Above the Crowd

All Markets Are Not Created Equal: 10 Factors To Consider When Evaluating Digital Marketplaces

November 13, 2012:

Since Benchmark’s investment in Ebay 15 years ago, we have been fascinated by online marketplaces. Entrepreneurs accurately recognize that the connective tissue of the Internet provides an opportunity to link the players in a particular market, reducing friction in both the buying and selling experience. The arrival of the smartphone amplifies these opportunities, as the Internet’s connective tissue now extends deeper and deeper into an industry with the participants connected to the marketplace 24×7 – whether they are in the office, at home, or out in the field. It is a special experience to see an entrepreneur go from a PowerPoint describing a new marketplace opportunity to having established an online hub at the epicenter of a particular industry.

Following our investment in Ebay, we have been fortunate enough to invest in several companies that link consumers and suppliers through a successful online marketplace. Companies such as OpenTable, Yelp, Zillow, oDesk, GrubHub, 1stdibs, UShip, and Uber have all reached significant scale within their respective markets. But we have also invested in several companies that we thought had marketplace opportunities that simply did not play out as expected. Simply put, some industries are much more susceptible to the arrival and success of online marketplaces than others.

A true marketplace needs natural pull on both the consumer and supplier side of the market. Aggregating suppliers is a necessary, but insufficient step on its own. You must also organically aggregate demand. With each step, it should get easier to acquire the incremental consumer AS WELL AS the incremental supplier. Highly liquid marketplaces naturally “tip” towards becoming a clearinghouse where neither the consumer nor the supplier would favor an alternative. That only happens if your momentum is increasing, and both consumers and suppliers are sensing an increasing importance of your place in the world. Much easier said than done.

Here are 10 factors to consider when evaluating the potential success of a new marketplace opportunity:

