(Source: Chiot’s Run)

[Published on Pluggd.in]

Founders of consumer businesses inevitably face the dilemma around when to start scaling their companies. Sometimes the decision is outside of their control, for example if their service starts to grow exponentially, but more often scaling is a deliberate decision and involves up-front investments to drive and support growth, such as filling out the management team, growing the sales and/or engineering teams, and increasing marketing spend.  Because any of these activities result in increasing expenses and cash burn ahead of revenue or usage, the decision around when to scale is a critical one.

Our contention is that entrepreneurs should demonstrate product-market fit before investing in scaling up.  In the Indian context, where new web services are cloned on a weekly basis, waiting to get to product-market fit can be difficult to do. Founders may feel pressured to scale prematurely, justifying this decision with reasons such as “it’s a land-grab” or “first-mover advantage”.

Scaling out prior to product-market fit can be very risky. In many cases, you have to be ready for a high-burn scenario – access to capital becomes a key constraint here, as evidenced in many of today’s ecommerce businesses.  You may also cycle through lots of management (especially sales and marketing) if you haven’t got the product, value proposition and messaging right. And you may lurch around from product to product or positioning to positioning as the pressure to deliver financial results grows.  All of this can distract the company from answering a critical question – do customers really value the product or service you are offering?

So, what is product-market fit?  While there is no ‘silver bullet’ definition, we typically look for evidence that customers value the product or service offered by the company and engage in a manner that indicates that they cannot live without the product. For example, we look for signs of the following:

  • Traction: Large and accelerating growth in monthly active uniques (MAUs) and daily active uniques (DAUs).  Note the importance of the word ‘active’.
  • Scalable customer acquisition: Ability to acquire customers cost effectively through scalable (and ideally organic or viral) channels
  • Repeatability/Engagement: High amount of repeat visits from existing users and signs of ‘value generating’ behavior e.g. repeat purchases for an e-commerce site, songs streamed for a music service or community engagement for a social networking site.
  • Virality: High k-factor
  • An initial set of users who will pay money for what you have

Here are some examples from within our portfolio of companies that achieved product-market fit – along with illustrative metrics in each case of how this was measured:

  • TutorVista: increasing length of stay / subscription and declining acquisition costs
  • Itzcash: increasing organic transaction volumes
  • Indian Energy Exchange: acceleration in trading volumes and number of participants trading on the exchange
  • LivingSocial: Rapid viral adoption and repeatability of economics and customer / revenue ramp across cities

There are several different approaches or strategies to accomplish product-market fit – the blogosphere is full of wise advice from founders and investors on this subject (see below).  However all these approaches hinge around a common core, namely proving that there is a reason for your company to exist before spending more money amplifying your message or building your expense base.

  • iterating constantly, starting with a minimum-viable product (a la Eric Ries and Lean Startup)
  • focusing maniacally on actionable metrics (a la Dave McClure and AARRR)
  • keeping a low-burn with a small, nimble and technically-oriented team
  • getting detailed feedback by directly observing users interacting with your product (a la Scott Cook of Intuit)
  • clearly detailing a hypothesis on your value proposition and disproving and proving that through actual data
  • making things people want (a la Paul Graham of Y-Combinator)
  • optimizing customer sataisfaction, perhaps through tracking Net Promoter Score (NPS)

Once you have product-market fit, you have evidence of a strong value proposition for consumers, advertisers and other customers.  This provides a foundation for a viable business model. Now you can – and should – scale.