What comes to mind when you think about marketplace fundamentals? The two most important concepts to understand are network effects and disintermediation. Let's dive in!
Marketplaces should be designed to maximise good interactions between buyers and sellers. We’re going to focus on so-called “two-sided marketplaces” where you have distinct buyers and sellers segments who interact with each other. For a two-sided marketplace, matching is key.
Network effects increase the chance of matching between your buyers and sellers. Network effects for two-sided marketplaces is best described with the Uber business model. The more drivers that are available, the quicker it is for a buyer to match with one. Quicker arrival times mean more buyers use the service which increases demand. In turn, more drivers are recruited which makes it better for buyers. This is also known as the flywheel effect.
Marketplaces with strong network effects are robust. Do you know what US marketplace generates over $1 billion of annual revenue with more traffic than Tiktok, Pinterest and the NY times? - Correct Answer: Craigslist. Hold up - wait a second? What? It looks like a terrible product to the unassuming but their value comes from their network effects. If you want to sell something in the US, Craiglist will be one of the fastest ways to do this and, for buyers, you’ll have the greatest selection of second hand items to pick from.
Quality of matching must also be spot on. If you have bad actors on your marketplace, they dampen network effects and this is why it’s important to have some level of curation on your marketplace to ensure quality. Finding the right balance is key, as if you curate too much and increase barriers to be part of the marketplace this will negatively impact network effects. On two-sided marketplaces in particular it’s really important to balance buyers and sellers. For example, if Uber has lots of drivers in a particular area, the drivers won’t have a good experience as they will be waiting for jobs and will use another app. To solve this, uber uses a mechanism for balancing supply and demand if there are not enough drivers in an area: surge pricing. It’s not actually to be a money maker for them, it’s to incentivize drivers to drive to the area and clock on if they are available to meet demand.
If you’re a marketplace just starting out, you should consider focusing on a very particular niche and localised area to offer choice. Uber started as a premium taxi firm in a particular neighbourhood in San Francisco. If they started nationwide, they would never be able to get waiting times down. Uber starts again with every city that they launch in because they need to create supply with taxis in the city from the get go.
Network effects are stronger in some markets compared to others - often known as depth vs. shallow effects. Consider deliveroo a takeaway delivery marketplace. For deliveroo, network effects are deep because buyers need choice to see value. When searching for a takeaway, a good value of options isn’t having 15 local restaurants to choose from, it’s about having a choice of different types of restaurants. Whereas for bolt to compete with uber you have just as many drivers available in the same areas and so there are shallow network effects. If your network effects are not very deep and it’s easy for your sellers to multihome and be on multiple marketplaces, then your network effects are much less defensible. Not all network effects are equal but they are always incredibly powerful. Once fostered, the flywheel will keep on turning.
Finally it’s important to consider how you monetise your marketplace without impacting these network effects. You can charge a subscription fee for sellers to list or buyers to get access but both of these options can impact network effects if buyers and sellers decide to not join the network. The closer you get to the transaction the better. Adding services that make the transaction work smoother is important and the more value you add, the more you can typically take from the transaction.
Below you can see how 2 users = 1 connection, 4 users equals = 6 connections and 8 users = 28 connections.
Next up, disintermediation.
Disintermediation (or network/lead leakage) is the process whereby a buyer and seller can avoid paying platform fees by transacting directly. It is very commonplace when the item is:
- High-value - the incentive to avoid fees will be higher.
- Repeat business - you form a trusted relationship with them off-platform.
- The marketplace isn’t responsible for the majority of the seller’s revenue - less risky to cheat and be offboarded from the marketplace.
- There is a face-to-face interaction - service marketplaces where people meet face-to-face have very high disintermediation rates.
- There are few value-added services - Amazon has low rates because they add value to their sellers with delivery services and sales support.
- More complicated sales cycles - where milestones payments or deposits are important.
Reducing disintermediation whilst not impacting network effects is one of the hardest jobs for marketplace operators. You can place obstacles to limit disintermediation but the most impactful way to handle this is to consistently add value to your customers and not set your take rate too high to incentivize buyers and sellers to avoid your high fee.
Where we see this cross-over with trustshare is that slow speed of payments result in high disintermediation rates. If you only need to take payment after the job is completed, you will encourage disintermediation. Take a freelancer marketplace, like TaskRabbit. As a buyer, I select my builder, who comes around my house and completes the job. I’m supposed to go on the app and complete the payment with the payment provider so the marketplace can collect their commission but typically payments can take over 10 days to reach the seller, who is right in front of me. The temptation to pay less in cash is very enticing. It’s not uncommon for potentially 60-80% of a marketplaces revenue to be lost through disintermediation.
Finally, making it safer to transact through the marketplace is really important, trust and safety and the negative PR that a marketplace can get from bad actors on a marketplace hugely impacts network effects. Airbnb in their early stages had an incredible story that news broke that one of their customers had trashed a New York apartment - Airbnb didn’t have any policy to protect buyers and sellers at the time but their leadership team immediately recognised the severity of the issue. They put in place a Host Guarantee that covered theft and vandalism which increased trust and protection to both buyers and sellers. No insurer would back it so the first weekend of claims could have turned Airbnb bankrupt. But they pressed ahead anyway because they understood that a lack of trust and security would have been just as damaging. A couple of weeks later, they had the track record to persuade insurers to back the policy and the rest is history.
Want to be the go to person for marketplace knowledge? Have a read through our “how to go transactional” article for the most common pitfalls in marketplace payments.