How Tight is Your Product-Market Fit? Rule of 40 Provides a Scorecard

In a prior blog post, we referenced Tolstoy’s famous line “Happy families are all alike; every unhappy family is unhappy in its own way.” There’s something about happy families. They just work. Each one is slightly different in its unique makeup, but overall there’s a universal magic about them in which everything seems to fall into place.

This is the essence of companies with tight product-market fit (PMF). As Marc Andreeson, co-founder of Andreeson Horowitz, once said:

”You can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can.”

Strong PMF is rare. If a founder isn’t sure they have found it, they probably haven’t. The “happiness” in a startup with tight PMF is unmistakable: customers rave about the product; team members are excited and the recruiting pipeline fills quickly; the numbers that dazzle investors. In its own way, the Rule of 40 score, which sums revenue growth and profitability into a single metric, provides a proxy for a tech company’s happiness and an unbiased measure of PMF.

One of our past clients, DistroKid, an online music distribution platform for artists, is a remarkable example of a bootstrapper (self-funded company) rapidly achieving strong PMF accompanied by a rockstar R40 score. 

DistroKid started with a brilliant technical founder, Philip Kaplan, who had experienced first-hand the challenges for musicians seeking online distribution for their songs. Philip saw an opportunity to build a market-leading SaaS product with better features than incumbents as well as a disruptive, artist-friendly pricing model. 

In an industry with a history of onerous royalty sharing arrangements with artists, DistroKid quickly achieved status as the “most artist-friendly” distribution platform by not taking a percentage of artists’ income. In addition, DistroKid offered new and better features than competitors, such as industry-leading speed. For example, DistroKid was the only platform that could get an artist’s music into Spotify within 24 hours of uploading. The combination of an off-the-charts product, no pun intended, with a visionary founder resulted in tight PMF and a remarkably high Rule of 40 score of over 200!

DistroKid embodies the magic of companies with tight product-market fit, or “happy families”. The early success helps in attracting a talented team. The product execution that worked early scales elegantly via a culture based on intense focus on product execution and customer happiness. High word-of-mouth keeps expenses down, enabling profitable growth that minimizes financial distraction.  

Not coincidentally, a product-led growth strategy underlies DistroKid’s stratospheric Rule of 40 score. Early growth via word-of-mouth takes longer than growth through traditional outbound sales and marketing channels. Yet this constraint provides a highly underrated forcing function on efficiency — to grow via word-of-mouth, tight feedback loops must emerge between product development, marketing, and customer behavior. With these tight feedback loops in place, everything can seem to fall into place. A small founding group blossoms into a larger, high-performing team.  

While this might look like a happy family, it should be noted that in the pre-PMF stage the experience of founders is typically anything but sanguine. We’ll dive into this further in our next blog post.

 


Horizon Partners is a boutique M&A advisory firm for bootstrapped technology businesses. To learn more, subscribe to the Horizon Partners blog.

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