-Month Growth: At the time, Snapchat, which was only a few months old, had a 50% MoM growth rate, which is exceptionally high. Typical successful startups might see growth rates of 20% month-on-month. This level of growth, especially in the context of a growing base, is indicative of a product that’s rapidly gaining traction.
3. DAU/MAU Ratio: At 50%, Snapchat’s ratio was very high, suggesting that a significant portion of the monthly user base is engaging with the product daily. In many cases, a DAU/MAU ratio of 20% is considered healthy. This high ratio points to deep user engagement and habit formation.
4. Retention After 90 Days: Snapchat was able to retain 50% of users after 90 days, a ratio well above industry averages, where even a 30% retention rate would be considered strong. High retention is a key indicator of long-term viability as it puts less pressure on acquiring new customers.

Jeremy Liew’s conviction that Snapchat had evolved into a habitual part of its users’ lives stemmed from the app’s compelling engagement patterns. The metrics demonstrated frequent and consistent interaction, with users returning to the platform multiple times daily.

This level of engagement indicated that Snapchat had seamlessly integrated into the daily routines of its users, becoming a habit-forming service. Liew recognized these patterns as hallmarks of a product that had achieved a deep product-market fit.

Does Having A “10x Better Product” Matter For Product-Market Fit?

The expression is often credited to Google’s Larry Page and Sergey Brin, who advocated for creating products that are ten times better than the competition—not just incrementally better.
The rationale is that a product or service offering a revolutionary improvement delivers overwhelming value to the user, making the choice to switch or adopt obvious.

I recently counter-argued to a VC discussing an investment opportunity that the best product rarely wins. “You need one that is good enough,” I said. The key is finding the right market, where customers are desperately waiting for that solution.

If your prospects are not desperate, there’s a good enough alternative. Let me tell you, if there’s a good enough alternative, you’re doomed.

Andy Rachleff (Source: Mixergy)

“Sure Aram, but a product that is good enough in an underserved market is 10x better than the alternative.”

I’m happy I lost that argument.

The AirBnB Case Study

Rachleff, who’s widely credited with coining the term “product-market fit,” describes Airbnb as a compelling example of product-market fit, illustrating how serendipity, coupled with a systematic approach, can reveal a market’s desperate need.

Initially, Airbnb stumbled upon their business model by renting out a room to offset their rent during a design conference, unexpectedly uncovering a significant demand for an alternative lodging solution.

However, Airbnb’s Founders quickly realized that a peer-to-peer events-related business was unsustainable. They pivoted to focus on providing all travelers—not just conference goers—with short-term rentals. This move from an event-based service to a broader platform for renting spaces demonstrated the essence of product-market fit: identifying a product that addresses a deeply felt need among consumers.

Serendipity plays a role in finding product market fit but the process to get to serendipity is incredibly consistent. 

Andy Rachleff – Wealthfront (Source: mixergy)

Rachleff emphasizes that while the discovery of such a fit might involve an element of luck, the process leading to it is remarkably consistent, highlighting the importance of remaining open to pivoting based on customer feedback and market signals.

Airbnb’s journey underscores that the key is not to create an excellent product but to find a significant, underserved market craving for that product. By quickly adapting to the needs of its target customers and providing an appealing alternative to hotels, Airbnb found its place in the larger hospitality market.

Product-Market Fit or Market-Product Fit?

Product-market fit is not always building a product first and finding a market for it.

In fact, the main reason why startups fail is that “they build a product nobody wants,” as Eric Ries would put it. I wrote before about the underlying cause pushing Founders to focus too much on the product, including the fear of failure.

Wealthfront provides an excellent illustration of “market-product fit.”

Rachleff understood the market opportunity for Wealthfront by recognizing the need for low-cost and automated investment advice. He was able to exploit this opportunity by utilizing technology to create an algorithm-based platform that provided personalized, goal-oriented investment advice to users at a fraction of the cost of traditional financial advisors. The combination of low-cost and quality advice allowed Wealthfront to quickly gain traction in the market and become successful.

Entrepreneurs might come out of a space where they understood the customers and are looking for products that could serve them.

Steve Blank (source: Startup Istanbul)

“I had this problem for 15 years as an employee and decided to become an entrepreneur to build the solution” is a popular narrative among Venture Capitalists. It is often a quicker way to product-market fit.

Borrowing from Stanford Professor Steve Blank, Rachleff claims that companies exploiting an inflection point in technology to answer a market need are well-positioned to find product-market fit.

Rachleff took his own medicine when he recognized the need for a financial planning service available to the masses and created Wealthfront accordingly. Financial advisors typically required their customers to own at least $10 million in assets in order to benefit from their services, but with Wealthfront, customers can access similar advice for only a few hundred euros. The service relies on an inflection point allowing applications to access banking services via APIs.

By utilizing technology and recognizing the market opportunity, Rachleff was able to successfully create an algorithm-based platform that provides quality advice at an affordable cost.

Why Justin Kan Is Right on Product-Market Fit

The main difficulty in Venture Capital investing is that early-stage startups produce very little data. VCs must exploit signals to arrive at an investment decision.

Product-market fit means being in a good market with a product that can satisfy that market.

Marc Andreessen (Source: a16Z)

Venture Capitalists look for three key signals to help them decide whether or not to invest in a business venture:

• The quality of the Founding team is a sign of its potential for success – strong technical and management skills are critical, but so is the team’s determination and track record
• The size of the market indicates the scope for growth and profitability. Investors want to know that their funds will generate a significant return by selling their shares in a huge company
• How the product or service fills an unmet need in the market, to avoid the startups’ cemetery as much as possible

Failing to score on these criteria is usually why VCs pass on investment opportunities.

Andreessen’s quote mentioned above focuses on two of these criteria. I often remark to entrepreneurs I train that Andreessen doesn’t look for “the best product”, but one that is good enough.

Overinvesting in features can be detrimental to entrepreneurs’ success because it can detract from their core offering, which may lead to business failure. Founders are too often overconfident in their reading of potential customers and don’t spend enough time listening to them.

No amount of money will make a product fit a market need if it is not real, urgent, and substantial. Reaching PMF does not guarantee success, but not reaching it almost always ends in failure.

Conclusion: tl;dr

Justin Kan’s quote accurately sums up the importance of product-market fit. Without it, companies fail as they build products that nobody wants or needs.

To achieve success, entrepreneurs need to understand their target market and create a product that meets those needs in order to get customers actively buying, using, and recommending the product to others.

Utilizing technology can help entrepreneurs quickly find an inflection point in the market, which allows them to provide quality advice at an affordable cost—something Andy Rachleff did when he created Wealthfront. Product-market fit is essential for any business looking to raise substantial funding.