Markets for Marketplaces: Future Disruption

"Uber for X" has become commonplace model for startups but often such startups overly-focus on ease-of-delivery rather than what made Uber truly disruptive. Uber built a marketplace in a highly fragmented market that allowed them to change the entire dynamics of an industry. The taxi industry is only one of many industries that are ripe for disruption from online marketplaces.

Much of the money currently spent on mainstream advertising (Google, Facebook, traditional media, etc) is by vendors who would be better served by industry specific marketplaces; and it's only a matter of time before those marketplaces appear.

That naturally raises the question of what makes a market suitable for an online marketplace. To answer that question I’ve been working on a framework to help evaluate markets based on their intrinsic properties.

The framework is based upon analysing a large number of online marketplaces and identifying the key factors that differentiate the successful ones from the failures and understanding why those factors played the role they did. I’ve broken the framework into looking at the properties of the demand-side (i.e the customers/buyers), the supply-side (i.e the vendors/sellers) and the transaction:

Demand-side 

Multiple-transaction behaviour

Do customers make multiple transactions within a reasonable time-frame (i.e. several+ transactions a year) ?

  • If customers are regular buyers it means a marketplace can amortise the cost of customer acquisitions over multiple transactions.
  • Lack of this behaviour means high customers churn (thus lower lifetime value) and a constant need to acquire new ones just to maintain size. 
  • Repeat buying also allows for stronger brand building and building a relationship between the marketplace and consumer.
  • If a marketplace can’t extract more value from a customers acquisition than an individual vendor can then it reduces the incentive for vendors to be on the marketplace.
  • In some cases bundling together of related markets can create multiple-buying behaviour when the individual underlying markets may not have it. For example while the markets for plumbers, electricians, locksmiths, etc. might not exhibit regular purchases the aggregate market for hiring tradesmen might do so.

Low vendor-loyalty

Do customers regularly switch between vendors ?

  • High-vendor loyalty can have much the same impact as a lack of repeat buying as both parties have a strong incentive to take future transactions off-platform .
  • Some markets have intrinsically low vendor loyalty as consumer needs vary between transactions (for example for with AirBnB people switch vendors because they travel to different locations or Just-Eat because people don’t want the same takeaway all the time).
  • High vendor loyalty can be countered with strong on-going value-add beyond the initial connection (Escrow, insurance, ease-of-purchase are common “value-add” techniques) or owning the relationship with the customer (i.e. essentially anonymising the vendor actually providing the service like HomeJoy do).

Large market

Is there customer spending of $10bn+ in the market ?

  • As a rule of thumb the valuation of marketplace startups is roughly equivalent to their gross transaction volume (Fred Wilson has a good article on marketplace valuation)
  • Most VCs are looking for startups with the potential to reach $1bn+ valuation which implies a market an order of magnitude bigger than that. 

Expandable demand

Is there "untapped demand” that can be unleashed by a marketplace ?

  • Some markets have “untapped demand” - demand that exists but doesn’t convert into transactions because of complexity in purchase process. 
  • Common examples include markets where consumers are worried about quality/risk (e.g. peer-to-peer vacation rentals) or where finding the right vendor is hard (e.g. handmade items). 
  • In markets with pricing elasticity demand can be expanded by marketplace reducing cost of transactions (through competition, optimisation, etc. for example UberX) 

Consumer Experience

Are there key problems in the consumer experience that can be solved ?

  • Trust is a key-example; in many markets where marketplaces have succeeded there have been significant trust issues around factors such as personal safety (Uber, AirBnB, etc.) and remote transactions (Ebay, oDesk, etc.) where marketplaces have put in place trust structures (vetting, reviews, monitoring, etc.) that improve customer experience.
  • Lack of transparency/feedback is another common problem that marketplaces solve. GrubHub provides live-tracking of food deliveries; fiverrr shows average response time of service providers and Linkedin benchmarks job applicants against other applicants.
  • Improving consumer experience can allow marketplaces to charge a premium to consumers who would otherwise be incentivised to transact off-platform (Instacart for convenience; StubHub for guaranteeing ticket legitimacy).

Supply Side

Fragmented supply-side

Is there a fragmented supply-side with small vendors controlling a large part of market ?

  • A fragmented market typically means higher customer acquisition costs for vendors. Marketplaces deliver benefits of scale and marketing and give vendors more power to compete based on their service/product rather than on customer acquisition strategy.
  • Decision making for consumers is often complex due to variety of choices and difficulty in comparing vendors. Marketplaces add a lot of inherent value by making finding and comparing vendors easier.
  • Larger vendors have lesser need for marketplaces, have disproportionate negotiating/pricing power and prefer direct relationship with consumers. In many such industries (i.e. insurance, budget airlines) vendors go out of their way to even stop price aggregators so it can be tough environment to operate in.

