Product/ Market Fit is a vital stage in the startup journey. But its is a tough concept to understand. I prefer to call it Customer/ Product Fit because it is about customer need. It is still hard to define. Think of it as being like the process of making a designer, bespoke suit. Lots of careful craftsmanship and testing to reach a product the customer falls in love with.
An Essential Part of The SaaS Revenue Model
Product/ Market Fit is a key concept for growing and developing any startup. You can't build the SaaS recurring revenue model without it. Investors and analysts see it as a key milestone on the path to building a successful new business. Almost every entrepreneur is aware of its importance. Most funding pitches will refer to the idea.
Yet I see a lot of business plans that go wrong dealing with Product/ Market Fit. Many have a bad way of handling the question. Or the description is confusing. Maybe the claimed fit just doesn’t exist. Or the evidence to support it is not in the pitch. In a few, the point is just not addressed.
The Problem of Definition
I don’t think the phrase is right to describe the idea. I prefer Customer/ Product Fit for a couple of reasons. The main challenge for a startup at the ‘fit’ stage is finding and defining a real customer need. What is the problem that someone will hire your product to solve? Product design is important. But in response to customer testing and feedback. Not in isolation. So the phrase should put customer first.
Using the word customer is also more helpful than talking about market. A lot of investors and entrepreneurs seem to define a market as something large and amorphous. Described by numbers and figures. Maybe sized by respected third party research. The Fit we are looking for is much more specific. It needs to talk about a recognisable person. With a problem that is practical and/ or emotional.
Think about all the problems that you might build a startup to solve. The things that you feel need fixing in your life. How many could you put a value to? My bet is no more than a handful. That’s one of the reasons pricing is so tough.
Values for markets are ascribed by others. They are not taken direct from customers. We can’t build a product this way. It needs to come alive. The customer needs to be real. Or at least a persona that an outsider can recognise.
Customer/ Product not Product/Market
The challenge may be that the concept is hard to define. For most SaaS metrics you can find a load of articles analysing and explaining the principles in detail. Books such as The Lean Startup and 4 Steps to The Epiphany describe each stage of the startup process. There is a fair bit of unfamiliar jargon. And plenty of illustrations and examples to make it all clear.
Product/ Market Fit is different. The most common advice is “You’ll know it when you see it”. Very helpful.
I love watching Guy Kawasaki talk about this stuff. When he describes Product/ Market Fit for YouTube. “The business will take off when people start dropping Mentos into a bottle of Diet Coke and filiming it” Or Twitter. “The turning point will be when everyone starts sharing pictures of their cat scratching itself.” Do you think those teams knew they had a fit when they saw such examples?
This is vital to build a SaaS recurring revenue model. Small business consulting is all about solving this type of problem.
Think About a Bespoke Suit
I am no closer to having a good definition than anyone else. However, there is an analogy I find helpful. Compare Customer/ Product Fit to the process for creating a bespoke, designer suit (or a dress if you prefer).
Everything about bespoke tailoring is slow and doesn’t scale. The measurements are by hand. The cloth is cut and stitched by hand. The craftsman needs to talk to the customers face to face. Many times. And all that is perfect for a startup that hasn’t yet found a Fit. You can spend any amount of time getting things right for that first customer.
Its a Collaboration
Your beautiful suit is also a collaboration. The customer will have ideas and preferences. From colour of cloth to how many buttons on the cuff. The designer will also offer ideas. A new style of lapel perhaps. Or an extra pocket in a useful place. Most new products are like this. It is not as simple as just asking the customer what he or she needs and then building. But finding a complete new market where the customers don’t yet know they want what you have to offer is also rare. Digging into the customer thought process. Learning from how your potential users work. Offering some new ideas of your own. This is exactly the cycle you need to go through.
Use Every Piece of Data
The other part of the initial process for bespoke is also important to remember. Your tailor will want to gather lots of data points. Measure every part of your body. Sometimes 2 or 3 times. Ask lots of detailed questions. What do you carry in your pockets? Where do you keep your phone? How does your weight fluctuate? Every tiny detail that could influence the fit and wear of your new clothes is investigated.
