[Also published in Wharton Magazine]
Liquidity is a term you might hear banded about in tech circles but it’s not often you’ll see it explained.
Marketplaces are extremely complex businesses to build. The demand and supply sides are often completely different. Their respective user bases differ in nature, relevant value proposition and periodicity of usage. Building a two-sided marketplace therefore poses the challenge of essentially growing two separate businesses, each with its own demands and pitfalls.
One of the most difficult aspects of building a marketplace from the ground up is knowing what elements to prioritize.
The complexity of marketplaces often leads to the creation of vast product ecosystems and auxiliary feature-sets.
Consider AirBnB, EBay, Etsy or Upwork. They each offer advanced tools to help sellers, full-featured seller profiles, reputation-related ecosystems and ratings, payment engines… and that’s just scratching the surface. So as a young marketplace with scarce resources, it’s tough to decide what to focus on. What is the single most critical element to grow a healthy marketplace?
The answer is liquidity.
Liquidity is essentially the ability of a marketplace to match demand with sufficient supply.
Every marketplace has a different concept of liquidity. For Lyft, it could be measured as the percentage of ride requests that are matched successfully to a nearby driver. For AirBnB, it might be the average number of nearby host properties available for rent across all searches on the site. For our own marketplace- Kinnek, it’s the average number of relevant quotes received per given request.
Liquidity is Vital
Regardless of how you define it, liquidity is the crux of a marketplace.
Take Craigslist for example. For nearly two decades it’s been the gold standard of an effective marketplace — not because of its interface — but because of its liquidity.
This is amazing, given that when it comes to ease of use, aesthetic feel and user interface, Craigslist looks like it hasn’t been redesigned since the Clinton administration.
Instead the true source of its power is the impressive liquidity the marketplace delivers. It often feels like whatever you post on Craigslist, you can find an interested counterparty. Renting your bike? Selling your old Nintendo? Looking for a tutor? Hiring a personal yoga instructor? The marketplace can deliver tons of responses to each post in a shockingly short period of time.
So if you’re building a marketplace and you don’t provide enough liquidity, it’s really a moot point to wonder why your users aren’t coming back and re-engaging.
Providing enough liquidity drives buyer engagement and contentment, which ultimately drives more purchase decisions, which results in happier suppliers (since they’ll make more sales through your platform).
This good experience leads to a positive feedback loop where those happy buyers come back and pump more demand into the system. This generates sufficient liquidity for suppliers, which leads to more purchases, so on and so forth. A virtuous cycle is achieved.
Finding the Right Balance
So now we’ve identified liquidity as the keystone of any good marketplace, what are the steps to achieving good liquidity?
First, you need to understand the two components of liquidity: the existence of supply and the demand-supply matching mechanism.
If a unit of demand enters your marketplace, you must first have enough supply to cater to that demand, then be able to effectively match that unit of demand to supply.
Create metrics around those two components of liquidity then monitor them closely.
Remember, it’s okay if liquidity yield is achieved by using slightly manual processes early on in the lifecycle of your marketplace. If you need to call a potential buyer and personally put them in touch with a supplier, do it.
If you need to do some manual legwork toresearch relevant suppliers for a non-standard request, go for it. Being “high touch” in the early days of your marketplace, when it comes to both acquiring supply and matching demand to that supply, isn’t the end of the world. In fact, that’s how most successful marketplaces are initialized.
As time goes on and the marketplaces handles more incoming demand, be sure to improve both the matching mechanism and your supply acquisition strategies.
As your scale increases so will your users’ behavior. You’ll need to learn quickly how to adapt to those changes to further grow the marketplace in a more automated fashion.