Product-Market Fit
There is no such thing as product-market fit for bureaucracy.
When starting a business, entrepreneurs focus on one thing. They call it product-market fit. It’s difficult to define. Sometimes, people say things like, “You have product-market fit when the dogs eat the dog food.”
The entrepreneur talks to a lot of people in search of a problem to solve. He finds one that he thinks he can address. He develops a new product or service. He puts himself out there trying to find people who have the problem his widget was designed to handle. He convinces a couple of people to test it. If it works well and this was a significant, unaddressed challenge, they tell two friends and they tell two friends and all of a sudden the phone is ringing off the hook.
This is a scientific experiment. Form the hypothesis. Test the hypothesis. Improve the hypothesis. Rinse and repeat.
You have product-market fit when you cannot explain with anything other than a slick-sounding word salad why or how demand has accelerated suddenly. You have product-market fit when your focus switches towards making sure you can fulfill the orders you are getting and doing so with positive free cash flow. Product-market fit occurs when someone like you figures out that there is a gap between demand and supply and bridges that divide successfully. We call that bridge “value.”
For the entrepreneur, product-market fit is life. It is a necessary, but not sufficient, condition for large-scale success. It is organic.
Everyone wants to have product-market fit and they want it as quickly as possible. Once you have it, you can raise money from venture capitalists to grow the fulfillment side of the business. You can hire solid employees. Journalists pick up your phone calls. You exude confidence in a virtuous cycle.
There are several pitfalls you must navigate.
The first potential problem is that product-market fit may not come on your first go-round. You talk to a bunch of people and you figure out what you imagine their problem is. You design a solution to what you think confounds them, only to find that you’re off the mark when you show them what you’ve built. Perhaps you misunderstood the nuances of the problem or you underestimated what they required to stick their necks out to try something new.
Many times, the entrepreneur will iterate towards a solution. This may take a long time, especially if he’s strapped for cash. Money is like gas in the tank.
Some people run out of gas before they can complete the iterations. They need a certain level of feedback to bridge the gap. If they don’t have sufficient funding, the project dies without having completed the mission.
Everyone has heard of venture capital. Why can’t our entrepreneur just get money from them? It’s not as easy as it seems. You might think that VCs would fund him if the initial hypothesis was intriguing or the potential windfall from success was large enough. Some markets just aren’t sexy at that moment in time (or ever). Some entrepreneurs may not present as the kind who can get to product-market fit. They just don’t look the part. VCs may be more focused on chasing the herd than on thinking independently. They’ll whipsaw from AI to crypto and then back to AI within the space of a couple of years, memory-holing their prior publicly proclaimed fealty to what turned out to be flash-in-the-pan transformational technology cycles. There are many reasons why funding can be difficult to obtain.
The second potential problem is the entrepreneur can fool himself into thinking that he has obtained product-market fit when he hasn’t. He wants it so much because of all the things it brings. He convinces himself that he has it. He believes. He tries to convince others. Maybe he succeeds in raising some venture capital. Instead of speeding towards an IPO, he drives at full throttle to nowhere. By misleading himself and others into thinking prematurely that he has reached the promised land, he foregoes the iterative steps that would have taken him there. Instead, he zooms into the desert. At some point, he’ll run out of fuel and the whole thing will be a bust.
The third potential problem is the entrepreneur who games the system. He understands that he isn’t anywhere in the vicinity of product-market fit, but he claims it anyway. He is polished and convincing when he tells anyone who will listen. Why does he do it? He wants the money. He wants the prestige. He wants LinkedIn to pat him on the head and tell him he’s a good boy. There are press releases for X and pictures of him speaking at conferences for the ‘Gram. When it fails, he’ll write a blog post lamenting the difficulty of starting up a new company. He’ll reflect thoughtfully on the lessons he has learned from the experience. If you’re not failing, you’re not trying hard enough, right?
There is no such thing as product-market fit for bureaucracy.
Consider this tale of an electric vehicle battery manufacturer in South Korea.
“A leading South Korean producer of electric vehicle batteries has declared itself in crisis as its customers struggle with disappointing EV sales in Europe and the US.
