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Measuring Product/Market Fit: 4 Metrics You Need to Know

2020 September 3 16:30 GMT-06:00

Your Business Needs Product/Market Fit to Succeed

Product/Market Fit is a concept in the business world that can help organizations supercharge the relationship between their business, their products, and the customers that buy them.

Metrics for Product Market Fit

Product/Market Fit happens when a business has successfully identified its target customer(s) and has served them with the right product that satisfies a need and that they enjoy using.

When these three factors interplay (better word for that), it can lead to creating greater value for your customers, greater customer satisfaction, and growth for your business.

Product/Market Fit helps organizations determine:

  • If their chosen market is a good fit for their business goals
  • If their business can deliver products/services that satisfy the needs of their chosen market

Because no product has unlimited potential in a specific market, your SaaS strategy should require you to know your target audience and if your chosen market is worth investing your expertise, time, and money.

In other words, if the market has potential beyond the next few years.

Why Product/Market Fit matters

When we consider that market trends and demand across all industries tend to fluctuate, we must acknowledge that not every product currently available will be able to satisfy every users’ needs.

If you want your business to survive and thrive, you should introduce products that address and satisfy the current market demand to stay on top of your competitors.

Whether the product you offer, the people you offer it to, and the price you sell it for is a match for the current demand, are all part of why finding a product/market fit for each of your products is essential.

Determining when you reach a Product/Market Fit

Understanding the moment your product team achieves a product/market fit can be relatively straightforward. Most of the time, you can feel it.

If your product delivers a solution that others are willing to pay for it regularly, and there is enough demand for this solution, you have a profitable product/market fit.

If customers are recommending your product and your business receives substantial positive reviews, then you have a good product/market fit.

What is not so clear-cut is understanding how much closer to finding the right product/market fit your team is during the process.

How do you know you are moving in the right direction?

In this article, we will take a look at the top metrics your product team needs to understand to measure product/market fit for a specific product and how effective it is to make sure that your team is headed in the right direction.

Metrics to Measure Product/Market Fit

Correlating a product to a specific market does not happen by accident. Businesses must test their products, tweak them, and find the perfect combination of features and marketing and sales tactics to attract their target audience.

This is accomplished with market research, product testing, and a lot of effort.

Total Addressable Market (TAM)

TAM is a metric you can use to estimate the size of your market and the potential revenue your business could earn from it. This metric is often used by start-ups and small businesses that are new in their industry.

With every competitor your business shares the market with, your total TAM decreases. Therefore, your TAM will never be 100% (unless you run a monopoly). How much TAM your company has is called your market share .

Once you identify your TAM, you can determine the percentage of customers your product will serve.

As you continue to test your product prototype with real customers and tweak it to match changing market trends, the closer you are to a product/market fit, your TAM percentage should increase.

If you identify early on that you have a small TAM, this is a strong indicator that your chosen market is not broad enough.

Measuring Your Total Addressable Market (TAM)

Assessing your business’s potential market revenue goes beyond measuring your total addressable market. According to the experts, the Bottom-Up Approach proves the most reliable method to estimate how much of your market share your business can acquire in revenue.

TAM Bottom Up Approach triangle

(Source: Slide Team)

The Bottom-Up analysis of an industry involves determining:

  • The total number of customers within a specific market (add the total number of reported customers each company in this market has) and
  • Multiply this number by the average annual revenue for each customer in that market, or ACV (annual contract value).

TAM = (Total # of Customers) X (Annual Contract Value [ACV]

This will require your team to perform extensive market research and delve into the specific numbers that big companies in your industry provide.

Sean Ellis Test

The Sean Ellis Test is a survey used by both start-ups and Fortune 500 companies to measure how much of a “fit” their product is to its intended audience.

In the survey, product teams ask respondents any questions that can provide you with information and feedback to determine if your product will likely resonate long term with its market.

Include the question:

How would you feel if you could no longer use our product?

Include the following multiple-choice answers:

  1. Very disappointed,
  2. Somewhat disappointed, or
  3. Not disappointed.
Measuring your Sean Ellis Test results

If more than 40% of participants answer they would be “very disappointed” if they could no longer use your product, you likely have a great product/market fit. This means your consumers base likely sees value in the item you sale.

Not every customer will qualify to participate. Ideally, you want to apply the survey to early customers who fall conform the following requirements:

  1. They have experienced the core product or the service,
  2. They have experienced the product or service at least two times, and
  3. They have experienced the product or the service in the last two weeks.

Respondents who fulfill these three criteria are more likely to understand how your product or service works and see the higher value it offers.

Cohort Retention Rate

The cohort retention rate measures the number of customers who are still purchasing a product after a determined period. Often, this period is calculated over 8 weeks.

For the SaaS industry, a 35% cohort retention rate is considered ideal.

Cohort Retention Rate chart(Source: Mixpanel)

Therefore, this metric is best for companies that have an established customer base.

Measuring your business’s cohort retention rate comes with several advantages for your product team:

  • They measure data for a full user lifecycle – a survey, on the other, collects data during a specific point in the user’s lifecycle. This information can change later.
  • They do not have to worry about response bias – you get information about all of your product’s users, not just the ones willing to participate in a survey.
  • They measure user behavior – the data you use to calculate retention rates is extrapolated from their purchasing behavior.
Measuring Cohort Retention Rate

When calculating the cohort retention rate, your product team can choose to measure various combinations of actions such as the number of users who continue to purchase an item, number of visits to a website or app, or the number of premium subscribers.

Cohort Retention Rate formula | Theia Marketing

Using the sample equation above, we can measure the cohort retention rate of users who purchased a product within 8 weeks.

Using this example, if 120 users purchased a product at the start of the 8 weeks, but only 56 users were still purchasing the item after 8 weeks, the cohort retention rate would equal 2%.

Product analytics platforms like Mixpanel and Pendo can help product teams calculate their retention rates as well as present other essential data points to measure your products’ success.

Net Promoter Score (NPS)

Your product’s net promoter score helps your team measure customer loyalty and satisfaction and consumers’ overall perception of your brand after they have bought and tested your product.

Much like the Sean Ellis Test, NPS relies on consumer feedback to measure a product’s future viability within a specific industry.

Measuring a product’s net promoter score is only encouraged during the Lead Product Process when your team is exploring your ideal product/market fit.

In this stage, you will want to collect as much feedback as possible from consumers.Net Promoter Score scale(Source: Helpshift)

The question: How likely are you to recommend [product name] to a friend or colleague?

Respondents are placed into three different categories, according to their response:

  • Promoters (score of 9-10): consumers are enthusiastic about your product and brand and are likely to keep purchasing and refer others.
  • Passives (score of 7-8): customers are satisfied with your product but could easily be swayed to purchase from your competitors.
  • Detractors (score of 0-6): unhappy or dissatisfied consumers who are unlikely to purchase your product again. They may detract future customers with their negative reviews.

Target passives and detractors by asking a follow-up question such as:

What would it take for you to recommend [product name]?

Any feedback from your respondents will bring you a step closer to crafting the ideal product for its intended audience.

Know your metrics before declaring a Product/Market Fit

Launching a new product for your organization is always a thrilling and scary experience.

While the road to a perfect product/market fit may be long with unexpected twists and turns, the information your team acquires from measuring your TAM, cohort retention rate, and NPS can provide your product team the data it needs to correctly declare it has found the ideal market (and customers) for your newest product.

 

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Karen Lopez

Written by Karen Lopez

Karen Lopez is Theia Marketing's marketing assistant.

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