Poor Product-Market Fit
Pivot Your Way to a Successful Launch
It may seem obvious, but building a product the market wants is critical to keeping your startup from running out of cash. It’s all too easy to keep your product in the back room, iterating on it for months or years, only to find out no one wants to use or buy it. Products the market doesn’t want not only waste valuable capital, but also waste your time as an entrepreneur. Finding the right balance between customer feedback and staying true to your change-the-world vision is hard, but it’s critical to all that follows: recruiting with a great team, raising capital, and selling your product.
Product-Market Fit
Many startups never achieve the elusive product-market fit. Once found, product-market fit transforms a startup’s trajectory. Before a company finds product-market fit, nearly everything the company does (or should do) is about the search for product-market fit. After the company finds it, everything is about scaling: ramping up operations to accommodate a rising number of customers. You want to scale users/customers, team, and infrastructure.
Some companies—Facebook and Zynga, for example—find product-market fit right out of the gate. Or at least they appear to. Others, like Intuit, go along for years, sometimes teetering on the brink of bankruptcy, until they crack the code.
The best entrepreneurs are relentless in their pursuit of big markets and products to fit those markets. So why do so many startups never achieve the fit?
Some spend too much time on technology. They keep building without getting user or customer feedback. All too often, this happens with purely technical founders building product for product’s sake. Some fear rejection: they take it personally when others don’t want their product.
Others fail to face the reality of what the data tells them. They refuse to confront the tough questions: was my thesis incorrect? If so, what should I do?
Still more never find a way to reach their market. The market need is there, the product is compelling, but they can’t reach their customers. Many companies trying to target the small-business segment have failed because of this. In such scenarios, a startup’s success becomes a lot less about building great product and a lot more about efficiently reaching the potential customers.
But worst of all is achieving product-market fit only to discover that the actual market is very, very small.
Big Markets
Companies targeting small markets are more susceptible to failure than their big-market counterparts.
These companies can still be rewarding businesses—for a time. Some entrepreneurs don’t have the aspiration to go after big markets or build big businesses, or they have a desire to build something small and boutique-like—a bed and breakfast, for example, or a local restaurant.
But when it comes to the most successful tech startups—Apple, Facebook, Google, Salesforce.com, to name just a few—great markets are synonymous with big markets. Companies with big markets benefit from economies of scale. They can spend more on customer acquisition and be more cost-effective on distribution, and, simply put, they have a lot more potential users of their product or customers to sell to. Amazon commoditized local booksellers; Walmart commoditized local retailers. Time and again, those going after big markets dominate those going after small ones.
As an entrepreneur, your goal is to find a big-market opportunity and deliver a product that captures it. Going after a big-market opportunity vastly reduces your chances of failure. To capture a big-market opportunity, you must start off with a big market.
No doubt that seems obvious, but I repeatedly see entrepreneurs start in small markets. It’s just as hard to execute on a big-market opportunity as on a small one—sometimes harder. Yet entrepreneurs continue to target small markets. Why?
Often, big markets appear unassailable. For years, Electronic Arts (EA) dominated the software market for games. At one point, the company had a market cap of more than $17 billion. Yet in just a few years, Zynga, a new tech startup, swooped in and dominated a new area of gaming: social gaming. This was a market that EA should have dominated but failed to. That’s because EA was trapped by its legacy model, whereas the founder of Zynga recognized a disruptive wave and seized it.
EA’s games were expensive to produce. Its distribution model of putting software on retail-store shelves was both costly and outdated. It had to spend tens of millions of dollars on marketing to drive awareness of new games. Even for existing games, the company had to spend heavily on marketing to drive demand for new versions. And many of its games appealed only to a niche of hard-core gamers.
For all these reasons, many venture capitalists steered away from investments in the gaming market. They worried about the costs of content creation, marketing, and distribution. EA’s competition came only in the form of other well-established players who could afford similar investments in development and distribution, such as Microsoft and Sony.
Ride the Wave
If you want to be a great surfer, you’ve got to find a great wave to ride.