  1. New Experience vs. the Status Quo. Great marketplaces do not simply aggregate a market; they enhance it. They leverage the connective tissue to offer the consumer a user experience that simply was not possible before the arrival of this new intermediary. OpenTable enables the consumer to search reservation availability across hundreds and hundreds of restaurants in a matter of seconds. That capability never existed before, and as a result the delta of the new experience vs. the incumbent experience (dialing restaurants one by one) is extremely high. Another company with a high experience delta is Uber. By aggregating thousands of licensed limousine drivers, and overlaying that with a new-age supply chain management solution, Uber gives it users an experience that is drastically improved compared to the previous alternative. Today, GrubHub announced “Track Your Grub”, a service that allows you to watch your food on the way to your house. When this experience delta is great enough, it creates “wow” moments for new users. “Wow” moments lead to word-of-mouth viral growth and high net promoter scores.
  2. Economic Advantages vs. the Status Quo. Some marketplaces provide enhanced economic advantages. oDesk enables companies to easily provision programming talent from all corners of the globe. This helps purchasers procure a cheaper alternative, while also providing brand-new economic lift to the programmer (supplier). Both sides experience an economic advantage. Another interesting example of this bi-directional advantage is AirBNB. For the property owner, the income is “found money” that simply didn’t exist prior to the marketplace. And in many cases the consumer receives a better price as well. If you can positively change the economics of an industry, you will find the participants on both sides rooting for your success. This gives you a huge head start when it comes to tipping the marketplace.
  3. Opportunity for Technology to Add Value. In many marketplaces, the technology offering greatly enhances the user experience. Zillow provides homebuyers with an abundance of data that was historically kept in proprietary systems. They have overlaid this data with maps and search technology that provide remarkable richness to the home buyer. Smartphones take this even further, with the ability to learn a great deal about any property with a one-click GPS enabled search. At Uber, the system has “perfect” information in an industry where just two years ago there was a complete lack of visibility (on both sides of the network) that led to enormous waste of resources. Uber’s system enables higher car utilization, more fares per hour for the driver, and faster and faster pickup times for the consumer. At oDesk, the platform enables the planning, development, and transfer of code from the supplier to the purchaser. The marketplace is also a work-flow system that enhances the overall experience for all parties. Facilitating work-flow reduces work for the participants, as well as increasing switching costs.
  4. High Fragmentation. High buyer and supplier fragmentation is a huge positive for an online marketplace. Likewise, a concentrated supplier (or purchaser) base greatly diminishes the likelihood of a successful online marketplace. A highly concentrated supplier base will be reluctant to allow a new intermediary in their market, and as a result will likely fight rather than support your arrival. They will also be very reluctant to share in the economics of the industry, as anyone in the online travel industry can confirm. The large airlines have all but obliterated the economics of online ticketing marketplaces, leading all the online players to focus on hotels where the fragmentation and therefore the economics are higher. If you look at the list above of successful Benchmark investments, you will see a common theme of fragmented supplier base.
  5. Friction of Supplier Sign-Up. In some markets signing up suppliers is relative easy. In others, it can be a painfully slow process that requires lots of touch and local presence. At companies such as Yelp, Uber, and GrubHub, new city launches are relatively quick after a process model had been established for how to launch those cities. The opposite was true for OpenTable where the installation of a personal computer and internet connectivity were part of the early roll-out requirements. High friction supplier signup can be a barrier to entry (as it is for OpenTable) if you are able to build a successful marketplace.  But in the early stages, this friction slows your roll-out and increases the costs associated with supplier aggregation. Remember, however, that supplier aggregation is the easy part. Aggregating demand is much harder and more critical.
  6. Size of the Market Opportunity. A proper TAM (total available market) analysis is imperative, but it is easy to make mistakes looking only at TAM. As a starter, if all the other factors are negative, it will not matter that the market is large. Some markets are crappy candidates for marketplaces. Second, you should also consider the percentage of the market that is likely to use the online alternative. In certain industries, there may be large portions of the market that may not be available to the new online marketplace. An interesting example is healthcare, which is unquestionably a very large market. However, the oligopoly of large players in this market controls a massive percentage of market and is unlikely to support a new alternative. You can also miss-analyze TAM in the other direction. In the case of OpenTable many investors missed the opportunity by mistakenly assuming the TAM was too low. In this case, they underestimated the percentage of the market that OpenTable could penetrate. OpenTable recently passed 10 million diners a month with less than 20% of transactions in North America currently online. You must combine a TAM analysis with the likelihood of marketplace success and penetration.
  7. Expand the Market.  Another potential error that can be made while analyzing TAM is to fail to understand that the features and enhancements of the new marketplace may actual expand the market opportunity for the whole industry. This may sound like a brazen claim, but certain marketplaces do indeed expand the market — by exploring new price points or enhancing convenience or usability. oDesk greatly simplifies the process of outsourcing code development, and as such many of its use cases are expansive to the overall market. oDesk’s presence increases the number of first time software outsourcers. Uber’s ease of use and simplicity have led many of its users to greatly increase the number of times they use an alternative car service. Some customers now use it as a second car alternative. As such, the company is meaningfully expands the market for black car services, which is in turn a huge boon to the suppliers that share in the economic expansion.
  8. Frequency. All things being equal, a higher frequency is obviously better. Yelp, GrubHub, OpenTable, 1stdibs (for the designer) and Uber are all high frequency use cases, where the consumers can rely on the marketplace as a utility. Many failed marketplaces attack purchasing cycles that are simply way too infrequent, which makes it much more difficult to build brand awareness and word-of-mouth customer growth. Another repeated mistake is attacking verticals where a satisfactory supplier “match” end’s the customer’s need to re-enter the market in search of an alternative. This second point negatively impacts many vertical service provider markets (such as pediatricians) where customers are actually prefer a monogamous relationship.
  9. Payment Flow. All things being equal, being part of the payment flow is superior to not being a part of the payment flow. This is due to the fact that it is much easier to extract reasonable economics when you are in the flow of payment. The supplier not only looks to you as a provider of revenue, but they receive that revenue “net of the fee.” Contrast this with a marketplace where you add value first, and then send a bill to the supplier at later date for services rendered. In this latter case the marketplace appears as an expense, and it’s easier for the supplier to view it is a “tax” versus a distribution relationship. Cash is king, and if you bring the cash, you are king. Unfortunately, some industries (like autos) just are not set up for this type of arrangement, as the payment likely lives at the end of a long purchasing process.
  10. Network Effects. Network effects are tricky and hard to describe but fundamentally turn on the following question: Can the marketplace provide a better experience to customer “n+1000” than it did to customer “n” directly as a function of adding 1000 more participants to the market? You can pose this question to either side of the network – demand or supply. If you have something like this in place it is magic, as you will get stronger over time not weaker. In the early days of OpenTable we noticed that the reservations per restaurant in a given city were correlated to market penetration. Clearly, the more restaurants that were on the network, the better the value proposition was for the consumer. Something similar occurs with Uber. As the company grows, they are able to facilitate more cars on the road, and along with their investment in route and load optimization, this allows for shorter and shorter pickup times. The experience gets better and better the longer they are in the market. UGC sites like Yelp and TripAdvisor also have strong network effects. Network effects are rare but golden. If you don’t have one try to find one; if you do have one, try to enhance it.

