October 10, 2018
The State (and Future) of Digital Marketplaces
When it comes to running a marketplace, one of the biggest questions that can come up in your daily operations is “Where will I get the funds to grow rapidly?” Note how the question is about growth, as opposed to survival (e.g. “How will I get funds to continue operations?”). In the venture capital space, money is typically spent on helping marketplaces achieve rapid growth, rather than keeping a company limping along.
With that in mind, assuming you’re running a vibrant marketplace that you’re looking to take to the next level, the main question is how can you make your marketplace attractive to investors. Before you go on, you’ll want to make sure your company actually is a marketplace, by reading these three telltale signs here.
Below are 5 ways to make your marketplace attractive to investors:
One of the unique elements of the marketplace business model is that they make it possible for transactions to occur that normally wouldn’t happen offline. For example, before Airbnb, letting a stranger sleep in your home was unthinkable. Today however, Airbnb is the largest hotelier on the planet. On a similar note, Uber made it more palatable for riders to get in a stranger’s car.
What sets Uber and Airbnb apart from many other marketplaces is the fact that it opened the floodgates for virtually anyone to become a driver for hire or hotelier, respectively.
On the other hand, there are other marketplaces which add value but don’t necessarily have the same growth style as the previously mentioned examples. ZocDoc is an example of a specialized marketplace that helps match patients with physicians. Although the marketplace brings significant value to the table, you aren’t going to see a surge in medical school enrollments due to ZocDoc’s popularity.
One of the most notable characteristics of successful marketplaces is their vibrancy, which is when a platform has a lot of activity going on. In theory they should be properties that have a large amount of sellers – which results in high levels of fragmentation – a market where power is spread across a large number of stakeholders.
The main reason for this is because when you have a small amount of sellers in a market, there’s going to be collusion against newcomers. This means existing sellers on the platform can fix prices, and team up to prevent sellers from joining the marketplace.
Additionally in these situations, the sellers won’t want to share their profits with the marketplace operator.
Putting aside the benefits to the marketplace operator, fragmentation means buyers have more sellers to choose from. This increases the value to buyers because they’ll have access to more inventory they normally wouldn’t have access to, at a variety of price points.
While there’s an art to setting fees for your marketplace, it’s typically the case that managed marketplaces (ones that take a hands-on approach with customers) are able to charge higher fees than unmanaged properties (marketplaces where transactions are facilitated by the buyers/sellers on their own).
For example, Craigslist doesn’t take a cut of user transactions, but at the same time, they don’t provide much in the way of value added services. eBay on the other hand collects transaction and listing fees, but they also provide satisfaction guarantees and peace of mind that they’ll help the buyer or seller should something go wrong.
As a rule of thumb, platforms that deliver more value to the end users (e.g. background checks, merchandise verification, etc.) can charge more than marketplaces which simply provide a platform for users to communicate.
When it comes to managing a marketplace, the more frequently transactions occur, the better. The main reason for this is because higher volume results in more opportunities to build brand awareness and achieve word-of-mouth growth. Uber and Doordash are almost utilities for their users because transportation and food, respectively, are both staples of human life. Since people don’t really care about who, exactly, drives them or delivers their food, these marketplaces don’t have to worry about breakage (transactions occurring off the platform).
With that in mind, high frequency doesn’t automatically lend itself to success. For example, a consumer might need a housecleaner every week. Initially they’ll turn to a marketplace to find a provider, but when they find someone they like, and who they can exchange contact information with directly, then there’s little incentive to make payments through the marketplace platform. This is why marketplaces such as ZocDoc charge practices a flat subscription fee rather than collecting a commission on transactions.
All that being said, having high transaction volumes within your marketplaces is essential because it provides an incentive for sellers to invest time in using your platform.
Although this is a fairly complex topic, network effects are best defined as a situation where a product or service gains additional value as more people use it. In theory this means that the one thousandth buyer/seller is going to have a better experience on the platform than the one hundredth buyer/seller. By leveraging network effects, these properties will get stronger, rather than weaker over time. Network effects are a core characteristic of successful marketplaces, and as such investors expect mastery within the platforms they invest in.
For example, as ride-hailing services such as Uber and Lyft gain more drivers, they’re able to manage more cars on the road, which results in increasingly shorter pickup times. Another example of a marketplace leveraging network effects is Restorando. In that case, as more restaurants join the platform, the better selection for consumers, resulting in a better value proposition.
Although marketplaces follow complex business models, that shouldn’t mean it’s difficult to understand what investors are looking for when they make their decisions. As a rule of thumb, if you’re looking to secure venture capital for your platform, the common thread of the previously mentioned tips is that you’ll want to focus on two core elements: adding value to your buyers and sellers, and developing out-of-the-box solutions to help your platform grow.
A Bi-Weekly Newsletter Focused Exclusively on Online Marketplaces