Startup Series: How to de-risk a two-sided marketplace
Some of the most valuable companies and startups in the world are two-sided marketplaces. Yet two-sided marketplace startups have double the risks. Building a marketplace is like building two companies simultaneously, with each one dependent on the other. In creating strategies for two-sided marketplaces, start-ups typically rely on models, that apply to products or services firms. This can lead to failure. This article introduces a new model for how to de-risk and validate assumptions in two sided marketplace startups.
What is a two sided marketplace?
A two-sided marketplace brings together two groups (usually suppliers and customers) to interact with one another and creates value through an intermediary platform and leveraging network effects. Network effects are created when a product becomes more valuable as more people use it (e.g. Snapchat or Instagram). With two-sided marketplaces, the value to a user largely depends on the number of users on the platform.
Two-sided marketplaces are fast becoming key players in every industry. One of the most popular two-sided marketplaces is Uber. Uber’s marketplace connects drivers with riders. Uber is one of the largest transportation companies in the world, but it doesn’t have any of its own cars or full-time drivers. AirBnb, Etsy and Craigslist are also great examples of two-sided marketplaces causing industry-wide disruptions.
A common model that start-ups often use is the Lean Canvas. Created by Ash Maurya, Lean Canvas is an adaptation of the Business Model Canvas by Alexander Osterwalder. The Lean Canvas is a 1-page business plan template that helps you deconstruct your idea into its key assumptions. Lean Canvas promises an actionable and entrepreneur-focused business plan. It focuses on problems, solutions, key metrics and competitive advantages and specifically on start-up factors such as uncertainty and risk.
Challenges with the Lean Canvas
Building a marketplace startup is like building two companies simultaneously: there are two separate customers with their own problems/solutions; however, to complicate the matter for marketplace start-ups, each side is dependent on the other. Since two-sided marketplaces are the product of their network, they are difficult to establish and maintain once created. Lean Canvas is for product and services start-ups and does not consider the assumptions about the interaction of the network and the difficulty of making sure the assumptions on both sides of the marketplace are accurate.
I have created Marketplace Canvas, which is an adaptation of Lean Canvas. The purpose is to create an actionable and entrepreneur-focused business plan for marketplace start-ups to test assumptions.
Elements of the Marketplace Canvas
It is important to look at each side of the marketplace separately. If the marketplace does not solve a problem on each side, then it will not be successful.
1. Customer Segment — With a two-sided marketplace, there are two different customers, one for each side. It is important to identify who the target customer segment is for each side of the marketplace.
2. Problem — What problem are you trying to solve for each target customer? Intentionally illustrating the problem for each side of the marketplace helps determine whether both customer segments’ problems will be compatible in a marketplace.
3. Solution — As Ash Maurya says, ‘Once you understand the problem, you are then in the best position to define a possible solution.’ Most start-ups are too passionate about the solution instead of the problem they are solving.
This is sink or swim time for most marketplace startups. Does the solution match one side of the marketplace or not? Does it match the other side? Two-sided marketplaces fail quickly if the solution for one side does not clearly match a need on the other side. With AirBnb, for example, both sides of the customer pool had problems. On one side, the cost of renting an apartment is enormous; on the other side, hotel prices are also high. The initial problem/solution was clear to both sides.
4. Unique Value Proposition — What is unique about your solution compared to others in the market? Why will target customers choose your marketplace over existing solutions?
If there is nothing unique about what you are offering on each side of the marketplace, even if the problem exists and you have a good solution, you still may not be able to attract both sides, which will collapse your marketplace.
5. Revenue / Pricing — One key decision here is pricing. Marketplace start-ups can draw revenue from both sides; however, in most cases, it makes sense to subsidise one side. Do you want to charge both sides or just one side? How much will customers be willing to pay?
6. Costs — It is important to look at the cost involved to service each side of the marketplace. This is not the cost of building the marketplace, but the costs for getting each side of the marketplace to join. For each side of the marketplace, it is important to know how much it will cost to add one more customer. For some marketplaces, the cost of attracting and integrating one side of the marketplace is a lot higher than the other.
These elements should be looked at collectively across the marketplace.
7. Acquisition strategy — You can’t just turn on a marketplace! The initial stages of a two-sided marketplace are challenging; it’s the classic chicken and egg problem, and it’s the area early-stage marketplace start-ups struggle with the most. Which side of the marketplace can you attract first? How will you attract them? Take Uber for example. Without riders, there wouldn’t be a demand for drivers, and without drivers, there wouldn’t be a reason for riders to come to the platform.
Since getting both sides in sufficient numbers simultaneously is almost impossible, marketplace startups need an acquisition strategy.
8. Network ratio — A two-sided marketplace works well when its design allows it to add increasing numbers of users to create a network effect. However, it’s important to know what your ratio assumption is between both sides of the marketplace. For example, Uber needs to consider the number of riders needed for each driver. This helps marketplace start-ups realise the ratio they need to maintain whilst scaling.
Getting the ratio wrong can lead to lopsided marketplaces, which can cause customer irritation and customer drop out on one side of the marketplace. For example, if the initial assumption is that 1 Uber driver is needed for every 100 riders, then the acquisition strategy is set up for that ratio. However, if it is found that 1 driver is needed for every 10 riders, this would cause riders to show up on the platform and be unable to get a ride, causing frustration and customer pain. Both the acquisition and scaling strategies would need adjusting.
9.Unfair advantage — Ash Maurya describes unfair advantage as ’once a startup achieves some level of initial success, it is inevitable that competitors and copycats will enter the market. If you don’t have a defence against them, you stand a real risk of being made extinct by these fast-followers.’ It is important to think about the unfair advantage/competitive edge across the marketplace as a whole. What is the unfair advantage of your marketplace?
Another challenge marketplaces have is what keeps both sides using the marketplace after they have been connected? Homejoy is a famous Y Combinator marketplace startup connecting cleaners with households. In 2015, the marketplace ceased operations. One of the reasons is that once a household was introduced to a cleaner, they then arranged an agreement between them, excluding the platform. The platform didn’t have an advantage for both sides to continue using it.
Two-sided marketplace startups have double the risks, yet if you are able to get it right it will have incredible returns and can majorly disrupt industries. I hope this Marketplace Canvas helps validate assumptions and lowers the risk for your marketplace startup.