How to Measure Product-Market Fit Over Time

by
Heather Tipton
Content Marketing Manager

Have you ever launched a well-developed feature only to have it fall short of your sales or customer retention goals? If customer adoption is low or it doesn’t drive enough revenue, these could be signs that your feature doesn’t have a good product-market fit.

Measuring product-market fit with metrics like customer retention rate and addressable market at regular intervals can help you determine what you’re doing right while pinpointing areas where your product or features aren’t meeting customer needs.

When to Look at Product-Market Fit

Product-market fit isn’t a static state of being, and measuring it isn’t a one-time activity. After all, products change over time, and your customers’ pain points and the market change, too. A shift in any of those areas can affect your product-market fit.

When during the product development process should you measure product-market fit (other than before and after launching a brand-new product)? Look at fit before and after you launch a new feature, trim an unused one, or update the functionality of your product. Measuring before these steps gives you a chance to check your assumptions about your value proposition against real feedback before you devote product team bandwidth to development. Measure after those points in product development as well to see if you met or missed your mark.

Similarly, measure product-market fit before and after you expand into a new target market or try to reach a new customer persona. Measure before expansion to make sure you know your new target well—you know the size of the new market; you understand the needs of your new users—and measure after to check if your strategy was a success.

Finally, if you spot an anomaly or drastic change in otherwise stable product metrics, take another look at your product-market fit. A climbing customer churn rate, for instance, can point to a problem with fit: maybe a new competitor entered the market that better serves your target customer base, or perhaps there’s an issue with your product pricing. Spikes or drops in a number of different metrics can mean you need to find (or re-find) product-market fit.

Measure Addressable and Obtainable Market to Determine Market Size

Market size is a key component of product-market fit—if the market isn’t large enough, it won’t be able to sustain your business. If you know (or suspect) the market has changed, it’s worth it to conduct that research again.To calculate your market size, determine your:

  • Total addressable market (TAM) by multiplying the total number of accounts in your market by their annual contract value
  • Service addressable market (SAM) by multiplying the segment of your TAM you can service by their annual contract value
  • Service obtainable market (SOM) by multiplying your market share from last year by your SAM for this year

The sign of a good market for your product is a SOM that’s large enough to be profitable for your company while remaining realistic for your business model.

Measure Growth Rate and Profit Margin for Company Performance

Taken together, your growth rate and profit margin can give you an idea of how well you’ve achieved product-market fit. This is based on the “Rule of 40” (or Rule of 40%), a common approach among SaaS companies to gauge their growth potential.

To calculate this metric, add your growth rate and profit margin together. If they equal 40 or more, that’s a sign your company has achieved sustainable, profitable growth—and that’s an indicator of product-market fit.

Note that this metric is more of a rule of thumb. It’s a quick way to gauge growth, but it shouldn’t necessarily form the basis of your product management strategy.

Measure Customer Acquisition and Lifetime Value to Calculate Company Health

Your customer acquisition cost (CAC) should be lower than your customer lifetime value (CLV)—otherwise, your company won’t be able to grow profitably. Your CAC equals the cost associated with sales and marketing for your product divided by the number of new customers you’ve acquired. Your CLV equals your customer value multiplied by your average customer lifespan.

You can look at these two metrics together as a ratio:

LTV / CAC = Your ratio

A ratio of at least 3 is a good sign you’re acquiring enough long-term customers to offset your costs and sustain growth for your product, which suggests you’ve found a comfortable product-market fit.

Measure Customer Retention to Check for Product Stickiness

A high customer retention rate goes along with high customer lifetime value. A sticky feature set is a sign of value: you’re serving your customers’ needs well enough they keep coming back to your product.

The benchmarks for customer retention rate vary depending on your industry and goals. That said, the average monthly rate for B2B SaaS companies is between 92 and 97% (that’s a churn rate between 3 and 8%).

To measure your customer retention rate, follow this formula:

(Total number of customers at the end of a given time period - Number of new customers acquired during that time) / Number of existing customers at the start of your time period x 100

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Measure Net Promoter Score (NPS) for Your Word-of-Mouth Potential

Calculate your NPS to gauge how well your product encourages organic growth through word of mouth. You can find your NPS by surveying your current customers on how likely they are to recommend your product to others. This question is typically rated on a scale of 1 to 10. Those who choose 9 or 10 are “promoters,” while those who choose 0 to 6 are “detractors.” The NPS formula is:

Percentage of Promoters - Percentage of Detractors = NPS

A high score means a higher potential for organic product growth driven by word of mouth, which is an indicator of great product-market fit. The definition of a high NPS depends on your industry, but a score of 72 or higher is a good place to start.

NPS does have some potential issues, however. It’s not specific—the score alone doesn’t explain why your customers are willing to promote your product. It also doesn’t account for different levels of influence among your promoters and detractors. Earning glowing praise from a well-known industry leader has the power to generate a lot of organic buzz, regardless of your NPS.

Use the 40% Test to Gauge Your Product’s Value

Another way to measure product-market fit is the “40% Test,” developed by Sean Ellis. Not to be confused with the Rule of 40 above, the 40% Test asks your customers what their response would be if your product left the market. If at least 40% of your customers would be very disappointed in that scenario, that’s a good indicator you’ve found product-market fit. This question is usually asked in a user feedback survey with these possible responses:

  • Very disappointed
  • Somewhat disappointed
  • Not disappointed
  • I don’t use this feature

Keep in mind that to satisfy the 40% Test, you’re looking for at least 40% of your users to respond with “very disappointed”—not “somewhat disappointed.”

You Haven’t Found Product-Market Fit: What Next?

If you haven’t yet found product-market fit (or a recent product change upended it), your first step is to pinpoint what’s causing the issue.  

You could be missing vital information about your customers. Do you fully understand their identity and customer segment? Do you know their needs and pain points? If you’re unsure, validate what you think you know about them. Write out your assumptions as hypotheses and test them. You can survey target users about their pain points, for example, or you can analyze your existing customer feedback to learn more about the features they would like to see.

Another potential problem could be your market. Perhaps it’s smaller than you thought, or it’s lacking growth potential. The only way to know is to conduct market research. If you’ve already calculated your market size, look for signs that something has changed. If a new competitor entered the space, check out our post on competitive analysis for more on that process.

Your struggle with finding product-market fit could also be because your product isn’t delivering the value you hoped. In that case, asking customers directly what they would find valuable is your best bet to figure out how to adapt your product so it solves their pain points.

Report on Product-Market Fit Regularly

Measure your product-market fit regularly to avoid surprises and to build a rich data history you can use as a benchmark to track your product’s success over time. Keep a consistent eye on how well your product is serving the market’s needs so you can iterate purposefully and focus on making the product changes that will drive the most value for your customers.