“SK On, the world’s fourth-largest EV battery maker behind Chinese giants CATL and BYD and South Korean rival LG Energy Solution, has recorded losses for 10 consecutive quarters since being spun off by its parent company in 2021. Its net debt has increased more than fivefold, from Won2.9tn ($2.1bn) to Won15.6tn over the same period, as western EV sales have fallen far short of its expectations.”
All of this is because of stunningly disappointing sales of U.S. electric vehicles.
‘But Tim Bush, a Seoul-based battery analyst at UBS, said the South Korean battery makers had been “badly let down” by US car manufacturers, which he said had failed to produce EVs sufficiently attractive to mass market consumers to meet their own bullish sales projections.
‘He noted that until as recently as last year, General Motors was forecasting it would sell 1mn EVs in 2025. It sold just 21,930 in the second quarter of this year.
‘“The Korean battery makers haven’t been making blind investments — everything they invested was based on order books with fixed volumes and pricing,” said Bush. “But the automakers didn’t invest enough in producing high-quality affordable EVs.”’
You might say that SK fooled themselves into thinking that there was product-market fit. They had order books that were bursting, so, on the face of it, they were in a good place. One doesn’t make this order of magnitude of a mistake without there being a significant distortion somewhere in the chain.
Bureaucracy is distortion of information and incentives.
This was a cascading consequence of the poor forecasts of demand by the American auto OEMs. These are some of the most sophisticated people in the world when it comes to planning automobile demand. Why did they get it wrong?
They didn’t.
The real problem was the original government mandate from places like the State of California to ramp up emissions-free vehicles and from the US government.
There was no gap between supply and demand to bridge. Americans don’t want EVs because they are expensive and they have limited use cases that are inconsistent with American population density and American culture.
The auto OEMs knew all of this, but went along with what turned out to be a shadow order book, thinking of it as a kind of tax that they needed to pay to be permitted to continue selling gas-guzzling SUVs with tolerable profit margins. The losses on their EV plans were more than offset by the profits on their mainstream businesses.
There was no product-market fit here because nobody along the line was interested in product-market fit. This was government telling people what they should want.
Bureaucracy is indifferent to the preferences of its constituents. It seeks to impose new preferences, to direct the river of human behavior. It is a form of control. This is not to be confused with process: a set of steps necessary to get from point A to point B. Bureaucracy tells people that they shouldn’t want to go to point B, but to point C instead. Bureaucracy tries to invent new demand where there was none and to eliminate existing demand where there was plenty. In contrast, enterprise risks capital to bridge unmet gaps between demand and supply. Markets are organic. Bureaucracy is artificial.
Cui bono? Who benefits from this tendentious activity? Plenty of people. In a perverted way, they obtain what we might call product-bureaucrat fit in bridging the gap between the bureaucrat’s policy demands and the lack of supply to meet it. In this case, the emergent Greentech companies garner impressive subsidies and government grants. They raise millions in SPAC IPOs. Someone is getting rich.
Without public sector directives and subsidies, the electric vehicle market in the United States would be significantly smaller. The bureaucrat will tell you that this is a phenomenon described by Paul Samuelson: the under-provision of pure public goods by private actors. Here, the public good is the cleaner air we’ll all enjoy when gasoline vehicles have been replaced.
What they don’t tell you is that, in a dynamic sense, there is an over-provision of public goods by bureaucracies, as they expand their empires into adjacent domains. Not only do we get cleaner air from the automobile sector, but soon we start to ban or restrict meat consumption. We inhibit fertilizer production …
George Friedman refers to an example of this in his book The Storm Before the Calm. After World War II, the US government guaranteed mortgages for veterans. Then they started to do this for lower and middle class people. Eventually, federal agencies started buying mortgages from banks. New financial products emerged to exploit the appearance of invulnerability suggested by an implicit government guarantee. Complexity piled on top of opacity until the Global Financial Crisis arrived.
Product-market fit is an organic increase in activity that emerges in a complex, adaptive system when self-interested economic agents interact. Product-bureaucrat fit is contrived. Yet, it can lead to similar increases in activity.