Zynga founder Mark Pincus recognized that new social platform Facebook could provide an incredibly efficient way to deliver and market games. Zynga’s social games used Facebook for initial distribution. They also incented existing users to get new users to play by making the participation of other users a core part of every game. In just one example, to build bigger and bigger cities in the Zynga game CityVille, users had to invite their friends to staff various functions in their city, such as the Town Hall.
Because they relied on lower-quality graphics, Zynga’s games were far less costly to produce. Their relative simplicity and the fact that it was free to start playing made them appealing to a much broader audience. Zynga made sure there was zero friction to adoption: that is, nothing was standing in the way between them and their potential users.
Zynga stole what’s called timeshare: it gave people an alternative place to spend their time during the day. Instead of consuming soap operas, they could now consume Zynga games and gain a sense of fulfillment—building a virtual city, for example—in the process.
The company also introduced innovative new adoption and monetization models. The games were free to play but required users to purchase virtual goods if they wanted to move up more quickly. Virtual goods were not a new concept—they had been available in Asia for years, and many skeptics of social gaming argued that such goods would never be adopted outside Asia.
But by making them easily accessible and a core part of the games, Zynga brought them to the mainstream. In part, this was because users felt they were getting the game for free to begin with, so they had less of an issue paying for items later. It was also possible because Zynga capitalized on social dynamics: players felt competitive pressure to buy virtual items that would help them win the friendly yet competitive games among their circle of friends. This coupled with addictive design and gameplay dynamics turned the games into cash machines.
Some of today’s most successful tech startups have come about because their entrepreneurs recognized a market opportunity or disruptive wave and designed products to take advantage of those waves, introducing even greater disruption in the process. Zynga capitalized on the opportunity presented by Facebook and then introduced more disruption through low-cost games, new monetization models, and a zero barrier to adoption. Zynga is just one example of a company that was hugely successful in finding product-market fit in this manner.
Great Product, Bad Market
A talented investor once told me, “A great market and a bad product is better than a bad market and a great product.” All too often, entrepreneurs target small markets. Although targeting a big market might seem close to impossible due to the gorillas already in that market, the reality is that attracting capital for businesses targeting small markets is a lot harder than raising capital to go after big-market opportunities.
Often, entrepreneurs are ahead of their time. Customers aren’t ready to spend money on or change habits for unproven benefits. The company runs out of money waiting for the market to develop; or it tries to start over, but it’s too late.
Company R (a composite) had a compelling concept, but customers weren’t ready to buy in. CEO R proposed a restart: rather than sell to the market segment he was in, he would target a different market segment. As a result, he would significantly reduce Company’s R’s sales and marketing expenses. Company R was mildly successful with its new plan but burned through lots of cash before it reconfigured.
If you have a great team executing flawlessly, but there just aren’t that many potential users or customers for your product, your team’s potential is restricted. Many market opportunities simply aren’t worthy of the teams that go after them. Conversely, teams that stick around in bad markets too long have to find out the hard way that the market always wins.
Product limitations can also restrict potential market size. Some products, for example, require significant customization and correspondingly high setup costs. That means it’s expensive and time-consuming to extract value from them. Thus, the product becomes limited to those customers or users willing to make the time and capital investment to use the product—likely a lot smaller than the total market size originally envisioned for the product.
Company W had a product that should have appealed to the owner of every web site on the planet. But it took three to six months to customize the product and have it start working. Those customers willing to pay the price of implementation in both time and dollars saved tens of millions. Unfortunately, only a few were willing to make that kind of upfront investment, ruling out all but about 1,000 customers in the world.
The trickle-down effect was immense: the sales organization was structured for heavy, long-cycle selling. The product was designed to be customized, so getting to a self-serve model, although always a goal, never became a priority. When it came to sales, other companies couldn’t compete directly on technology. But they came close by offering different solutions that solved the same problem. Those solutions weren’t as effective, but they were good enough. Although the company had an incredible team, the true market—as restricted by the reality of the product—held them back.
