If You Think 10% Is A Good Transaction Fee For Your Marketplace, Then It Will Struggle

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Editor’s note: Sunil Rajaraman is the co-founder and CEO of Scripted.com, a marketplace for businesses to create content at scale; Scripted has a pool of 80,000 freelance writers and 1,000 customers. Follow Sunil on Twitter @subes01.

Like many others, I read the news about Zaarly, reported by TechCrunch’s Rip Empson last weekend, with some degree of shock. Zaarly is a well-funded business with an extremely talented team and ample resources to execute on their original vision, so I cannot understand why they decided to pivot so early in the game. Bo Fishback, co-founder of Zaarly, offers a detailed explanation here, but I can’t help but think they gave up on their original vision way too early. Zaarly’s pivot highlights a much larger point, which is that marketplaces take a lot of time and effort to build.

Why are marketplaces difficult to build? The reason is liquidity; Simon Rothman of Greylock Partners writes the best material on the subject. There is always imbalance until you have that moment. People point to Airbnb and Uber as great examples of startup marketplaces, but they’ve only hit liquidity in certain big cities. Try searching for Airbnb listings in niche markets and you’ll see what I mean. oDesk is just about there, but remember it took them 10 years and a lot of resources to build up both sides of the marketplace successfully.

Josh Breinlinger wrote a great piece about the early days of oDesk, which provides some perspective on how difficult it is to get the flywheel spinning so to speak. Achieving liquidity is akin to nailing low-cost customer acquisition on both sides of the marketplace. Most companies only have to worry about customer acquisition cost in one dimension, e.g. if you are selling hard drives, the hard drives have a fixed cost associated with production + distribution. Marketplaces are effectively fighting a two-front battle.

In his article, Rip noted how Zaarly is doing revenue-wise: At the peak of their “reverse Craigslist” days, Zaarly was processing $1 million in transactions a month. Let’s examine this further:

$1M in transactions * 15% fulfillment * 10% transaction fee = $15K in monthly net revenue

As a marketplace entrepreneur, you do not want people necessarily making a living off of you.

That sounds pretty abysmal, but it illustrates just how difficult it is to build marketplaces. Despite raising ~$15 million, Zaarly appeared to have a pretty significant imbalance in its marketplace; I would assume it was on the seller side. I’d be willing to bet if they’d stuck it out a bit longer, they would have figured out how to remedy the imbalance.

Carefully consider how the regulatory environment will change before building your marketplace business. Investors and entrepreneurs mistakenly think showing off how much individuals make from their marketplaces is a badge of honor. But touting this information is misguided and not something you should be actively sharing. What entrepreneurs are really doing by sharing that info is two things: inviting the feds and The Freelancers Union to investigate your company; and effectively saying that a small number of suppliers are doing most of the work in your marketplace.

As a marketplace entrepreneur, you do not want people necessarily making a living off of you. LiveOps was sued for this years back, and employees claimed that LiveOps should be considered their “employer of record” when work started to dry up.

Bill Gurley of Benchmark wrote one of my favorite pieces on marketplaces. If I had to add an “item 11,” it would be to start your transaction fees higher than 10 percent. I understand that companies start here to deter competition and provide a better deal for suppliers. But imagine having to build a business that completes $1 billion in annual transactions within five years in order to build a $100 million top-line business. Start much higher than 10 percent. You can move down eventually, but you cannot move up.