Why Marketplace Liquidity Should Be Your Top Priority
How a liquid marketplace can be the leading indicator of healthy growth, yet the concept often remains shrouded in complexity.
👋 Hi there! I’m Chandra Ishano, the mind behind noulej.com.
When a marketplace is up and running, supply (restaurants, homes, drivers) serves demand (eaters, travelers, passengers) smoothly. But starting out, with neither supply nor demand, getting the flywheel going is challenging. You must convince one side to commit before the other. Without restaurants, customers won’t check your app. Without customers, restaurants won’t onboard. This “chicken-and-egg problem” is a major barrier to launching a marketplace.
Our exploration will dive into understanding marketplace liquidity and the factors influencing it. We’ll dissect key metrics and how diminishing marginal returns affect our quest for a liquid marketplace.
1. Understanding marketplace liquidity
Marketplace liquidity is fundamentally about the efficiency with which a platform matches buyers (demand) and sellers (supply). It is often described as the lifeblood of marketplaces, as without it, the platform essentially lacks a product. The core product in any marketplace is the ability to facilitate transactions seamlessly. This is why understanding both demand and supply liquidity is crucial. Demand liquidity refers to the probability that a buyer’s search or request on the platform will result in a transaction, while supply liquidity is typically gauged by the Utilization Rate of the supply side.
Different types of marketplaces, such as double-commit marketplaces like Tinder and Upwork, buyer-picks marketplaces like Airbnb and Gumroad, and marketplace-picks like Grab and Uber, each have unique liquidity needs and metrics that are critical to their success.
👀 Why Liquidity Matters in Marketplaces?
Liquidity in marketplaces is not just important; it’s essential for the survival and growth of the platform. High liquidity ensures that transactions are frequent and friction is minimal. It’s about how swiftly users can find what they’re looking for, which is measured by the fill rate of demand or supply that is intent on making a transaction.
Moreover, liquidity is a prerequisite for generating network effects, where the value of the service increases as more participants use and trust the platform. This creates a virtuous cycle that enhances user satisfaction and attracts even more users. In simple terms, liquidity measures how effectively a marketplace can turn supply and demand into successful transactions.
In essence, high marketplace liquidity means that users are more likely to trust the platform, transactions occur swiftly and reliably, and the overall user satisfaction is high. This not only helps in retaining customers but also in attracting new ones, thereby expanding the marketplace’s reach and impact.
2. Key Metrics to Measure Liquidity
Liquidity
Determine whether your marketplace is primarily constrained by supply or demand. Most marketplaces focus on demand because attracting and satisfying customer needs is often more challenging than attracting suppliers.
- Focusing on Demand Liquidity: If you identify that demand is your primary concern, this focuses on how well the marketplace meets the needs of its users seeking goods, services, or information.
- Focusing on Supply Liquidity: If you determine that your marketplace is primarily constrained by the availability of suppliers, then focusing on supply liquidity becomes essential. This is often the case in marketplaces where the quality or availability of suppliers directly influences user satisfaction and transaction success.
For GrabBike, which operates a ride-sharing service, demand liquidity could be measured by the number of rides booked per session.
Unit of Intent as Denominator
The unit of intent should closely relate to potential transactions. It should be a measurable action taken by users that indicates their intention to engage in a transaction, but it should not be affected by the amount of available supply. Select a metric that sits as close as possible to the actual transaction without being overly influenced by supply constraints.
Once you have your unit of intent, calculate your liquidity by determining the ratio of successful transactions to the units of intent. This fill rate will help you gauge the efficiency of your marketplace in converting intent into actual transactions.
Market Health as Driver of Liquidity
The market health metric serves as a leading indicator of marketplace liquidity. It offers an immediate snapshot of the marketplace’s current state, focusing on how potential transactions could unfold based on current conditions. This metric is crucial because it measures the quality of user experience before a transaction completes, thereby predicting future success or identifying potential issues.
Identifying the drivers of liquidity in a marketplace involves understanding which aspects of market health are most predictive of transactions occurring. This process is vital for maintaining and enhancing the efficiency and effectiveness of a marketplace.
For GrabBike, ETA (Estimated Time to Arrival) had a strong correlation with the # rides completed per session with R-squared value of 0.93. Grab decided to pick ETA as the Market Health Metric for several reasons:
- It had the strongest influence on rides completed.
- ETA is a clear and intuitive metric that is easy for both internal and external stakeholders to reason about, think about, and goal against.
