Traits of a Successful Online Marketplace Venture
At Javelin, we have been fortunate enough to invest in several consumer marketplace companies such as Thumbtack and Vacatia. We also have deep operating experience building marketplace companies ourselves, such as Rent.Net and Move.com. We are big believers in marketplace investments, not because they are trendy or the latest venture investment craze, but because they are fundamentally hard to start, hard to build, hard to maintain, and ultimately very hard to replicate.
I thought it would be useful to identify some common properties and traits that we look for when evaluating new marketplace ventures, which we believe correlate with higher levels of company success.
“The Scrappy Spark”
Can the entrepreneur(s) figure out how to get the demand/supply flywheel started? — this alone is a good screen for strong marketplace entrepreneurs because it requires them to be scrappy, to think outside the box, or have some unfair advantage/secret that allows them to start scaling marketplace liquidity. At the beginning, marketplaces inherently have a chicken and egg problem, because it’s hard to get the supply without showing demand, and it’s hard to generate demand without having supply. Many entrepreneurs can’t solve that problem, or think it will be much easier than it is. It’s important to remember there there is NO silver bullet. It takes a ton of blocking and tackling, and moving really quickly to get both sides going almost simultaneously. Usually a marketplace will start with some form of “hack” on the initial supply. However, you need to start showing demand right away and not just accumulating supply, otherwise the constituents who represent your supply will churn out. It’s a very delicate balance that must be maintained from the start. We look for entrepreneurs who know how to spark a marketplace, both on the demand and supply side. Navigating this tricky beginning is a key signal that the team has the executional abilities to succeed.
Rent.Net (co-founded by my partner Jed Katz) started with a small supply of apartment listings, but also became one of the first advertisers on search engines in the early Internet, even before they had much of a marketplace to market, so that the early “supply” would see some early results, and their experience would be positive. Then the company worked like mad to add to the supply as soon as possible, since the demand was automatically growing. Move.com was different because the company “hacked” their supply by gaining listings from Coldwell Banker, Century 21 and ERA, among others, and rolled in all of the traffic from Rent.Net (which came in through an acquisition), so it was a faster start. And with a brand name like Move.com, it didn’t take long to get a bunch of new real estate focused traffic. Then, the realtors started doing more on the marketplace, as did the relocation services.
Thumbtack ignited their “Scrappy Spark” by finding destinations online where service professionals were spending their time or advertising on an ad-hoc basis. They reached out to these professionals with Thumbtack built profile pages, and encouraged them to claim their profiles. This not only gave Thumbtack a direct relationship with the service professional, but it also had the benefit of starting their demand generation via SEO and online paid channels that they were able to arbitrage effectively to demonstrate that their marketplace had value.
Religious about testing, iteration, and metrics
Often times growing a marketplace is about fine tuning and calibrating fill rates, response times, overall liquidity, and marketplace integrity not through one or two step functions, but through thousands of small optimizations. There is almost no way to predict what those optimizations will be, so as a company you have to instill a culture of constant testing and iteration and be crystal clear about the most important KPIs for your marketplace. It is important to measure everything and manage to your KPIs, discarding hypothesis that didn’t show results and quickly adopting the ones that show promise. More importantly, this is a culture and a management philosophy that must be instilled into the company by the founders. It should permeate the entire organization. As an investor, we are not looking for entrepreneurs to always have the right answer. We are looking to see if they have built an internal company process and culture that will help them ultimately find the right answer(s).
When we invested in Thumbtack, the thing that struck us the most is the level of mastery the team had over their metrics at such an early juncture of the company’s development. They took the time and precious, seed resources to invest in internal tools and dashboards that tracked every relevant metric and helped them answer any question related to their KPIs. Even though many questions about the business remained, such as what business model would work and scale, we had confidence that the team had the right process in place to get to the best result over time. And after several business model iterations, they finally found one that allowed the company to unlock major revenue growth.
The ultimately defensibility of any marketplace is the ability to attract and lock in supply, and build in high repeat usage on the demand side. This is the positive feedback loop that creates marketplace stickiness and liquidity.
One approach to achieve this goal is to spend a lot of money on marketing and brand building. This is a common path for many of the travel OTA marketplaces like Priceline and Expedia, as well as Angie’s List and Home Advisor.
However, as Series A investors, we are obsessed with capital efficiency. We want to see our early stage capital go a long way, get to a sizable level of revenue, and be able to attract favorable, minimally dilutive, later stage capital. So unfortunately a marketing cost heavy approach to building a marketplace is just not that appealing. That leads us to look for source of “leverage” with our early stage marketplace bets (and frankly all of our bets). What do I mean by “leverage”? Typically it is some business model, distribution, or marketing strategy that allows a company to get big without a lot of cash burn and a ton of headcount. In Thumbtack’s case, this was their SEO expertise in the early days. For Vacatia (a resort residence marketplace for vacationing friends & families), it is the team’s unfair advantage of being industry insiders, and being able to negotiate large scale business development distribution deals with major players in the hospitality space.
Other examples of leverage are community and high word of mouth (i.e. Nextdoor), a disruptive business model that attracts both supply and demand with favorable economics (i.e. AirBnB), or high average order values (AOVs) on transactions (eg. Laurel and Wolf, Kinnek), which even at small take rates, translate to large net revenue for the company.
A marketplace can have one or several of these points of leverage. In each pitch meeting, this is one of the critical elements that we are searching for. This “leverage” allows the marketplace attract more capital, grow with strong profit margins, and ultimately be able to invest in more capital intensive efforts, like brand building and mainstream advertising as the company matures.
Large Total Transaction Volume (aka “Deep TAM”)
This almost goes without saying, but since marketplace take rates typically cannot exceed 25% (and some would argue should be as low as possible), the Total Transaction Value or GMV of the marketplace needs to be very large to support a big business. If the total GMV of a marketplace is $20B, that means the TAM for that particular marketplace company is not going be more than $2B-$4B. Generally we are looking for marketplaces where the total GMV exceeds $40B. In Thumbtack’s case, the total GMV of the home services market is $1 Trillion! Obviously the larger the better, as it lessens the impact of potential competitors and moves the opportunity away from a “winner take all” dynamic. As investors, we would much rather invest in a market where there can be multiple winners.
This is of course not an exhaustive list of important marketplace investment criteria. Questions around disintermediation, marketplace integrity, and regulatory challenges (where applicable) do come up frequently as well. Also, maintaining and optimizing for a high perception of value for all marketplace participants by constantly calibrating and iterating around the KPIs that reflect that is paramount as a marketplace scales. How the team approaches analytics and an iterative product philosophy is the best early clue any investor will have to give them confidence that these other important factors around a successful marketplace will have solid execution behind them. In the earliest stages, where signs of scale are just not there yet, we gravitate towards evidence of “The Scrappy Spark”, a strong religion around iteration and metrics, sources of “leverage” and a Deep TAM as the critical ingredients of a successful marketplace investment.
— Alex Gurevich, Managing Director