Understanding Network Effects and Their Impact on Marketplace Operations

By: Charles Costa | October 1, 2018 | Marketplaces

Marketplaces come in a variety of shapes and sizes and exist in virtually any vertical you can think of. The reason for their popularity is that they enable marketplace operators to profit off the activities of others. With marketplaces, it’s up to the seller to provide inventory and/or services for buyers. The marketplace operator only has to provide a safe and secure environment for buyers and sellers to transact.

That’s a broad overview, but in short, all marketplaces follow 3 laws that we’ve covered here. Those laws are:

  • Disparate buyers and sellers: Having an ecosystem with a variety of buyers that are matched to a variety of sellers.
  • Trust is the product: In order for transactions to occur, buyers and sellers need peace of mind that listings on the platform are accurate and that there is a fair and equitable dispute resolution process.
  • Autonomous value: This is created when marketplace operators offer services that enhance the platform for buyers and sellers.

Although the previously referenced laws are a solid foundation, something not discussed in the article is the importance of network effects. They’re also a core component of marketplaces, and as such are the 4th law of marketplaces. Network effects are phenomenons where a product or service gains additional value as more people use it.

In the case of marketplaces, a platform is only as good as the quality of buyers and sellers it attracts. Buyers are only going to come to a platform where there are a variety of sellers, and sellers are only going to invest time and money in a platform with active buyers. Not sure how to get your marketplace flywheel moving from scratch, we’ve covered that here.

Putting all that aside, you’re probably wondering why network effects matter to marketplace operators. You only need to look at the dominance of eBay in the online auction space. During the early days of the web, Amazon and Yahoo! tried building out their own auction platforms. Despite having plenty of resources, they couldn’t overtake eBay. Why?

eBay maintained a competitive advantage because it optimized the experience for buyers and sellers. This enabled eBay to retain quality sellers, who in turn attracted active buyers. Since sellers were happy transacting through eBay, they didn’t see a reason to use other platforms.

All that in mind, let’s take a closer look at network effects and how you can leverage them within your marketplace.

Understanding marketplace (2-sided) network effects

Have you ever wondered why Craigslist is still relevant today, even though its interface is something you would expect from a website built during the dot-com bubble? The answer is that buyers and sellers don’t come to Craigslist because it necessarily is a great product. Rather, buyers and sellers use the platform because of the network Craigslist provides access to.

On marketplaces that depend on 2-sided network effects, buyers are attracted to the platform because of the sellers. Likewise the sellers come to the platform because of the buyers. Once a marketplace gains popularity, it’s often difficult to break it apart. The main reason for this is because marketplaces need to meet the needs of buyers and sellers simultaneously. After all, what good is a platform with plenty of consumers if there’s nothing to purchase?

Although networks are a significant way for marketplace operators to protect their platforms from the competition, something that has changed from the days of Craigslist is the number of marketplaces where buyers and sellers can transact online. The increase of platforms on the web means that buyers and sellers no longer have to rely on one provider to meet their needs.

It’s relatively simple for sellers to list items across multiple properties (such as Amazon and Etsy simultaneously). With buyers on the other hand, there’s virtually no reason they aren’t going to shop around when shopping for goods and services.

Improving buyer and seller loyalty

Sellers listing goods and services across multiple marketplaces is known as “multi-tenanting.” In order to overcome this threat, marketplace operators need to build for buyer and seller loyalty. Improving buyer and seller loyalty can be done a variety of ways, but one of the most notable methods is through removing the friction associated with transactions, in terms of purchasing the goods/services and paying sellers within a reasonable timeframe.

Streamlined purchasing processes result in higher transaction volumes, while improving seller satisfaction. Taking experience improvements further, marketplace operators can use gamification to reward buyers and sellers for transacting through the platform.

Another way to build for loyalty is to make your marketplace a go-to destination for buyers and sellers, by using intelligent messaging. This means tailoring the purchasing experience to buyers and sellers so that you’re treating them as the individuals that they are—so they only receive communications when they’re most likely to engage with them.

Making sense of it all

Although network effects are a great way to improve the competitiveness of your marketplace, successfully leveraging them doesn’t mean the marketplace operator has a viable business model. Network effects play more of a role in buyer/seller retention rather than overall growth.

If the marketplace operator doesn’t build for buyer and seller loyalty, the platform operator is going to find themselves in a bind since they won’t have a competitive advantage, a lack of which leads to increased churn and a likely collapse of the marketplace.

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Author: Charles Costa

Charles Costa is a content marketing manager who specializes in helping companies grow, one word at a time. Prior to Kahuna, Charles worked with brands such as Airbnb, Iron Mountain, and IBM on their content marketing efforts.

Charles' work has been featured in the Huffington Post, and he also was a contributor to the developer publication, Sitepoint.

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