Tribe Capital partners Arjun Sethi and Jake Ellowitz quantify product-market fit
“Product-market” fit is one of the most crucial aspects of building a startup. But how do you quantify it?
The term product-market fit (PMF) has been around for years, and while people keep saying, “you will know it, when you have it,” it has never been quantified.
According to Arjun Sethi, Co-founder of San Francisco-based VC firm Tribe Capital, people often think “when you have x, you have product-market fit.”. However, in reality, he says a family of concepts work together to deliver PMF, which then creates the magic eight ball.
In the recent episode of Prime Venture Partners Podcast, a series featuring the makers and doers of the startup ecosystem, Arjun and his fellow partner Jake Ellowitz spoke to Amit Somani, Managing Partner of Prime Venture Partners, on quantifying the product-market fit.
Tribe Capital, founded in 2018 by Arjun Sethi, Jonathan Hsu, Ted Maidenberg, and Jake Ellowitz, is a sector and stage agnostic VC firm. Some of its portfolio companies include Shiprocket, Teampay, Patch, Humi, Front, Carta, Bolt, and Cover, among others.
Listen to the podcast here.
Meet the guests
Arjun Sethi is a serial entrepreneur-turned-VC. In 2007, he founded Roflplay, which was acquired by Lolapps. Then, he launched MessageMe, which was acquired by Yahoo. He served as the Head of Mobile Growth at Yahoo for over a year.
In 2018, Arjun joined Social Capital LP, leading the early-stage venture team. In the same year, he co-founded Tribe Capital.
Jake Ellowitz joined Tribe Capital in 2019 as a Data Scientist, and is now a Partner and the CTO at the VC.
He says that working with the portfolio companies is often aided through frameworks using data analysis and digging deep into raw metrics.
“Tribe is more akin to a company...We build products, we run them the same way startup companies do with a scrum team stand ups and thinking about what type of artefacts and products that we can deliver beyond just capital to the investments and the companies that we are representing,” Arjun says.
Jake Ellowitz and Arjun Sethi, Partners of Tribe Capital
Quantifying product-market fit
Tribe uses ‘growth accounting’ and ‘cohorts’ as metrics while investing in startups.
According to Jake, growth accounting first seeks to understand if the top line has growth. If yes, what does that growth look like? “It (growth accounting) gives you kind of one flavour of what is contributing to the growth,” Jake adds.
Similarly, a cohort is probably one of the most important things to look at. It reveals the evolution of a customer, and how it changes with the evolution of the business. Nuances like customer engagement and seasonality come to the forefront when cohorts are explored.
While there are different ways to understand how a business is evolving and growing, pinpointing one particular flavour that works best is the secret.
“Understanding the business, understanding the customers, and understanding what’s happening in the market will give you hints in terms of how to pry it apart,” Jake adds.
Taking the example of Tribe Capital’s latest investment Shiprocket, the investor says that a good starting point for cohort analysis is by understanding customer engagement.
He explains that there are different types of customers — some with just a few shipments, others many, and then there are customers shipping a tonne like enterprises. Looking at how each of these different customers are engaging will tell different stories.
To add to this, Arjun says that it is not only revenue but also engagement and usage that can show a company’s growth potential.
CMGR or Compound Monthly Growth Rate allows businesses to predict potential monthly growth. In other words, if a business has a particular use per view rate today and depending on how many it got in a month, one can predict how fast the business will grow every month.
While predicting the growth using CMGR, Jake says considering a longer horizon is usually more beneficial. CMGR 3 or three-month horizons might show noise like seasonality, among others.
Whereas, a CMGR 12 would provide a more accurate forecast as it controls for annual seasonality that would reveal the average growth rate, every month, the earlier year.
Arjun says, "Defining engagement is really important because that’s a part of demand and that is going to be your (business's) leading indicator of where you think you may be able to price charge, or understand what your revenue metrics are going to look like."
The investor adds that quick ratio is a very useful SaaS metric, but when businesses have a large month-to-month variation, it will actually artificially depress the quick ratio.
“All these metrics will just give you proxies. And it is really the higher-level strategy, product execution, and hiring a great team and all other things that are running a business that are going to really matter,” says Jake.