Re-Thinking Product-Market-Fit for Growth Investing
Status-quo definition and its pitfalls
There are lots of literature and thought leadership on product-market-fit (“PMF”) but few are able to 1) differentiate between venture and growth investing and 2) translate findings into a framework for investment execution. This article is focused on underwriting PMF at the growth stage of investing.
At its simplest form, PMF is the extent to which a product meets the needs and demands of a given market relative to alternatives. Since the product, market and alternative solutions in the market are all constantly changing, PMF must constantly be re-evaluated. Once a company achieves PMF, there is no guarantee that it can be sustained. Conversely, a company with no PMF can achieve PMF in certain circumstances.
A critical distinction between venture and growth investing lies in how PMF is identified. In venture investing, PMF is often about validating a novel idea or technology that addresses a specific problem, with success measured by initial customer adoption and market validation. At the growth stage, however, the focus shifts to scaling a proven product, optimizing for efficiency, and expanding market reach. Growth investors must assess not just whether PMF exists, but how durable and scalable it is in the face of competition, market saturation, and changing consumer preferences. Understanding these nuances allows growth investors to better predict a company's trajectory and assess its return profile.
To provide a clear example of evolving PMF definitions across its company life-stage, consider Airbnb:
Early stage (2008-2009): Initial PMF was defined as "Will people rent out rooms in their homes to strangers?" Investors like Y Combinator and Sequoia focused on basic metrics like number of bookings and host retention.
Growth stage (2010-2014): PMF definition expanded to "Can this model work across different property types and geographies?" Growth investors looked at city-by-city expansion metrics and category expansion beyond rooms to full homes.
Later growth/pre-IPO (2015-2020): PMF became "Is this a sustainable hospitality platform that can compete with hotels?" Investors focused on unit economics, regulatory risks, and ability to expand into adjacent services like experiences.
Common PMF traps specific to growth stage investing
A common misstep is prematurely shifting focus to enterprise customers before the product reaches sufficient maturity. Companies often rush to serve larger clients without having refined their product capabilities, leading to strained resources and potential damage to market reputation.
Another trap is expanding into new geographic markets without first establishing a repeatable success model in existing territories. Companies need to prove they can consistently acquire and retain customers in their current markets before taking on the complexities of new regions, each with unique customer behaviors, regulations, and competitive landscapes.
Similarly, many companies fall into the trap of expanding their platform offerings before achieving dominance with their core product. This premature diversification can dilute resources, confuse market positioning, and weaken the company's competitive advantage in its primary market. Success in the core offering should be firmly established before pursuing platform expansion strategies.
While revenue growth often captures attention, it must be built on sustainable value creation rather than on aggressive sales incentives or deep discounting. Ideally, revenue growth is generated in tandem with increasing sales efficiency and gross margins.
Growth-stage companies must prove not just theoretical market size, but actual penetration capability. Consider RingCentral – despite a large business communications TAM, they struggled to achieve sustainable growth in mid-market and enterprise segments where Microsoft Teams held dominance.
The journey from engagement to monetization is another critical consideration. Slack's experience highlights this challenge – while they achieved strong enterprise engagement, converting users to paid enterprise features proved difficult. In contrast, Atlassian's success came from implementing a product-led growth strategy that effectively monetized their collaboration tools.
Framework for evaluating growth stage PMF
PMF must be understood from the context of where returns will come from. Using a PMF framework, return vectors can broadly be categorized into the following. Returns will almost always be derived from more than one of the below:
Selling a new product into a new market
Selling a new product into an existing market
Selling an existing product into a new market
Selling an existing product into an existing market
1. Selling a new product into a new market
Underwriting a business where growth is primarily driven by introducing a new product into a new market represents the most uncertain yet potentially rewarding opportunity for growth investors. This scenario is rare, as new product launches typically involve expansions or adjacent features sold to the existing customer base.
Although a company may qualify as 'growth-stage' in terms of scale, this type of investment is akin to underwriting PMF for a venture-stage company. Early indicators of PMF—such as pilot program results, initial customer feedback, and adoption rates—become crucial data points. Growth investors making investments primarily in this category must be prepared for higher levels of unpredictability compared to typical growth-stage investments.
A key consideration in this investment category is the performance and PMF of the company’s existing products and services, as these typically fund the growth of new offerings. The stronger the PMF and cash flow generation from current offerings, the more initiatives a company can pursue with new products.
2. Selling a new product into an existing market
When a company launches a new product in a market where it already operates, the focus is on leveraging existing customer relationships and market knowledge to drive adoption of the new offering. Underwriting PMF here involves evaluating how well the new product complements the company's current portfolio and meets unmet needs within the existing customer base.
Modifying the initial PMF definition presented, investments in this category can be thought of as:
The extent to which a new product can more effectively address and satisfy the existing needs and demands of a given market, elevating the standard of how well those needs are met relative to alternatives.
When launching new products in existing markets, companies should measure success relative to their previous product launches in those markets. This approach carries less risk than entering entirely new markets since companies can leverage their established distribution channels, existing brand recognition, and current customer relationships and trust.
3. Selling an existing product into a new market
Expanding an existing, proven product into a new market is a common growth strategy that involves leveraging the product's established PMF while navigating the challenges of a new customer base in a novel market. The key questions to ask are:
What evidence shows the core problem exists in the new market?
How do customers currently solve this problem in the new market?
How does the pain point severity/frequency compare to the original market?
Are there any hurdles (e.g., regulatory) present in this new market that was absent in the original existing market?
Are there opportunities to enhance the product offering or introduce tweaks to better serve or attract these consumers?
Early in the new market entry process, investors should examine and compare KPIs in the new market and compare it to those that were achieved in the existing market where PMF was proven. KPIs could include speed of market penetration, customer acquisition costs (CAC), time to profitability and usage/customer engagement.
Cultural differences, local competition, and varying consumer behaviors can significantly impact the success of market expansion. Tailoring marketing strategies and possibly modifying the product to meet local preferences can enhance acceptance. Strategic partnerships with local firms may also facilitate smoother entry by leveraging established networks and market knowledge.
4. Selling an existing product into an existing market
The underlying investment thesis for this category of investment is based on the belief that a core product offering, having achieved PMF in its selected target market, can be sold to a larger number of consumers within the same market. Once PMF has been re-validated for a product in a given market, the next logical set of questions are:
Are there enough consumers remaining in this target market to support continued sales growth?
What is the proportion of greenfield consumers (those not currently using a similar offering) versus those who would be rip-and-replace or use the product alongside existing solutions? Even with a superior value proposition, persuading consumers to switch from competitors can be time-consuming and challenging.
Where can these consumers be found?
How can we validate that these consumers belong to the same segment and exhibit similar behavior and purchasing criteria?
Are there any competitors adopting innovative approaches that could slow down the rate at which we can acquire the remaining consumers in the market?
What obstacles might prevent these consumers from adopting our product, and how can we overcome them?
If an investor can re-validate PMF for a given product in a select market and intelligently answer these questions, they can significantly de-risk investments in this category.
Closing thoughts
Understanding and evaluating product-market fit is a dynamic process that is critical at every stage of a company's growth. For growth investors, differentiating between the nuances of PMF in venture versus growth stages allows for more accurate underwriting of investment opportunities. Examining return potential through the lens of both product and market categories (new versus existing) enables investors to more precisely assess risks and potential returns.