It is unlikely that you will find a marketplace opportunity that would score ten out of ten with respect to this list. However a 7 or 8 out of 10 would imply that your opportunity of success is much, much higher than if you only match 3 or 4 out of 10.  It is also important to realize that finding a great opportunity is only a start, and this analysis could easily mislead one into underestimating the critical role that execution plays when it comes to marketplace businesses. Great marketplace execution is more nuanced and less systematic than other venture backed categories, and for every successful marketplace, you will find an amazing entrepreneur that out-executed the many others that had chosen to attack the same market. In addition to great marketplace characteristics, you also need a world-class entrepreneur to make the dream come true.

*For a real-time look at this analysis in action, see Our Most Recent Marketplace Investment, DogVacay from Los Angeles.

28 Comments

  1. Drew Meyers November 13, 2012

    Timely topic, as I’ve been contemplating what to build at startup weekend in Seattle at Zillow HQ (my old stomping grounds) this coming weekend. The idea I’ve thought most about is a peer to peer marketplace for travel agents/trip planning. I believe, for a trip to Beijing from San Francisco, I’d rather work with someone sitting on the ground in Beijing, who is like minded to me in some way (ie knows the startup & social entrepreneurship space), rather than someone sitting in San Francisco who likely knows jack sh*t about Beijing besides what they heard from their friend or on a travel webinar.

    Reply
  2. Jonathan Mendez November 13, 2012

    Hi Bill – Wondering what the differences/exceptions are if the market is a B2B?

    Reply
  3. William Mougayar November 14, 2012

    Hi Bill, Great analysis, and you and I go back to 1997 in terms of digital marketplaces (ref. my book Opening Digital Markets which has an endorsing quote from you). 

    Where do you place the part about business/revenue model innovation that emanates from the network itself? 

    What I’m implying is that close to the network effect factor, there are conditions that get created, allowing native/organic monetizations that are original to the network itself, and that sometimes becomes an overriding success. 

    Reply
  4. Yeh Diab November 14, 2012

    This is really wise:

    8. Frequency

    “…Another repeated mistake is attacking verticals where a satisfactory supplier ‘match’ end’s the customer’s need to re-enter the market in search of an alternative.”

    One way to hedge this—assuming you won’t get out of the bloody vertical—is to offer compelling products/services after the matchmaking. (In the pediatrician example, maybe you handle admin for pediatricians; that is, you keep your beak in the payment flow.) In that case, you’re probably better off positioning yourself not as a pure marketplace, but as a supply-side solution—and, “lookee here, we can get you customers too.”

    The irony perhaps, for this and other “one-and-done” scenarios, is that you’ve solved buyers’ problems so well they no longer need you. So what else can you do? Maybe become more of a centralized marketplace—you make the rules—on how buyers and sellers perform, either because it’s in your terms of use (e.g. oDesk) or—better—because you leverage domain standards to make the marketplace work effectively and address problems when it doesn’t (e.g. GrabCAD) or—even better—because your technology is a functional requirement (e.g. Uber) or—best—you are the pediatrician/seller (e.g. Zipcar).

