2 Ways to Win with Marketplaces

Guest post from Andrew Lockley (@andrewjlockley)

Many of the startups I see try to make a marketplace model work. Nearly all will fail.  This tends to be a winner-takes-all model.  The sizes of firms in any given sector tends to follow a ‘power law’ distribution, where the largest firm is likely to end up bigger than the rest of the market put together.  This model isn’t forgiving of the half-arsed attempts of many entrepreneurs.  It’s the ultimate go-big-or-go-home opportunity.

Fundamentally, there are two ways to win – and you need to pick one, then execute successfully.  Don’t get it wrong.

Firstly: Spend Big, Charge Big

Marketplaces like fiverr.com charge large margins – typically around 20% of transaction value.  These markets are usually reliant on high liquidity – large numbers of buyers and sellers are available at any one time.  This means you’d need to either spend aggressively on marketing, or deal in a defined niche which leads to easier and earlier dominance.  This strategy is very prone to circumvention – where vendors will try and cut out the marketplace from the transaction.  This leakage risk often leading to warnings in the UI, such as ‘do not exchange emails and do business outside this marketplace, or we’ll come round and eat your first-born children in front of you’.  These marketplaces work well in ‘high promiscuity’ environments, where there’s little repeat business.  When buyers are promiscuous, it’s harder for sellers and buyers to disintermediate the market by directly transacting.  High promiscuity usually means there’s an asymmetry of information – the marketplace knows more than the buyers and sellers do about forthcoming transactions.  Uber works on this model (currently 20%, pushing to 25%) – you don’t use the same driver each time, so you can’t transact privately.  Homejoy tried this model, and imploded – largely because of leakage in low-promiscuity home cleaning markets.  If you have the same cleaner every week, soon paying a large cut doesn’t make much sense.

Secondly: Spend Little, Add Value, Charge Modestly

A radically different approach is to charge very little, and add a lot of value.  Payment networks, such as PayPal, often grow like this. Marketplaces, such as Etsy (3.5%), can also use this strategy.  If you charge a small percentage, your suppliers won’t have much incentive to cut you out.  What’s more, if you add value, suppliers have an incentive to push customers to use the marketplace, instead of dealing direct.  Tools such as online tuition rooms (in services markets), and financial services such as escrow, can incentivise suppliers to bring new customers to the marketplace.  They become your sales force – and they pay for the privilege!  Because the suppliers are always pushing users onto the platform, and costs are lower, and churn is rock-bottom.

If you’re skint, like most European startups, you’ll have to either use the first model in a very tight niche – or use the second model. If you’ve no warchest, and you try and use the first model in a large, diffuse market, you’ll die.

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