Learn how to do this. Get as much information from and about your customers as possible. Measure when you can. Ask and probe and test for the rest. Look at every piece of the picture. Pay special attention to things that don’t seem to fit. Use the data to make sure your design is right.
At this point the customer leaves the shop. Their suit is then handmade with wonderful craftsmanship and skill. That is, the tailor makes a great product. This should be obvious. But its not. You do not have Customer/ Product Fit if you product is a ropey old beta. You might have some potential interest. But you have not reached a Fit.
Test, Test, Test
And even after all that data gathering and all that craft the process is not done. Now our bespoke tailor is going to test his product. The customer returns for a fitting. Inch by inch the suit gets checked and rechecked. Notes are taken. Pins are deployed. The tailor takes the clothing back and makes his adjustments. This can happen several times. Only when both designer and customer are completely happy does the suit become the perfect fit.
Testing is one part of the startup journey where advice and expertise is plentiful. So use it. Show me Customer/ Product Fit with no tests. No iterations or tweaking to reflect user feedback. I will show you a startup that is not there yet.
Build Something Users Love
In the end the best bespoke tailors will not let a garment out of the store until the customer is in love with it. This is the true craftsman’s definition of Customer/ Product Fit. On reflection it is pretty good definition for a startup as well. This is a process without a guide book. Every founder will need to reach his or her own Fit.
I do small business consulting for startups to help solve this type of problem. If you would like more ideas about building a growing a SaaS business in your inbox every week, subscribe below.
Building a SaaS business can feel like one long series of experiments. No-one can afford to just keep trying random ideas. My new project using Codigital provides a great engine for the startup community. We can collaborate to find the best ideas about customer onboarding. Everyone who participates in the project will benefit.
Sometimes the SaaS recurring revenue model feels like a variation on an old cliche. Run enough A/B tests on enough scenarios and you will create a unicorn…in the end. Right now some start ups are raising enormous amounts of cash. You could be forgiven for thinking they plan to follow this approach to its logical conclusion. Things are a little harder if you don’t live on the world of multi million dollar seed rounds.
If your cash runway only extends to trying a few ideas, how do you find the best? This month I am trying an experiment to help SaaS companies answer this question. This article outlines the test. Summarises progress to date. And is honest about an important limitation. You will also find this link Sunstone Codigital Onboarding Project . We would love to have your contribution.
Background and the Experiment
I facilitate an awesome group of SaaS startups in Scotland. When we meet the exchange of ideas and experience generates real value for everyone. We also have a slack group. This is a great tool for keeping the the conversation flowing every day. I thought it would be great if we could add more ways for the community to collaborate. Evaluating ideas generated and ranking them is ideal. An old friend recently introduced me to Codigital. A SaaS startup with a product which does just that.
Here’s how it works. Ask an open question and start a project to share ideas. Anyone you invite can suggest an idea as an answer to the question. So far so Quora. Then the clever bits. First any participant can suggest edits to every idea. That means the answers can emerge as a collaboration.
Rating is not by simple upvotes. Participants rank ideas by a series of head to head comparisons. Kind of serial A/B testing. What emerges is a proper evaluation of the merits of each idea. Collaboration and consideration not just favourites or likes.
I love the concept so I decided to give it a try. The discussion topic for my next SaaS Group discussion is customer onboarding. I have set up a Codigital project with this question:
“What are the best ways to onboard SaaS B2B customers?"
Progress and Participation
4. Proactively contact trial lists, offer to run trial with them online
5. No catch all answer. Depends on platform, vertical and general skill of target users
6. Only set up a free trial for people who really want to try it out.
7. Provide free trial period initially
These are in the rank order at the time of writing this post. If you don’t agree then jump in and share your own thoughts. The ideas that rank at the top are always interesting. Sometimes the more innovative ideas lurk further down. Keep an eye out for originality as well as popularity.
The project will remain open for another couple of weeks. I hope it will fuel a great discussion in the SaaS Group. I am looking forward to sharing the results.
