If I was a VC investing in a seed stage marketplace..
Having been through the process of building a marketplace, I’ve had the opportunity to dig into the dynamics of this kind of business. It is very simple when you look at the top of the iceberg (buyers meet sellers). But when you jump into the water, it is much more complex. Building a marketplace is a good balance between science and art. Hard by definition. At UniqueSound, we learnt it big time by addressing a market that didn’t have the structure to adopt our solution.
So, I’ve tried to step back and identify the questions to be answered in order to have a better idea if the marketplace you build has what it takes to be a winner.
If I was a seed stage VC… here are the 7 questions I would absolutely check out before making an investment..
1. Is the market big enough?
2. Is the market structured to welcome the marketplace?
3. What’s the balance between price, volume and frequency?
4. Is your marketplace creating new opportunities?
5. Is there a clear ROI and promise that makes the decision making easy?
6. Is there a clear go-to-market strategy?
7. Is the marketplace likely to be by passed?
1/ Is the market big enough?
Ok, this is obvious. But still, it must be taken into account. Some startups address a market that is VC fundable. Some don’t.
When you’re addressing a large market like Real Estate, Senior Care, Automotive, Home renovation (…) it’s pretty straight forward that your market will be big enough. All the markets mentioned are more than $500B globally. Of course, you won’t address 100% of the market. But if you start with a niche of this market representing 1% of the whole market, that’s still $5B. It’s a good playground to start. And if at one point you feel constrained in this market, you’ll have a big market in front of you to grow your business.
If you go after a small market -let’s say $1B globally- and you take 15% of the market (which is BIG — for instance Salesforce has 18% of the CRM market), that means a $150M in Gross merchandise volume (or gross revenue). If you’re a marketplace that takes 10% of margin, that means a potential of $15M in annual revenue, which is far from the $100M that is a kind of VC reference. As a VC you don’t want to fund an early stage company that will have a lot of difficulties to reach Series A or B because of the market size.
But more than the numbers and the potential revenue, what would worry me with a small market is this:
- A startup can potentially reduce the market size. If you promise to sell a product at $20 while it currently costs $40, you are literally dividing the market by 2. So your small market gets smaller.
- Pivoting in a small market where you feel constrained is more difficult than in a large market where you can visualise more ways to pivot.
NB: Of course there is an exception — the so-called Blue Ocean markets-: The markets that are small for now but we know they’ll be big in a few years. It’s more or less a bet. It’s up to the investors to take the risk. I guess that’s why we call it capital-RISK, right?
2/ Is the market structured to welcome this solution?
The structure of the market is at least as important as the size of the market. By structure I mean asking yourself:
Does it seem reasonable to think that the main actors of the market, the legal framework and the mentalities will be likely to adopt this solution?
The sub questions are:
Who are the main actors/buyers? Is the market you target fragmented or not? Do buyers and sellers have habits? Are they happy with these habits? Are there legal issues? Is your market tech savvy enough? How is the competition? What are the alternatives? Are we in a situation of oversupply (ouch) or over demand ($$)?
At UniqueSound –a marketplace that connects agencies and video producers in need of music for their videos to a global network of +1000 composers- we have been blocked by the structure of our market:
a) Agencies and producers already have their personal network of composers or music houses. They don’t need more supply.
b) Ad agencies’ workers like to work with their friends or people they know well. That’s fair but that doesn’t fit with a platform as we envisioned it.
c) Big ad agencies group own many small agencies that work independently. So when you get one customer in a small agency it doesn’t mean it will be easy to spread within the whole group. There are no cross-agency processes.
d) When it comes to music scoring agencies and brands want a service and not a self-service platform.
e) Oversupply of composers tended to naturally drive prices down.
f) Video is booming but 99% of videos don’t need music or just a cheap and regular background music.
g) Culturally people see music as something free (Soundcloud, streaming sites). They don’t see it as something rare you have to pay for.
3/ What’s the balance between Price x Volume x Frequency ?
You want to make sure that there is a good balance between price, number of customers and frequency.
You sell a high budget product to a small number of customers who don’t come back often: Looks like the north face. Why not, but your margin must be huge.
