The Best Types of Marketplace

Marketplaces are one of the oldest commercial constructs known to man. Since the Romans came together to buy and sell fish, vegetables and vases, humans have been designing and refining marketplaces to meet their needs and generate value (forum is Latin for ‘public open space’).

Marketplaces come in different shapes and sizes and exhibit a variety of behaviours. My favourite marketplaces demonstrate certain characteristics which optimise them for growth and value generation. Here are 5 of those:

#1 HIGH LIQUIDITY

High liquidity doesn’t just mean many buyers and sellers. There have to be enough buyers and sellers to achieve critical mass, of course, but liquidity comes when they start transacting with each other. High liquidity is when they transact often — when there are a high number of transactions per user. Ideally these transactions should be spread across the user base, and not just concentrated in a small number of high-volume super-users.

Why is this good?

High liquidity is desirable because it translates to frequent touch points with your users. Not only does this mean that you have more regular cash flows — monthly instalments of £100 are better than an annual transaction of £1200 — it can also mean that customer churn is lower, since you begin to build trust and stickiness for the users (more on this below). High liquidity also allows you to build brand awareness and generate word-of-mouth growth, which reduces your Customer Acquisition Cost (CAC). Finally, high liquidity is particularly useful in the early stages of a marketplace because it affords frequent feedback and therefore faster iteration in terms of improving the product.

How to measure it?

Liquidity in a marketplace is often measured as a percentage of items sold in a specific time period. The time period depends on the type of marketplace, but typically it is a shorter period for smaller ticket/higher volume marketplaces. You can also analyse liquidity to see what percentage of your users generate the majority of transactions — in the early stages of a marketplace it is important to have an even spread of transactions across all users.

So what?

High liquidity comes with all sorts of benefits which help to grow a marketplace. That is not to say less liquidity is bad — there are many examples of successful marketplaces which have lower liquidity, such as AUTO1. However in general high liquidity makes the job of an entrepreneur easier, and marketplace founders should chase liquidity before chasing growth.

#2 HIGH RETENTION

This is another seemingly obvious successful marketplace characteristic, summarised well in this post by Samaipata Ventures. Retention is when users — buyers and suppliers alike — keep coming back after their first experience on the platform. Most often these are analysed in the form of cohorts, which illustrate the activity of a group of users acquired in a specific week/month/year. It is common to analyse cohorts across number of buys, revenue or margin.

Why is this good?

High retention is desirable because it means you get more value per user for the amount you spend acquiring them. Put another way, it means your Life-Time Value (LTV) to CAC ratio is higher (although if it becomes too high, for certain marketplaces, it may mean that growth is being restricted). High retention also means that your business model is working — if the customers you acquire only transact with you once, then your product probably isn’t delighting them (admittedly some lead generation marketplaces are built around very low retention rates). If your customers love the product, they are likely to keep transacting.

How to measure it?

Typically retention is measured as a percentage — an average of each cohort’s retention over time. A more accurate measurement is to look at individual cohort trends — this will give you an indication of your retention trend, rather than just a simple number. Ideally user cohorts will improve over time — understanding this is especially important for early stage marketplaces, which should be looking to quickly iterate the product and retain more of each cohort as each week/month goes by.

So what?

User retention is one of the first metrics that marketplace entrepreneurs should work on — it is important to get this right before optimising for growth. You don’t want to pour water into a leaky bucket.

#3 HIGH TRUST

High trust is when users have confidence that they will receive the product that they have purchased, or in the case of supplier-pick marketplaces such as Uber or Rev, when they are confident that their job request will be fulfilled.

Why is this good?