Low-conversion/High-conversion

Is the market low-conversion for individual vendor but high-conversion for the overall transaction ?

  • Some markets (e.g. housing) are defined by high-levels of shopping around between vendors before a transaction takes place; marketplaces have a significant advantage in such markets because their overall conversion rate is going to be higher than that of any individual vendor giving an advantage for customer acquisition.

Supply-side servicing

Are there unique “add-on” services that a marketplace could deliver to their supply side because of their position ?

  • OpenTable offers restaurant management software, Ebay Motors offers consumer financing and Amazon Marketplace offers warehousing. In all cases they’re services that the marketplaces are in a unique position to offer and cause significant stickiness (discouraging vendors from moving elsewhere) as well as bringing in additional revenue streams.
  • Generally these add-on services are added as the marketplace matures rather than from the start and typically only form a small segment of overall revenue, but in maturing markets can provide significant defensive barrier against new entrants

Expandable Supply

Would a marketplace reduce the barrier-to-entry into the market ?

  • If a marketplace allows new vendors to enter the market or for vendors to service part of the market that was inaccessible to them before this can cause a fundamental economic shift in the market allowing for more varied offerings and more competitive pricing.
  • With some marketplaces it’s not unusual for customers to become vendors (Etsy, Ebay and AirBnB are all examples where this happens)
  • Such vendors can give marketplaces significant boost because they’re often exclusive to their platform and thus have closely aligned interests. 

Transaction

On-Platform Transactions

Can the entire transaction be captured on-platform ?

  • First-generation marketplaces (craigslist, autotrader, yelp, etc) were essentially lead generation tools with the transaction happening off-line; modern marketplaces have tended to focus on markets where the transaction can be captured online.
  • If a marketplace doesn't have access to the whole transaction it forces them to rely on intermediate stages. Typically this results in optimising for lead generation rather than for completed transaction. This can result in misaligned incentives, such as job boards focusing on maximising number of job applications rather than quality of applicants.
  • Without knowing the value of the transaction marketplaces are forced to price generically. They have to choose between over-charging for low-value transactions pushing them off the platform or underpricing for high-value transactions where they can’t capture the value being delivering to the vendor. 
  • In practice successful off-platform marketplaces use flat-fee or subscription models that tend to underprice the value delivered to high-value transactions but operate in high-value markets (housing, autos, recruitment, etc.) so even pricing for the low-end of the market results in decent profits.

Market open to a Marketplace

Are the market participants willing to move to an online marketplace ?

  • Some markets are reluctant to move online. Typical characteristics of such markets are being relationship driven, high-levels of secrecy, price negotiation and high-customisation.
  • A common case is markets where publicly advertising availability causes negative signalling  Employment market for high-profile individuals (actors, sports people, company executives) and the M&A market are examples.
  • Another common case is when there’s significant pre-sales work to customise the transaction. Many consultancy and professional service businesses falls into this category.
  • Very few marketplaces have succeeded in bringing these types of markets online so far. Angellist is a notable exception but it’s not clear if it’s success is generalisable. Solutions may have to be very domain specific.

Willingness to pay

Are the market participants willing to pay for a marketplace ?

  • Either the vendor needs to be willing to give up a cut of their revenue or the consumer needs to be willing to pay a premium.
  • Taking commission from vendors is more common; generally in sophisticated markets where the pay-per-customer  model is the norm (through online advertising, referral fees, etc.) it’s fairly straight-forward to on-board vendors on this basis. In markets where this isn’t the norm and especially low-margin industries this can be much more difficult.
  • Consumers paying a premium is more unusual; having to pay more via a marketplace than they would if they went direct incentivizes the consumer to avoid using the marketplace. Hence the marketplace has to deliver significant added value if this is the approach taken.
Markets don't have to have all of these properties for a marketplace to be successful, but markets without a significant number of these properties have tended to struggle. This framework is very much still a work in progress so feedback would be very welcome.

Interested in Marketplaces ?  - Follow me on Twitter @imranghory - I can also be reached at imranghory@gmail.com
3 responses
Nice framework, Imran. It would be interesting to see a summary of how some popular marketplaces measure up against it (and perhaps, for contrast, some examples of markets that would be unattractive according to the framework.)
Hi Imram, amazing analysis, mad respect for you, thanks a lot. I´m reading a bunch about marketplaces and this is definitely one of the best analysis I´ve read so far. Regarding the supply side, do you think the fact the vendors have or don´t have a salesforce should be taken into consideration? Also can you please explain a bit more low conversion /high conversion?
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