While traditional marketplaces have existed for decades, there has been a rise of digital marketplaces since last two decades. I have been helping a peer-to-peer travel marketplace for the past few months and I have spent a lot of time thinking and learning about marketplaces and business strategies associated with them. So, I would like to share my lessons here.
What is a marketplace?
We discussed about different types of network effects in this article. One of them was a two-sided marketplace.
The real distinguishing characteristic of a two-sided marketplace is that there are two different classes of users: supply-side and demand-side users. They each come to the network for different reasons, and they produce complementary value for the other side.
In simplest terms, a marketplace is a gathering place for commercial transactions — a clearly defined space where products or services are bought and sold.
Some of the distinct characteristics of a marketplace are:
- Marketplace takes care of end-to-end customer experience. They act as a middle-man and facilitates transactions and payment flow. Taking care of payment rather than having customers pay offline creates more value of a marketplace and foster trust on the network, leading to higher stickiness of a marketplace. Sometimes, marketplaces don’t facilitate end-to-end transactions and payment take place offline. For example, Zillow is a marketplace where they connect home-buyers with real-estate agents. They used to simply connect both sides and were not part of a transaction until last month, when they changed their business model and started buying homes by themselves.
- Marketplaces aggregate and commoditize suppliers who provide similar types of service in the marketplace. For example, couriers on Postmates offer same service and they have nothing unique to offer to the customers, thus supply gets commoditized over time.
Most of the marketplaces are disrupting existing players. It’s difficult to change status quo, as customers are used to buy services of incumbents. In addition to that, initially, digital marketplaces’ services lack the familiarity, predictability and trust. For example, at Airbnb, guests were reluctant to stay at an unknown’s place and also hosts were reluctant to stay to rent their property to an unknown.
As mentioned in the 20/20/20 model, below are the rules to build a successful marketplace.
Part 1: Build a product/service providing consumers with the same utility 20% cheaper
Part 2: Help service providers earn 20% more than their usual rate
Part 3: You should make 20% margins after satisfying consumers and service providers
So, it’s important to provide better and cheaper service, and create value proposition for both supply and demand-side users to create a successful marketplace.
Why is it difficult to build a marketplace?
It’s difficult to build a marketplace. As mentioned in this article (recommend reading in full), starting and scaling a marketplace is hard and may face below problems. Marketplace is not just about connecting buyers and sellers but has to address below factors too. The author of the article has provided a pyramid to help us understand how to prioritize below issues.
1. Trust & Safety
2. Reliable logistics
3. Service delivery
4. Incident resolution
5. Service personalization
6. Supreme delight
But, before that, how to attract one side of the market to participate before the other side has gathered in sufficient numbers to make it worth their while — this remains the most fundamental question for any marketplace.
For example, if there are not enough sellers on the marketplace then buyer wouldn’t find value and will leave the marketplace. Similarly, if there are not many buyers over the course of time, sellers will get frustrated and might stop selling their service/product. Thus, there is always a chicken-egg problem that exists in a marketplace. It is very important to balance supply & demand and create liquidity in the market.
How to create liquidity in a marketplace?
Marketplace business model works great at scale. Thus, it’s very important to achieve liquidity. However, the challenge is always to get to liquidity.
Liquidity is defined as the number of transactions filled out of the total potential transactions in a marketplace.
As mentioned in this summary article, while starting a marketplace, companies often start with seeding supply side. If buyers don’t find enough values on network, they might leave as there is nothing for them to lose, but suppliers might see the value and wait for demand to be created, as it would generate economic opportunity for them. The key is to identify, seed and aggregate supply in the initial days. I have seen various ways to create supply.
Companies generally convince existing sellers to list their service on the marketplace by offering promotions, providing referral bonus and taking cheaper take rate. Sometimes, companies also pay suppliers out of pocket to create inventory on their marketplace. Marketplaces also leverage various growth hacking tactics to achieve critical mass. In B2B and B2C marketplaces, companies often partner with businesses to generate a supply. For example, Instacart partnered with multiple grocery stores
Apart from that, companies also create stand-alone product or service, which add value in suppliers’ operations. As Chirs Dixon said, come for the tool, stay for the network.
The idea is to initially attract users with a single-player tool and then, over time, get them to participate in a network. The tool helps get to initial critical mass. The network creates the long-term value for users, and defensibility for the company.
For example, OpenTable started as reservation tool for restaurants. They didn’t require customers to reserve restaurants. Once they had enough restaurants on OpenTable, they started providing real-time visibility to buyers to reserve restaurants.
Another approach that I have seen is — marketplaces leverage established networks’ traffic and user base to promote product or recruit supply. For example, in early days, Uber leveraged Craigslist to recruit drivers. The similar tactic can also be employed to acquire demand. Airbnb used to post their listings on craigslist through platform integration to get more visibility to hosts’ listings.
Recently, I have seen a new business model emerging where companies running marketplace buy products from the seller before finding/matching a buyer for it and then sell it on the marketplace. Opendoor is a recent example of this.
In early days of a company, resources are limited, so it makes sense to focus the efforts of a business by certain geography, market segment or a vertical and scale business further from there. For example, all local marketplaces (e.g. Uber, Instacart, Letgo etc.) launched in a certain geography first and then expanded into other markets. Similar to that, Airbnb launched their service by offering homestay and later expanded into experiences, restaurants and events.
Once supplier base is created, it’s important to connect customers to suppliers and create virtuous cycle of supply and demand. As shown in image, in virtuous cycle, high number of suppliers will lead to high number of buyers on a marketplace, which would further attract more suppliers to the marketplace and the cycle continues, which in turn creates more liquidity. Once network effect is created on marketplace, users won’t find much value in competitors’ marketplaces and marketplace gains defensibility.
In subsequent articles, I will write about types of marketplaces, business models and metrics. Consider the series as a primer for those who need a quick overview of marketplaces.