High trust is important because it is a critical driver of liquidity. When users first start transacting on a website there are multiple fears which must be assuaged, otherwise they will prevent transactions from happening. It is especially important for marketplaces where the Average Order Value (AOV) is larger than normal, such as Airbnb, since customers will want to feel confident that what they have bought is what they expected to buy. It is also important for them to feel that the payment process is secure. Many marketplaces have trust features built into their structure — eBay is a good example of how a marketplace built trust through user reviews, for both buyers and sellers. Different marketplaces will require different trust mechanisms depending on the perceived risk. The larger a marketplace becomes, the more important it is to have trust mechanisms, since larger platforms are more likely to attract bad actors.

How to measure it?

This is a difficult one to measure, but a proxy for trust can be user retention or spread of liquidity. If users have a poor experience then they lose trust in the platform and churn off. Often this can happen without the marketplace operators being aware, especially if the AOV is small — users have a bad experience and leave without a word. Equally, if they don’t trust the platform after they register, users are less likely to transact on it, which can lead to liquidity concentrated in a small user base.

So what?

Trust is easy(ish) to generate, but also easy to overlook. It is particularly important for high AOV products, and should be built into the structure of a marketplace early so that behaviours are established before optimising for growth.

#4 HIGH FRAGMENTATION

High fragmentation occurs when the demand and supply sides of the marketplace are dispersed and generally unconnected. Deliveroo is a good example of a marketplace with high fragmentation — the demand side consists of unconnected individuals, while the supply side consists of independent restaurants or chains of restaurants who are in direct competition with each other.

Why is this good?

Highly fragmented buyers and sellers do not have enough power to move the industry in a particular direction, meaning the marketplace can exert more control. This allows a potentially higher take rate (although marketplaces should be aware of charging an exorbitant rake). Fragmentation on the supply side means that sellers tend to be small, so they get added value when they join the marketplace and experience increased demand. Think of the extra revenues that a small restaurant can make from Deliveroo orders without needing to increase its fixed costs. As Bill Gurley mentions here, a concentrated supply base won’t allow a new intermediary in the market, which obviously makes life difficult for early stage marketplaces. For the fragmented demand base, a marketplace consolidates supply in one location, and can often improve user experience through storing address and payment details.

How to measure it?

There are economic measurements such at the Herfindahl Index, which analyse market concentration, however these are less useful for early stage technology marketplaces. Usually the fragmentation of supply/demand will depend on the industry. The air travel market is a good example of a low-fragmentation industry, which means low take rates for marketplaces such as Skyscanner. In consumer marketplaces only supply will vary in fragmentation, whereas both supply and demand fragmentation can vary in B2B marketplaces.

So what?

High fragmentation is crucial to profit for a marketplace entrepreneur. It allows for a meaningful take rate, and hands control to the marketplace operators. It also means users extract real value from the existence of the marketplace, which makes it sticky.

#5 PAYMENT OWNERSHIP

This is when the marketplace owns the payment process for the transactions within its walls. A marketplace which does not own the payment process is most commonly a lead generation marketplace, with suppliers paying to access the demand and a subsequent transaction between two actors once a relationship has been established.

Why is this good?

Ownership of the payment process is important for a number of reasons. Not only does it afford the marketplace operators full information of transactions within their walls, but it often generates greater profitability, since the potential take rate is higher. In addition, it also drives a number of characteristics mentioned above. Trust is usually higher in a marketplace which owns the payment process, since it can (usually) assure secure payment. Retention is also higher, since secure payment and standardised processes reduce the scope for poor user experience. Finally, quality control is possible with payment ownership, since payments can be reversed if incorrect transactions occur, as is the case with eBay and PayPal.

So what?

Payment ownership may not suit all types of marketplace. Move24 is a good example of a successful marketplace which does not completely own its payment process. However, for transaction transparency, quality control and greater profitability, payment ownership is a characteristic of great marketplaces.

Conclusion

High functioning marketplace can be difficult to establish. Not only do you have the chicken and egg problem with supply and demand, but there are a myriad of other factors to get right, only some of which are mentioned above. It will also take time — more time than many other technology businesses — to see results. Nonetheless, these results can make for a compelling value proposition and, very occasionally, a place at the table with the tech giants of this world.