Structural Issues
Some markets come with structural issues that can make achieving product-market fit extremely difficult. Life-science companies, for example, frequently face regulatory hurdles (for example, FDA compliance) that are specific to their market.
Markets like these often have existing monetization models—ways they turn their efforts into money—that companies must live within as well. When it comes to monetization, your users can pay, or a third party can pay you. Third parties can be advertisers, in the case of ad-supported businesses. Or they can be other large companies, such as healthcare insurers reimbursing patients for healthcare costs. One big mistake startups make is assuming people will pay when they won’t.
It’s very hard to change human behavior. That’s especially true when it comes to trying to convince people to pay for something they’re used to getting for free. Consider the case of healthcare startups. The widespread adoption of smartphones and iPads coupled with rapidly rising healthcare costs has encouraged many entrepreneurs to go after massive healthcare IT opportunities with innovative new software and hardware. Many assume that consumers will pay for these applications, yet consumers are used to employer-provided insurance covering their healthcare costs. As a result, these startups have to be extra savvy not only about finding the right product-market fit but also when navigating the structure of their market.
Finding Fit
As legendary entrepreneur Steve Blank once said, the best way to find product-market fit is to “get out of the building.” Users and customers can’t define your vision for you—nor should they—but they can inform it. Today you can get out of the building physically and go visit users or customers, or you can do it virtually.
Virtually getting out of the building can be as easy as putting up a landing page (that is, a one-page version of your product or service) and buying Google ads to drive traffic to it. Or you can release a beta of your product and drive organic growth.
It can mean building a version of your app and putting it in the app store to see if people will use it. It can also mean talking to customers and getting a few of them to commit to be early users of your product, if you build it.
Whatever your approach, these days there is no excuse for not getting out of the building. And certainly in the software world, there is no excuse for not pivoting repeatedly, and inexpensively, until you find product-market fit.
Reaching Your Market
Great product-market fit means having not only a product that matches the market, but also a way to distribute that product efficiently. As the old joke goes, you lose money on every sale, but you make it up in volume. Unfortunately, that model doesn’t last long.
Small businesses have always been the siren song of target markets due to the immense number of them. But startups that go after small businesses find out the two painful truths of this market: the customers have little money and are very hard to reach.
When it comes to reaching customers, some markets hold you hostage. Company M, which was started long before Apple introduced the iPhone and Google introduced Android, had an innovative mobile product for consumers. However, the product had to be integrated with the wireless carriers (AT&T, Verizon, and so on) to work. Not only did the company have to negotiate business deals with the wireless carriers and get those carriers to certify its applications; it also had to develop, test, and integrate its software with every phone vendor on whose phone the software was to ship.
After several years, the company got its software deployed and started generating revenue for the carriers. Every time a phone shipped, the company made money. Then a not-so-funny thing happened: the carriers decided they didn’t like the revenue split they had negotiated with the company, and they put a ceiling on the amount of revenue Company M could make. While still generating tens of millions of dollars in revenue, the lucrative contracts now had a limit. The company’s revenue potential was restricted, as was its potential value.
The company had little recourse. The carriers controlled the distribution channel—each carrier had tens of millions of subscribers, and there was virtually no other way to reach them. The choice of target market limited the company’s upside. “One thing’s for sure—I’ll never build a business like that again,” the founder often said when asked about what he was going to do next.
Of course, partnering with big industry players that have existing distribution offers one huge advantage: you get to leverage their distribution. That works great as long as the value equation is relatively equal: your partners value your product, and you value their distribution. But if you end up with only one partner, or your partners can get a similar product somewhere else, watch out. You soon find your market holding you hostage.
When to Pivot and How
Changing direction is one of the biggest strategic decisions a founder ever has to make. Change course too early, and you never see an idea through long enough to understand whether the market will accept it. Wait too long, and you risk running out of cash. Change direction frequently, and you lose the confidence of your team and investors in your ability to lead. How then should an entrepreneur decide how and when to pivot?
Knowing when to pivot is what makes entrepreneurship an art and not a science. But the first step is to confront the data. Most entrepreneurs start with a thesis, whether they articulate it or not. They believe that if they build X, then Y will happen. More often than not, their thesis is incorrect.