After just a few days, the process is already working. We have had 7 ideas from 8 participants. Most of those participants have also taken part in the ranking exercise. The app provides a nice summary which you can see opposite:
The ideas also look promising. This is what we have so far:
1. Demonstrate the service’s value to the business
2. Targeted relevant messages throughout the trial lifetime
3. Put a screencast of a demo trial on your website
Benefits and Limitations
One of the reasons this app attracted me was past experience. My previous firm carried out a project of this type with all UK staff. 15,000 people in all. The topic in that case was applications for the Internet of Things. It gathered over a hundred ideas. More than 10,000 staff were active participants. I was the partner responsible for the project. I learned a whole lot both good and bad. Codigital is the opportunity to put these into practice and deliver even better results.
The openness and flexibility of this approach was a key benefit. We received a much broader range of suggestions. Far more than we could ever have imagined on a traditional project. One of my favourites was right before launch. A junior in the post room offered to create an animation to introduce the concept. His drawing and storyboarding were stunning. Last I heard he was shooting up the ranks in marketing.
We used a different mechanism to score ideas. A sort of virtual stock market. This was great at encouraging participation. Although it did tempt some people to game the system. I think Codigital avoids this risk.
More important, the evaluation did tend to favour the more obvious answers. The top suggestions are top for a reason so this is not entirely a bad thing. But there is a risk of missing the true innovations. The out of the box thinking. As noted above, I will be scouring the list for this type of contribution.
This brings me to the biggest single limitation. Generating and selecting great ideas is difficult. It is only one step in delivering business improvement. Executing those ideas in a real business is what counts. My previous project was fun but frustrating for this reason. Our client didn’t pick up and run with anything we suggested. We didn’t have a plan to help them execute. Result - some great conversations but no real change.
Execute with World Class Small Business Consulting a Startup Can Afford
That is the essence of why small business consulting the Sunstone way is different. My focus is to help startups grow and develop. Not to create great reports.
I will be keeping a close watch on the progress of my project. I will also be working on tools and support. Aiming to help participants take advantage of the ideas generated. I need your help. Please join the project. Share your ideas and collaborate with the great suggestions already contributed. Everyone will benefit.
Building and growing a startup is tough. Underneath all the Unicorns are hundreds of companies battling for investment. The growth of Slack or WhatsApp is record breaking. It challenges founders everywhere to hustle for traction. Read the endless articles on beautiful UX design. And remember the struggles to achieve product/ market fit.
Maybe that’s why entrepreneurs often ask for more help. But the best source of help is within. Startups are the best source of innovation in business and technology. Teams also advocate powerful values. Openness, sharing and learning are at the core of the startup dream. Innovation and values lay the foundations for amazing communities.
EIE15 - Scotland's Premier Startup Event
Here in Scotland we had the premier event for our startup community this week. EIE 15 brought together a bunch of amazing companies. The largest gathering of investors we see all year. And every advisor and supporter in the ecosystem. From inspirational speeches to 1 minute pitches with a heady brew of networking. Its an awesome day.
Community Makes the Difference
Anyone can see that it is impossible to recreate Silicon Valley in a 1,000 cities. Hero entrepreneurs and multi billion dollar funding rounds are beyond most places. But we all have the potential to build a great community. I love following and celebrating startup communities. Some of the best ideas and the biggest changes are rooted in community efforts. For example the startup community in South Africa is tackling the problem of xenophobia @iafrikan. Or explore the incredible startup world of Trondheim in Norway @arcticstartup.
Community brings startups three things. Working together means resources, experience and connections get shared. Everyone grows faster as a result. Openness allows small teams to build on the efforts of others. Testing products, linking APIs and tackling markets. Connected ecosystems offer support and encouragement. Just knowing that others have been through the fire and lived makes a difference.
Small Business Consulting to Help Build and Grow
We Can All Be Part of Something Great
“Its not a zero sum game” is a favourite mantra. This is what it means.
