Council Post: Finding Product-Market Fit In Open-Source Business Models

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I am an investor at Y Combinatorwhere I invest and partner with startups in B2B software, in cybersecurity and enterprise infrastructure

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Successful open-source (OS) companies in enterprise infrastructure have demonstrated the power of building companies that leverage communities. Since successful OS projects might have hundreds or thousands of free users, they have potential customers in varying shapes and sizes.

bessemer estimates that several successful OS companies only monetize less than 5% of their total user base. In the early startup days of achieving product market fit (PMF), it’s often critical to identify and serve a narrow ICP (ideal customer profile) and find repeatability in acquiring and closing customers. Startups need to serve customers that have a similar set of common characteristics—a narrow ICP definition enables startups to focus in the early days.

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Unlike typical enterprise software companies, OS startups have to go through two journeys of finding product-market fit. First, they have to build a product that users would download and use for free. Then, they have to create features that users would actually pay for. In many ways, OS startups have to build two product road maps and companies. The challenge for OS startups then becomes: how to define the ICP for users that would potentially pay, and finding repeatability in converting free users to paid customers.

This set of common customer characteristics in an ICP could include the size of the customer (the number of employees, whether it’s a small, medium or enterprise-sized company, etc.), vertical (technology, financial services, etc.), common Problems faced, common set of software tools used and user persona. A good example of a narrow ICP for a developer productivity company could be: engineering managers and directors who work in technology companies, that have 50 to 75-plus engineers that frequently deploy code each week, and use a continuous integration tool.

Since OS startups have thousands of free users already, they can grow revenue quickly in the early days, but yet not achieve PMF or repeatability. One of the most common pitfalls in the early days is believing that an OS startup has PMF, if it has strong revenue growth and scale, but no concrete definition of ICP. This is especially true if the OS startup is serving the enterprise segment.

Large enterprise customers often have use cases, problems, integrations and tech stacks that are unique to their needs only. For example, early large enterprise customers might pay for integrations into their tech stacks that are outdated or bespoke. Similarly, they might pay for security and analytics features that only apply to their needs.

In the early days, an OS startup might go through the list of its free users, convert four to five large enterprise customers into deals and achieve $3 million to $4 million annual recurring revenue (ARR) due to high-contract values. In reality, the startup still might not have PMF because those large customers did not have a common set of characteristics. Once that startup moves on to serve their next 10 customers, they often realize that their product failed to get traction because the problems, integrations and use cases of the early large enterprise customers weren’t representative of the broader market.

Enterprise deals also require much longer sales and implementation cycles to close, and there is a slower feedback loop from such customers. In my view, in the early days, it’s far more impressive to sign 10 similar customers worth $10K each ($100K ARR) with a common set of characteristics than signing five dissimilar enterprise customers worth $100K each ($500K ARR). It’s obviously possible for an OS startup to find PMF in the enterprise segment, only as long as there is commonality in the types of customers.

The other big pitfall in the early days of building an OS startup is serving both the enterprise and small to midmarket segment at the same time. Bigger enterprise customers have a completely different set of needs than smaller customers. They might need customizations, integrations, security, auditing, control and have a different tech stack versus smaller customers.

As a result, startups do not find repeatability in the sales process because both sets of customers need different things. Of course over time, successful OS companies grow and can serve both simultaneously. At the beginning, focus is critical to iterating on the product and finding repeatability.

OS companies are in a unique position because they already often have thousands of free users on their platform. The playbook to build in the early days is identifying who is a good customer and who may not be.

Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?


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