The founder of Company B believed he could reach the market by signing up small businesses as customers and giving away the company’s service for free to consumers. It turned out that the small businesses wanted the company to have millions of consumers using its service before they would sign on as customers. Although the founder eventually pivoted, it took him more than 24 months to make the change, wasting valuable time in the process. He went through multiple sales and marketing executives before admitting that although he was right about being in a big market ripe for disruption, his approach to taking his product to market simply wasn’t going to work.
“What is the data telling me?” is critical question to ask yourself; being honest with yourself about the answer is even more so. When there is a difference between your thesis and the reality of the data, it’s time to think hard about a pivot.
Data can make a potentially tough discussion with management, investors, and board members a lot easier. Although sunk cost logically shouldn’t factor into what you do going forward, the reality is that sunk cost weighs heavily on both management’s and investors’ emotions when making decisions. Discussions about pivots may still be emotional and challenging, but when you use the data to frame them, they become a lot more productive.
Pivoting can be tough. But staying in a bad market is even tougher; and, ultimately, the market will eat up all your capital and beat you. Iteration is great for perfecting a product once there’s demand, but more often than not, radical change is required—either in product or market—to achieve product-market fit.
Capitalizing Too Early
Raising too much capital too early can make pivoting even harder. The vast majority of investors prefer to invest in a strategy that’s already working, when a company is at a key inflection point and needs capital to scale.
Some companies have to raise large amounts of capital even to have a shot at achieving product-market fit—those building hardware, for example. But outside of those companies, it’s best not to raise too much capital until you’ve achieved product-market fit and are ready to scale.
Ironically, raising too much capital too early reduces your options more frequently than it expands them. Most investors expect companies to spend the money they raise in support of growth, not keep it for a rainy day. Whether they admit it or not, founders who raise a lot of money feel intense pressure to spend it.
Moreover, with big capital comes big expectations. The founder of Company E raised tens of millions of dollars based on his reputation as the former head of a very well-known tech company and the size of the market he was targeting. He marketed his deal exceptionally well and raised more than twice as much money than he had planned. He promised his new investors exceptional growth: growth that never came because he never achieved product-market fit. Thinking it was just a matter of getting the word out, he spent exorbitantly on marketing that never paid back with results, instead of focusing on product.
His competitor, Company C, came from behind and achieved ten times as much annual revenue in 24 months, starting from nothing. Company C ultimately became the market leader.
What did the two teams do differently? Company C’s team focused ruthlessly on building just enough product to satisfy the company’s target market, and then spent aggressively on sales and marketing once they saw that customers loved what they had built. In contrast, the founder of Company E painted a great vision, but having promised so much, never faced up to the fact that the market didn’t want the product he’d built. After spending some $40 million, the company was recapitalized, and the investors brought in a new CEO to try to turn the company around.
Pivots That Worked
Many very successful companies started out doing one thing but had to change their target market in order to be successful. Microsoft began by building software-development tools but seized on the opportunity to sell the operating system software (DOS) that went with the new (at the time) personal computer IBM was introducing. In fact, Microsoft licensed the first version of the software from another company so it could ship the software.
Payments company PayPal started out as a service for beaming payments between Palm Pilots; it wasn’t until the company focused on e-mail–based payments—and rode the huge wave of Internet auctions taking place on eBay—that the company became a runaway success.
Intuit was started in 1983, but it took years for the company to get significant traction in its market. The company teetered on the edge of bankruptcy before its marketing campaigns and the launch of Windows 3.0 made it successful.
In all three cases, although each company stayed true to its vision, each pivoted to capitalize on a large underlying wave.
Summary
Product-market fit is that often-elusive but critical success factor for every startup. Companies targeting big markets beat out those targeting small ones. Bad markets kill potentially great startups.
Failure comes from
Market success comes from
- Going after a big market
- Building a product the market wants
- Pivoting until you reach product-market fit
- Efficiently reaching your market
- Riding a huge wave