Understanding If You Have Model Market Fit
Of course, once you have a $100M business its easy to understand where you end up on the Model Market Fit graph. But what about before that point? Your Model Market Fit hypothesis revolves around some simple math:
ARPU x Total Customers In Market x % You Think You Can Capture >= $100M
Take the average annual revenue per customer/user, multiply it by total number of customers/users in your target market, then multiply that by the percentage you think you can capture. That should equal or be greater than $100M.
This might seem simple, but many teams I see and advise don’t do this. Each variable in this equation has some assumptions, and I recommend thinking through them in this order:
Total Customers In Market
First, define your target market. You should have done this already at the Market Product Fit stage anyway.
Once you have this definition you should do some research on how many target customers meet those criteria. If you find that this number is too small, then you can expand the criteria to target a larger market, but then you need to return to the Market Product Fit step to see if that remains true. You also need to understand if customers meeting the expanded criteria are willing to pay the same amount.
After you have defined the market, you can do some qualitative research to understand what their willingness to pay is for your solution to build your ARPU hypothesis.
If you find this to be too low to fit the Model Market Fit equation, then you can think about increasing prices. If you do increase prices, you need to make sure that Channel Model Fit still holds true. You may need to change the definition of the market to find customers with higher willingness to pay.
% You Can Capture
This variable is probably the hardest one to predict. If you have nailed down your target market and know how many target customers there are and you understand what they might be willing to pay (ARPU) you can back into the % of the market you need to capture to create a $100M+ business.
If anything, it is easy to overestimate the percentage you think you can capture. For example, if you are a SaaS startup and this variable comes out to 50%+ then you should be worried.
Instead, for SaaS businesses where there aren’t strong network effects, I use 10% as a rule of thumb. Great SaaS companies will capture more than 10% of their target market over time, but this is a good starting point.
Companies with strong network effects can assume a higher percentage because you are typically playing an all or nothing game. If you win, you will probably capture the majority of the market.
Moving from Market to Market
If you’ve read some of my other material I also typically recommend starting with a niche market in the earliest days and then expanding out.
Often when you use the Model Market Fit equation with the niche market, it never ends up equaling >$100M. That’s fine. In that case, you just need to have hypotheses for what the next expansion markets are and how big they are.
The more times you need to expand to get to a $100M+ business, the riskier your core hypothesis is. Every time you expand there is risk that your four fits don’t hold true.
Putting the Four Frameworks Together
Model Market Fit is the last framework in the four fits. We’ve gone through:
In the next posts I’m going to put the four frameworks together using a case study from my days at HubSpot and how to use the frameworks yourself whether you are in a small startup or big company. Subscribe to my email list to receive each post.
And, if you are interested in learning how to put these frameworks into action on a detailed level, consider becoming a Reforge member.