Marketplaces part 1

This article was initially published in Viktor Kyosev’s (COO of Greenhouse) weekly newsletter, where he shares his views on the topic of startups, growth and fast-growth markets:

In my career, I had the privilege to work on three marketplaces, Snaplio, which was a marketplace for photography services, Tinggal, a marketplace for budget hotels, and Greenhouse, where we are currently focused on building the region’s first marketplace with a focus on professional services.

I have always been interested in reading about and building marketplaces, and today I want to share why.

An online marketplace is a type of web platform that connects those looking to provide a product or service (sellers or also referred to as supply-side) with those looking to buy that product or service (buyers or demand side). With the rise of the internet, we can help buyers find sellers, whereas before, they might have experienced challenges.

At first glance, most consumer marketplaces seem identical to any retailers. If you want to buy an item, you can either go to the store down the road or purchase it on a marketplace like eBay. Behind the curtains, the two models could not be any different.

Marketplaces maintain high margins and demonstrate moats (a defensive measure that allows a firm to retain a leadership position and increase margins). At the same time, retailers experience a perfect competition, prices are competed down, and there are no moats.

Most importantly, marketplaces experience network effects. Meaning, the entire network gets more valuable the more people use it. A typical network effect would be (as per the image below), buyers benefit from more sellers and sellers benefit from more buyers. When the wheel starts turning, it becomes a tough model to compete with.

Let’s take eBay as an example, being a well-known company to demonstrate how that translates to success.

Another well-known case and my personal favorite is Airbnb. More guests attract more hosts, and more hosts attract more guests.

Let me try to summarize what makes a marketplace such an attractive business model:

  • Typically demonstrates network effects.
  • The community does most of the work. Think about how, in the case of Airbnb, now every host is doing her best to have a very attractive profile on the platform, continually optimizing pictures, description, features, and prices. On the other hand, guests leave reviews and start communities where they discuss and recommend to each other different hosts.
  • No physical constraints on growth. Airbnb does not own any apartments, making it a very asset-light business.
  • Often very capital efficient. In the case of eBay, it turns out the founders never used the money they received from investors. They just wanted the strategic help of having those investors on board to guide them.

Now that we covered why investors and entrepreneurs like marketplaces, let’s take a look at why users tend to use them.

  • Identity and Reputation – the seller is building an identity over time, so you know who you are trading with
  • Payments and Friction reduction – typically there is an element of online payments, making it a much faster, frictionless experience
  • Trust and safety – the marketplace works hard to eliminate all bad parties from the platform.

So, where is the catch?

Many entrepreneurs soon find out that it’s tough to get the virtuous cycle of supply and demand to reach liquidity. You need to improve and grow both supply and demand sides in near unison. Too many sellers but just a few buyers will result in attrition of sellers and vice versa.

Other challenges include:

  • Success rate – how successfully can the two sides find each other?
  • Time to match – how long does it take for supply and demand to match?
  • Take rate – what commissions you can negotiate with your supply side, and is that sufficient to sustain the business?
  • Switching to a different network – how easy is it for your users to join another similar platform?

Running a marketplace feels almost like running three businesses at the same time. First, your supply side, growing the number of sellers, and engaging with them when the demand is still low is a challenge on its own. Second, generating consistent demand across different territories/verticals while keeping customer acquisition costs down is another puzzle that consumes a whole lot of time, effort, and resources. And last but not least, facilitating all that, monitoring for bad users that are trying to take advantage of the platform, maintaining consistent unit economics, engineering network effects is incredibly complex as well. Yet, if a marketplace works, it works really well. Once there is liquidity, it’s hard for others to compete. That’s why you probably can name only one platform that offers homestays.

Since the topic of marketplaces has a lot of depth, I would like to ask you about what should I expand on in the next newsletter?

  1. The history of marketplaces
  2. What’s next for marketplaces
  3. Network effects