This is part five in a series about 4 Frameworks To Grow To $100M+. Subscribe to get the rest of the series.
In the introduction to this series, I explained there are two types of companies:
- Tugboats, where growth feels like you have to put a ton of fuel in to get only a little speed out.
- Smooth sailors, where growth feels like wind is at your back.
The difference between these two are not the common mantras of build a great product, product market fit is the only thing that matters, or growth hacking.
In part two, I talked about why we should think about Product Market Fit as Market Product Fit, how to lay out your Market and Product hypotheses, and how understanding whether you have Market Product Fit comes down to Qualitative, Quantitative, and Intuitive indicators.
In part three, I covered Product Channel Fit - that products are built to fit with channels, channels are not built to fit with products.
In part four I covered Channel Model Fit - that channels are determined by your model. I went through the ARPU ↔ CAC spectrum and how your product and product tiers need to align on this spectrum.
Which brings us to part five, Model Market Fit.
Model Market Fit
Model Market Fit is the concept that your market (and # of customers within your market) influence your model.
The first time I heard about the underlying concept of Model Market Fit was from Christoph Janz @ Point Nine Capital. He wrote a post called The Five Ways To Build A $100M Business. He then followed that up with Three More Ways, but I'm going to focus on the first five as they represent most of the $100M+ outcomes out there.
In Christoph's post he published the following graph:
Credit: Christoph Janz and Point Nine Capital
On the Y-Axis is the average annual revenue per customer that you generate from your model. On the X-Axis is the total number of customers you need to create a $100M+ Business. Most companies end up falling in one of five areas that Christoph named:
- Elephants - Products that get 1,000 customers paying $100K+ year. These are typically products built for enterprise customers like ServiceNow.
- Moose - Products that get 10,000 customers paying you $10K+ per year. These are typically products built for the mid market like HubSpot.
- Rabbits - Products that get 100,000 customers paying $1K per year. These are typically products targeting small businesses like SurveyMonkey, Mailchimp, or Gusto. Products targeting consumers at high value moments also live here. For example companies in real estate, insurance, etc.
- Mice - Products that get 1M customers paying $100 per year. These are typically products that target prosumers like Dropbox, or companies that are subscription ecommerce like Ipsy or Dollar Shave Club.
- Flies - Products that get 10M customers generating $10 per year typically via ads. Facebook, Snapchat, Buzzfeed, etc. all live here.
What we can do is draw a line down the graph. This is what I call the Model Market Fit Threshold.
If your business ends up above this threshold, then you have Model Market Fit. If you are below the threshold, then you don't have Model Market Fit.
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.