The “real” product market fit (PMF) that startups seek is a SCALABLE SOLUTION to a BIG problem in a BIG market. In SaaS, PMF is when you can add and retain $20K/month in MRR at the same cost as the $5K/month you added 12 months ago. It’s rare, but it happens. And it’s beautiful. We are investors in 15+ SaaS companies, and have found there are often false positives in the journey to “real” product market fit. Here’s what we’ve learned, much of which applies to any startup.
1. You have ten to twenty customers… and have for a while
Most commonly, this manifests as founders selling to “friendly” former customers/clients, but being unable to expand to cold prospects. Sometimes this is startups selling an SMB solution to lots of other startups in their accelerator or accelerator alumni family. I call this a Ponzi Scheme (!!). But this type of false positive can happen even without “friendly” sales. It just might be you found 15 customers – and not 16 – because the product doesn’t solve a problem for many.
Solution: Look for larger schools of fish nibbling at your product but not buying. Solve their problem.
2. Founders sold the product but the sales people you’ve hired can’t figure it out
Founders have infinite passion, and passion is contagious. Founders may be able to sell a product that hired guns can’t because the founders can share the future vision and sell that. Hired guns need to sell what’s on the truck. If it’s not working, it means the product is missing key features or isn’t hitting a real pain. Of course there’s also the chance you hired the wrong sales people – an issue that is often confounded with a PMF issue. You can sort the two out by having some advisors with related sales expertise observe your sales team in action and peruse your pipeline.
Solution: If not a hiring problem, spend more time with potential “cold” customers to understand their needs.
3. Services are > 25% of your revenue
If the service layer on top of your software product is thick, you might be faking product market fit by customizing the product for every customer. This is typical early on – especially in enterprise SaaS – but needs to decline rapidly to successfully scale.
Solution: There are two root causes behind this type of problem. The first is that the product doesn’t have the right features, integrations or workflow for a critical mass of customers. This is solvable by developing these features as you learn from your early customers what is important. The second likely root cause is that the target customer/market prefers buying services instead of software. This is a harder problem to solve and common in non-techie industries (examples: food manufacturing and event planning).
What is normal for a service layer? Below are some helpful stats from the Pacific Crest 2013 SaaS Survey. A typical professional services layer (as a percent of 1st year ACV) is 21% for enterprise and much lower for SMB and Very Small Business (VSB) SaaS.
Professional Services (% of 1st Year ACV) by SaaS Customer Type
Source: Pacific Crest 2013 SaaS Survey
Services can either be implementation or ongoing services. Almost all enterprise SaaS has implementation services associated with it. Many successful SaaS companies like Salesforce build consulting ecosystems around them to support implementation. This is a terrific way to externalize the service layer so it doesn’t affect your awesome SaaS valuation multiple. Ongoing services are harder to externalize, though it is done successfully in some industries like advertising and marketing where agencies have built a service ecosystem on top of the software providers.
4. You can’t get access to senior deciders
Inability to access senior deciders – assuming you have a tenacious sales team – is a clear sign that your product or service doesn’t meet a big pain.
Solution: Find a really painful problem to solve.
5. Your first round of renewals goes horribly wrong
I’ve seen first renewal cycle rates as low as 50%. Now that’s a burning platform. This can be caused by lack of or poorly executed post-sales enablement (training, lifecycle marketing, etc), or it could be a PMF problem – your product just wasn’t what your customers had hoped for. You need to talk to your customers to figure out which one it is.
Solution: I’ve written before about improving post sales enablement. If that’s not the issue, and PMF is the problem, it may be that additional features or better UI/UX solve the problem. Worst case, you’re back to finding a really painful problem to solve.
We often see false PMF rear its head between 25K and 50K MRR just a bit before or after a Series A raise. It’s easy to see a PMF problem when a seed stage company has little to no revenue, but at higher levels of revenue, the revenue itself deceives our simple human brains. When recognized early, false PMF spurs quick corrective action or pivot followed by continued ramp. When not recognized, teams attempt to muscle through it… pushing a rock up hill. This isn’t sustainable because sales efficiency is very low, revenue ramp is anemic and the company quickly hits cash crunch.