Blueprint for a Sustainable Service Marketplace
We wrote this piece in May 2014, prior to Uber’s recently announced $1.2BN round of funding. Nonetheless, our thoughts on how to build sustainable marketplace value…
Building Sustainable Marketplaces
The number of independent professionals has exploded in the last 5 years. By 2019 there are expected to be 50 million independent professionals in the US alone. More Americans are starting their own business partly due to a cultural shift — people in their 20s and 30s seeing their parents get laid off in 2008 and 2009, and realizing that you can’t rely on pensions, 401ks, or loyalty from large firms. However, much of this growth has also been fueled by new online marketplaces that have enabled them to market their services to new clients over the Internet at an unprecedented scale.
As these marketplaces have developed in the small business service sector, a discrepancy has formed in the value propositions experienced by the market participants. When I say marketplaces, I’m referring to the broad array of web or mobile platforms that combine clever algorithms with consumer marketing to aggregate and match up suppliers of services with buyers of said services.
Some marketplaces deliver value primarily to the demand-side of the market. The thinking here is that customer demand will attract suppliers to the market. Groupon, the pioneer in daily deal coupons, is a prime example of a successful demand-side marketplace with a simple customer pitch: get 50% off any service you want. They were one of the fastest growing tech companies of all-time.
In contrast, some marketplaces take a more balanced approach in delivering value. Uber, a leader in the transportation-as-a-service space, is a prime example of a successful dual-sided marketplace. They offer drivers more passengers at market rates and offer consumers convenient taxis. Other marketplace platforms are focused primarily on the supply side of the market. NetSuite is a prime example offering an e-commerce platform that lets their existing customers sell their products to shoppers online from their integrated back office system.
Using Groupon and Uber as case studies, we will compare and contrast the performance of these marketplace models with respect to how value is created and sustained for both the supply and demand sides of the market. We hope to offer some insight to marketplace analysts and investors.
Single-Sided Market Model
Most people have heard of Groupon — a pioneer in the daily deal industry. The company’s value proposition to customers is clear and immediate: save money. Buy a groupon and you get an immediate 50% discount on any service — a massage, a haircut, a dinner, etc. There is also no limit to the number of groupons you can buy so the long-term value is also clear.
On the business side, Groupon’s pitch is — we’ll get you lots of new customers if you discount your services. Groupon saw significant growth in its early stages as businesses were able to give clients the heavy discounts they wanted while filling some capacity with new clients at around 25% of what they would normally charge. The long term value proposition to businesses required a leap of faith that these new customers would later become repeat customers paying full price for the services.
Dual-Sided Market Model
Uber is the most popular transportation app on the market today. For customers, the app lets you pick the type of car you want. Next you’re picked up and driven to your location by a friendly driver with the payment processed automatically. The customer value is clear: convenience.
For the business, Uber lets drivers check in, receive nearby taxi requests, and not have to worry about credit card processing or disputes with unruly customers. Driver hours are flexible and they have full control over who they pick up because client ratings are made available to the driver. Finally, you get rewarded for providing great service in the form of customer reviews and ratings. The business value is also clear: increased earnings, flexible schedules, and a safer working environment.
Revolt of the Underserved Market Player
After researching the financials and talking to participants for both marketplace models, we noticed a recurring theme with the single-sided marketplace model as they grew over time.
It turns out that the underserved side of the market begins to churn after a period of time. With Groupon, many small businesses would use Groupon for 6-12 months and look back to see what their return on investment was. That is to say, how much revenue and margin did the business give up through discounts, compared to how many new and recurring clients the business gained. What we found was that most of the business owners we spoke to had decided that Groupon’s economics did not make sense for them — although discounted service offerings bore them short-term volume lifts, these new customers did not convert into recurring customers. The leap of faith that was required of them did not pan out after all.
We also discovered that over time clients were motivated by price and less so by quality of service. Unfortunately, focusing on short-term surges in these types of customers reduces the resources businesses have to spend on more profitable clients. Fewer than 2% of Groupon buyers became repeat customers. With fewer repeat customers, these businesses were not able to accurately predict future cash flows which impaired their ability to operate profitably.
Note that this sequence of events usually does not happen overnight. It takes time for the underserved side of the marketplace to observe then respond to the unsustainable marketplace dynamics. Aggressive sales tactics, marketing and the size of the market (millions of small businesses in the US alone) further mask the churn rate for businesses because the new signup rate often exceeds it in the beginning. Groupon for example has cycled through over 650K merchants with a churn rate (90%) that requires them to replace their entire supplier base frequently.
Fair and Steady Wins the Game
The growth trajectory and churn rate for dual-sided marketplaces are noticeably different from the single-sided marketplace. Using Uber as our example, once an Uber driver, immediately you can fill your unutilized capacity with passengers at your normal rates, and over time you can build your reputation as a service provider. Drivers are not required to take a huge leap of faith before joining. Most people don’t realize that Groupon is only 4 months older than Uber. In the last 5 years, Groupon saw its valuation skyrocket to almost $18 billion (in November 2011). The company was one of the first big tech IPO’s after the great recession, fueled entirely by its frenetic growth rate and media hype. With the market now corrected, Groupon is valued at $4.9 billion. Revenue has begun to slow (2013 revenue growth of 10%, vs. 45% in 2012), and operating margins have compressed to 2.9% in 2013 compared to 4.3% in 2012 (its first year of positive operating income).
Uber, on the other hand, has seen slower but steadier growth. In 2013, it was leaked that Uber was valued at $3.5 billion in its most recent round of financing. That’s a steady climb and right on the heels of Groupon’s $4.9 billion value. The trends suggest it is only a matter of time before Uber eclipses Groupon in revenue, operating income, and market valuation.
This chart illustrates the dynamics of both marketplace models. Single-sided lend themselves to high-growth rates but can be unsustainable. Dual-sided tend to exhibit slower but steadier growth.
Take Care of Both Sides, Everyone Wins
Groupon, the most successful single-sided marketplace focused on customer aggregation and transaction volume and experienced high initial growth. The marketplace growth model was built around the idea that where customers went, vendors would follow. Uber, one of the most successful dual-sided marketplaces grew at a much slower pace while delivering equitable value to both sides.
In conclusion, we believe it is the responsibility of the marketplace to ensure that both sides of the market can operate within the marketplace sustainably. We readily acknowledge that without buyers there is no market. However if 90% of the sellers churn then the entire market suffers. We believe that the best way to build a marketplace is to focus on delivering sustainable value to both sides of the market. Better marketplaces lead to more productive exchanges between people which leads to a more connected and productive society.
- Text work done
PS — I’d love to hear your thoughts on this article. Please leave a comment below or email me at sam[at]pocketsuite[dot]io