You sell a high budget product to a small number of customers that come back often: Interesting. => Make sure there are ways to control the leakage. You have to build a game-changing platform. Contently is a good example.
You sell high budget product to a large number of customers that don’t come back often: Interesting => Customer acquisition cost will be critical and you need high margin. Beepi can be a good example.
You sell a high budget product to a large number of customers that come back often: We have a winner. Vettery, the staffing marketplace is a good example.
You sell low budget product to a small number of customers who don’t come back often: Ouch!
You sell low budget product to a small number of customers who come back often: Not the easy way
You sell a low budget product to a large number of customers who don’t come back often: Interesting, but how do you make sure that you can retain mindshare?
You sell a low budget product to a large number of customers who come back often: We have a winner. Think Uber/Airbnb/Instacart/Asos/Zeel/Transferwise.
The additional point I would like to understand is the trend of the price:
How much did your customer pay for a similar product as yours 5 years ago? How much do they pay today? Do they think they will pay the same price in 5 years? Or less? Or more?
4/ Are you building a marketplace that will create new opportunities?
To me, this is a crucial question to answer.
Are you going to build a marketplace that will “just” bring online something that was offline? Or have you some reasons to believe that your solution will boost the market size? i.e allowing new customers to enter the market Or make the current buyers buy more?
Let’s make it simple:
- 3 years ago, I used to take the cab twice a month. Now I take a Uber twice a week. Boom!
- 3 years ago, I used to book an hotel room 5 times a year. Now I book an Airbnb 10 times a year. Boom!
Mechanically, a marketplace tends to reduce the average price of a service (again, look at Uber). So I would see a bigger opportunity in a marketplace having the potential to bring new customers on the market.
5/ Does the value proposition offer a clear ROI?
Selling is so hard that you need to have a killer argument to make the decision easy for the customer. It seems to me important to stay far from value proposition like “better quality” “better service”. Not tangible enough.
I would like to see a clear evidence that your solution is:
- Faster: “You will save X hours.”
- Cheaper: “We charge 50% less than the average.” Or “ Our solution will make you save $2K per month and we’ll charge $400/month”
- More transparent: You bring transparency. Example of Home Team that provides more transparency for in-home senior care.
- More secure: Guaranteed price (99 Design)/ Insurance for the client..
6/ How are you going to reach your customers?
This seems to be super obvious too. But if the entrepreneur doesn’t know who his client is and doesn’t visualise a clear path to meet him, that’s risky.
At a seed stage, you’re not supposed to know the secret sauce of you go-to-market. But you have to know what you want to test, why and how.
It can be PR strategy, referrals, content, events, side projects, direct sales. Whatever. But you need to start to visualise some clear ways.
For instance, someone who has worked closely with Contently told me that they’ve noticed that Shane Snow — co-founder- was awesome in events and that after every meeting he came back with a lot of business card of leads. So they decided to leverage that at its maximum and to embrace the “personal evangelisation” embodied by Shane Snow (230K followers on Linkedin).
What I would like to hear:
Direct sales: “We have one sales guy and he makes X calls a week. Conversion is Y so we need to hire 5 sales guys to make Z revenue.”
Side project: “We’ve built this side project and it brought us X customers. We plan to make 2 new side projects to attract X and here is how we will execute it.” Crew is a great as using side projects.
Again, you don’t need to know the secret sauce of your go-to-market but you need to know what you want to test, why you will test it and how.
7. Leakage risk
This is the least important point because there are many ways to avoid/ reduce leakage (great UX, additional services, ratings..).
There is one point to consider in order to make sure this marketplace is too much at risk:
Will the buyer be loyal to the supplier? If yes, there is a warning. Let’s say I find on Handy a house cleaner that I trust and I want to book him or her every week at the same time? Do I really need Handy from that point? Same thing about a babysitter, for instance.
Marketplaces where the buyer has no interest in being loyal to the supplier minimise the risk of leakage.
Conclusion
All the startup’s stories are different and that’s not because you don’t know exactly how to answer those questions as an early stage marketplace that you’re not going to be successful.
But I am positive that for both the investors and the entrepreneur, these questions must be looked into seriously and having a reasonable idea or conviction about them will help to make the right choice.