How often do you hear that a startup is going to change the world? Communities of startups will change the world. Groups not individuals will be the mechanism. The future of work will be self employed, networked and varied. Fewer and fewer people will work in a corporation or for a government. The skills we learn in our twenties will need to evolve or transform. Everyone will have 4, 5 or 6 “careers”. Communities will support and celebrate this lifestyle.
Work will be for a lifetime. The idea of retirement will become outmoded. Each individual will choose to vary the pace and intensity of work. Adapting to life circumstances along the way. It has to be this way. Demographics and economics will not support the current model. Technology is busy breaking it up.
Not every startup community will be the home of billionaires and unicorns. The vast majority will consist of hard working people, co-operating and succeeding. Having fun and living life well. We all have the chance to be part of something great.
EIE15 reminded me that we have many of the elements in place here in Scotland. Structural basics include great universities and a supportive Government. Two incredible companies have reached “unicorn” status. Skyscanner and Fanduel - check them out. The exhibition hall was full of great entrepreneurs aspiring to join them.
More huge successes would be welcome. Our urgent need is to build a strong community of mid size growing businesses. Too many startups are caught in a trap of small. The billion dollar blowouts are great . We must back them with hundred or more in the $10-100million range. There are lots of companies with the potential. I could list 20 without thinking. The challenge is to make the step from early stage traction to established business easier.
The community also needs a voice. We connect through big events like EIE15. A host of meetups and other small scale events are also available. Open Tech Calendar lists 68 right now. On a daily basis hubs like Codebase, Entrepreneurial Spark and Rookieoven (my favourite) are home to buzzing groups of founders. Someone needs to bring these stories together and tell them to the wider world.
This week reminds me to keep helping startups grow and develop. My small business consulting is all about this focus. This is a community effort. It is about answering questions not a defined formula. If you want to join those discussions subscribe below.
A startup I know well posed an interesting question this week. The company is raising seed funding. The founder has taken a cautious path so they have good traction and a revenue model. Nonetheless this is their first formal round. One of the potential investors is unsure of the valuation. Said investor is proposing a discounted cash flow (DCF) valuation.
DCF is a well known and respected technique. Analysts use it to value companies and long term projects every day. What is it? Wikipedia has this definition:
In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted by using cost of capital to give their present values (PVs). The sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.
This is crazy
The investor who thinks this works for any startup is crazy. The basis of DCF is a forecast of future cash flows. Startups operate in a world of complete uncertainty. Forecasting revenues is near impossible. When I review startup business plans, I am interested in the financial forecast. But I am looking for messages about ambition, traction and product/ market fit. I don’t place any reliance on the actual numbers.
If you look closer you will see the little word “All”. Proper DCF uses all future cash flows. Most startup business plans only include 3 year forecasts. I have seen DCF valuations of capital projects that cover 20, 30 or even 50 years. At seed stage most startups do not even survive the 3 year horizon.
Small Business Consulting Gets Technical
If you get this, it is easy to dismiss DCF. Irrelevant in the startup world. I agree that it makes no sense as a basis of valuation. But I think it does hold some lessons for a SaaS business. The reason? Consider the parallels with lifetime value (LTV).
LTV is one of the core SaaS measures. In concept it is just like DCF. You calculate the revenue or gross profit for each customer. Over the life of that customer. Your LTV is the sum of the future expected revenues from each customer. Then calculate an average to give an individual customer LTV.
This is a newer and less developed way of measuring value compared to DCF. What lessons can we learn from LTV’s older, more grown up cousin?
“Discounted by using the cost of capital” covers several things. Including some reasons not to use DCF for a startup valuation. The words are bit of financial jargon. So the best way to illustrate this is by unbundling the terms.
On the surface LTV is better than DCF at estimating lifetime. In many calculations there is no fixed lifetime for DCF. Churn puts a time horizon into every LTV number. The maths of using churn this way makes sense. But it hides an important truth. Churn happens to the customers that leave. In every cohort there are customers that stay around. These accounts are gold mines.
Mobile network operators discovered this early. Your average customer is an expensive habit for an MNO. He or She changes the handset every 2 years. This means an extra customer acquisition cost. Often linked to a drop in monthly revenue. Some people don’t do this. They keep that old Nokia forever. Many love those things. The monthly line rental and the call package just keep rolling in.