3. Factors Influencing Liquidity
Geographic Reach
Understanding the geographic reach is crucial when analyzing potential liquidity in a marketplace. For instance, platforms like Upwork facilitate transactions globally, while others like Tinder are more localized, focusing on city-specific interactions. This distinction affects how we approach liquidity, from global strategies to city-specific tactics.
In local marketplaces like Tinder, the correlation between the number of participants within a specific radius and liquidity is significant. Defining this geographic area accurately helps in optimizing the density required for effective marketplace transactions.
Category Concentration
Category concentration can accelerate liquidity in popular categories. By promoting in-demand categories, a marketplace can attract more buyers, thereby increasing overall liquidity while reducing customer acquisition costs. For example, Instacart as marketplace has 1 million active buyers at a certain point in time, how many of them are in the market for a banana? How many are looking for garlic? How many want a soap? Only a small segment of the 1 million active buyers will be interested in each category. This means we cannot just evaluate the overall liquidity of the marketplace, instead do it on a per-category basis.
Demand and Supply Balance
Achieving a balanced demand and supply is pivotal for maintaining marketplace liquidity. This balance can be described using the “healthy market line,” where ideally, there are enough buyers for every seller to ensure continuous transactions. This ratio should be monitored and adjusted as the marketplace evolves, ensuring that neither side overwhelms the other, which could lead to reduced transaction completion rates 35. For instance, too much supply with insufficient demand can lead to unsold inventory, while too much demand with little supply can frustrate buyers, harming the marketplace’s reputation and liquidity.
Example for Gumroad:
Oversupply: Gumroad could face an oversupply scenario where there are too many creators offering similar products, leading to a saturated market. This situation is especially risky for new or less-known creators who might struggle to gain visibility. Impact: An oversupply can drive down prices and reduce the earnings per creator, which may lead to demotivation and eventually higher churn rates among creators, particularly those who are struggling to make substantial income.
Overdemand: Conversely, there could be instances where demand outstrips supply, particularly in niche or specialized categories where there are not enough creators to meet consumer interest. Impact: This imbalance can lead to missed revenue opportunities and customer frustration if potential buyers cannot find the products they are looking for. Over time, this result in consumers turning to other platforms.
4. Impact of Liquidity on Marketplace Growth
Retention and Engagement
Marketplace liquidity is often the strongest driver of retention and engagement for platforms. When users consistently find what they need, like on Amazon or Shopee, they are more likely to return, creating an ultimate engagement loop. For instance, GrabBike measures its liquidity by the percentage of app opens that convert into a ride. A crucial market health metric for them is the average estimated time of arrival (ETA) a user sees when opening the app. If the ETA is too long, users might opt for alternatives, which directly affects user retention.
User Experience Enhancement
A user-friendly interface significantly enhances the user experience by making navigation and transaction processes smoother and more efficient. Uber, showcased in their Investor Update 2024, be able to improve customer retention for Grocery Vertical up +580 bps by invest in user experience improvement.
Marketplaces that invest in robust order processing, responsive customer support, and secure payment systems see higher user satisfaction and trust. Another example, Uber, written in their Investor Deck 2022, advanced machines learning improve the precision of matching 1000x and pricing optimization +300% for a decade.
5. Challenges in Achieving Liquidity
A network effect occurs when a product becomes more valuable as more people use it, making a networked product without users essentially useless — like Grab app with no drivers. Today, launching a product is harder than ever due to fierce competition for attention, and the dominance of major players underscores the significance of network effects. While copying features and marketing channels is possible, convincing a vast user base to switch is not. Initially a B2C phenomenon, networked products are now increasingly seen in B2B contexts, with apps like Slack and Notion starting with a few passionate users within a company and then spreading throughout the organization.
It can be called, The Cold Start Problem, is a classic conundrum faced by new marketplaces, encapsulating the difficulty of attracting the first group of users when neither buyers nor sellers have a compelling reason to join an empty platform. Experts often liken this to the “chicken and egg” scenario, where the presence of sellers is contingent upon the presence of buyers and vice versa.
❤️ Inspiration from this article came from numerous conversations with marketplace entrepreneurs and professionals. THANK YOU!
Borja Moreno de los Rios (ex-CEO at Merlin, Fonder and GP at Silence), Andrew Chen (ex-growth at Uber, Author of The Cold Start Problem), Julia Morrongiello (Investor at Point Nine Capital), Sahil Lavingia (CEO and Founder at Gumroad), Sameer Singh (Venture Partner @ Speedinvest), Anna Via (ML Product Manager at Adevinta, Board Member at DataForGoodBcn), Manfredi Sassoli de Bianchi (Marketing & Growth Director at MyTutor.co.uk).
