Simon Rothman

How To Structure A Marketplace

Next Story

The 7 Habits of Highly Effective Mediocre Entrepreneurs

Editor’s Note: The following is a guest post by Simon Rothman of Greylock Partners. Rothman is particularly passionate about Marketplace technology (Etsy, Kickstarter, Airbnb, etc) and how to garner success in that category.

Marketplaces are endemic to the consumer web: Largely popularized by eBay, we’ve recently seen quite a few variations on the theme, like young guns Etsy, oDesk, Airbnb, and Kickstarter. Old or new, the two elements that bind all marketplaces are network effects (a good thing) and the chicken-and-egg problem (not such a good thing).

Obviously, marketplaces are tough to build. But they’re even harder to kill — And they can be incredibly durable and profitable once they reach liquidity. But that’s the hard part. Despite the difficulties, there’s a tried and true way to structure a marketplace, one that hopefully ends in success. Let’s start with the basics:

The first marketplace to reach liquidity wins.

Ten years ago, there were an enormous number of auction startups: forward auctions, reverse auctions, live auctions, group auctions, and more (much more). Today there’s really only one… eBay.

Two-sided markets are naturally dominant: unlike other models, the bigger you are, the stronger you are. Marketplaces strengthen with scale and scale comes from liquidity.

Liquidity isn’t the most important thing. It’s the only thing.

Until you reach liquidity, you’re vulnerable. After, you have the opportunity for dominance.

But what is liquidity? Liquidity is the reasonable expectation of selling something you list or finding what you’re looking for.

It isn’t an exact science. Some guidelines:

-       A conversion range of 30-60% is a reasonable expectation.

-       The higher your average selling price, the lower the conversion rate may be.

-       The harder it is to find a good elsewhere, the lower the conversion rate may be.

-       Price dispersion is a sign of the inefficiency of your market, and in turn, illiquidity.

Marketplace Structure.

There’s a question of who are your market participants: individuals, small businesses, or large businesses. But the more fundamental question is centralization vs decentralization.

For every aspect of the marketplace, ask: does the user do the work or does the platform do the work?

If the user does the work, it’s decentralized. If the platform does the work, it’s centralized. At a high level, decentralization gives you speed, but the cost is an inconsistent and possibly poor user experience. When you structure your marketplace you need to evaluate each action and decide whether it should be centralized or decentralized. It may be instructive to look at a few case studies to appreciate the decision points:

Examples to Follow.

eBay centralizes customer support and payments. It decentralizes everything else, including ratings, reviews, photos, pricing, metadata (for most, but not all items), fulfillment, transaction terms, and communication. This enabled rapid early growth with the community absorbing much of the work. The byproduct has been a folksy feel and inconsistent purchase experience.

Uber centralizes almost everything, the exact opposite of eBay. For example, drivers are almost treated as Uber’s own workforce, having to go through an interview and test process. The platform, not driver, determines pricing, plus the platform centralizes payments, driver verification, vehicle location, transaction terms, and customer support.

The only thing decentralized is ratings. Why have they done this? It’s a premium service with high customer expectations, so it centralizes everything to have a clean and consistent user experience. The tradeoff is speed of expansion.

Airbnb is a hybrid approach and sits somewhere between eBay and Uber. They’ve centralized photography, payments, user verification, ratings and reviews, communication, terms, customer support, and insurance – everything that feels like booking a hotel room. They’ve decentralized pricing, description, profile, and key exchange – everything that feels like a home. It has created the safety and convenience of a hotel room without losing the charm of a bed and breakfast.

It’s an understatement to say that building a thriving marketplace is tough. Getting both sides of a transaction at the same place at the same time for the same thing can feel like it’s an order of magnitude more difficult than a more traditional one-sided commerce business. But when the magic happens, it happens, and all of a sudden you’ve got Kickstarter.

Image:  hospi-table