You can make an simple calculation of the impact of this. Take a typical SaaS SME customer paying £50 subscription every month. The company has nice ow churn of 1% per month. The average LTV formula is:
LTV = MRR X 1/CR where MRR is monthly recurring revenue and CR is the churn rate.
For our example customer this gives LTV of £2,500.
The technical term for revenue which keeps going forever is perpetuity (P). The formula for calculating the value of a stream of payments in perpetuity is:
P = MRR/IR where IR is the monthly interest rate or cost of capital if you have that number.
Imagine an interest rate of 10% per annum. High by today’s standards. Above the range of 4-8% quoted in this article from Forbes last year.
Using this rate P is £6,000. The customer you keep is worth almost 2 and a half times the average. Before you factor in the extra customer acquisition costs involved. Remember you have to replace every user who cancels a subscription.
Cost of Capital
Applying calculated values for cost of capital makes no sense in the startup world. The uncertainty overwhelms the logic. Thinking about how to approach this provides a great frame of reference for some big decisions.
Time value of money is real. A dollar today is worth more than a dollar in a year’s time. But the difference is not infinite. Discounts to encourage people to pay for a year or more upfront make sense. The cash upfront can be a lifeline for a startup. Dry interest rates don’t capture the value that represents. You do need to think about what works when pricing up your product.
Capital structure is not a relevant factor. The startup parallel is opportunity cost. Or cost of choice if you prefer. Again not something to wrap up in a percentage rate. But think about adding features, tackling new markets and so on. Early doors the question is which option brings the best return. As you become established this changes. Now you need to ask a different question. Will investing in something new earn a good return? Is it better to put more resources into your proven business model?
Weighing up risk is one for the future. Every step on the startup journey is high risk. A founder cannot be reckless but risk analysis can lead to paralysis. Be aware but don’t lose the bias to action.
Building a scalable SaaS recurring revenue model is neither art nor science. Skill and judgement play a part in every decision. A rigid set of rules and boundaries has little meaning. A framework that helps your team recognise the context of your choice can be a big help.
Professional finance managers have developed some great techniques. DCF has an important place in this arsenal. The basis of these models is valid theory and sound maths. The variables involved kill the benefit for a startup. Understanding how established methods work can still provide valuable lessons. The core SaaS concept of LTV is a cousin of DCF. Looking at both is illuminating.
No two SaaS businesses will be the same. Within any business, the context of each decision will also be different. No advisor can lift the load of making tough decisions from an entrepreneur. Great small business consulting for a startup means helping founders make those choices better. Helping new leaders learn their craft. Subscribe for more insights direct to your inbox.
Learn the Startup Craft to Build Your Revenue Model
Tuesday 28 April was the third gathering of a group of SaaS companies in Scotland. I am lucky enough to facilitate the discussion. It is some of the most fun I have. This time round we concentrated in customer acquisition. You can see some of the ideas shared in more detail here. Follow this link to find a list of all the great companies that participate.
The main topic was the benefits of Inbound v Outbound approaches. I also posted on Medium about some of the thoughts stimulated:
The Best Way to Grow the SaaS Revenue Model?
Openness and sharing
Whatever tactics you favour, SaaS growth is not an easy nut to crack. One thing we can do is help each other get there. There is a already a great spirit of openness and sharing when the group gets together. I also love the eMail Alan Bonner sent after the event. Some great ideas. I have shared the full text on the Ideas page.
Ways of sharing
I have a couple of other ideas which might help things along….
There is very little data available on the SaaS marketplace. I have made a start on building something for Scotland. Have a look at my SaaS Scotland page for a collection of 192 Scottish SaaS companies. I would love to add to this database if you know of others that I have missed. I will also look to add more than just basic data in due course.
We already have a LinkedIn Group for SaaS. I have now switched this to be an open group. Feel free to join in. I will be honest and say that I am not convinced by LinkedIn as a way of sharing and engaging. So I have also set up a Slack channel. Drop me a line if you would like to contribute.
Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.