    Or you’re just so big and so good you happily swallow Paypal.

    Thanks for writing this useful post.

    Reply
  5. Michael Frnak November 15, 2012

    Like this post a lot and seems like a pretty good framework!

    How do you think about elements of a marketplace service that exact switching costs on the customer side beyond network effects? These elements could range from lockin via subscription to the customer’s accrual of a history of data that cannot easily be ported to a competing service.

    Reply
  6. Brian Magierski November 15, 2012

    Excellent post Bill and sage advice. Glad to see you and Benchmark continuing to pursue marketplace models aggressively and intelligently. We met way back in the early ecommerce days when I was starting iMark.com from Austin TX, a competitor to Tradeout.com that Benchmark invested in.

    I too agree that mobile presents amazingly compelling opportunity for marketplace models. Currently, I am pursuing one – Appconomy – that will massively change how retail shopping works for buyers, retailers and their product suppliers. Think about combining Amazon-like capabilities plus the social and immediate gratification pleasures of real-world shopping. We chose the launchpad of China (Shanghai) for this one, and intend to take it global from there. Look forward to continuing to follow you and Benchmark’s marketplace investments.

    Speaking from experience in these types of marketplace model businesses – your 10 factors are spot-on. Thanks for sharing.

    Reply
  7. Varun Khona November 20, 2012

    Bill, the timing of the post was spot on for us! Thanks! :)

    What is your opinion about marketplaces offering travelers sightseeing experiences hosted by locals (AirBnB for ‘things-to-do’ on a holiday). Vayable.com and Gidsy.com have seen some considerable traction here. How do they hold up against these 10 check points?

    Reply
  8. david waxman November 21, 2012

    awesome post! really informative and helpful. Question, in reviewing a marketplace idea I have been playing around with the one factor that didn’t score an A or B was Sign up process – on the supplier side you mention good examples to look at (yelp, uber, etc). any case study suggestions to look at on “aggregating demand”?

    Reply
  9. Bernat Guitart November 23, 2012

    Thanks Bill, very nice article, only one question about the payment flow:

    It’s “being part of the payment process”, more important than make improvements to your added value proposal? In other words, what’s first, engage your potential customers or monetize from the near beginning?

    Thanks!

    Reply
  10. Louis Foussard January 9, 2013

    Great information…

    Although it all seems way above my current market involvement. Always learning though, so thanks!

    ~ Louie

    Reply
  11. Abhijit Maheswari January 27, 2013

    Thanks Bill for sharing a very informative piece for entrepreneurs building marketplaces.

    A Liquid and well executed marketplaces indeed brings in inefficiencies in their respective segment, not to mention the larger value creation in the economy as a whole. This might also lead to more businesses/ideas created on top of these marketplaces like http://www.opentable.com, http://www.airbnb.com and the likes as and when they decide to open their APIs. Its also very exciting to see entrepreneurs going after markets which hitherto, have a strong traditional hangover – Art market like http://www.artsy.net, http://www.artfinder.com and others.

    “..Connected to the marketplace 24×7 – whether they are in the office, at home, or out in the field….” – I couldn’t agree more, next phase of marketplace would increasingly be about 24/7 experience, it is a challenge as well as an opportunity.

    Reply
  12. andy miller February 11, 2013

    Curious on your thought on a market like Angie’s List. I have some ideas around information based marketplaces for investment firms that would be analogous.

    Reply
  13. Dan March 16, 2013

    Great article, very neat, will definitely use it for the marketplace I am developing.

    Reply
  14. Agroads March 18, 2013

    Excelente artículo!

    Reply
  15. Douglas Gan March 30, 2013

    You wrote this article from the depth of experience you have gained from the insights you are privi to. I admire your candor and this article, I believe is just the tip of the iceberg of what you really had in mind.

    I’d be happy to discuss the depth you have and use the knowledge you have gained over the years to build my business.

    Dropped you a LinkedIn note earlier, hope to get a reply from you soon! *cheers*

    Reply
  16. One company you’ve missed (perhaps because the industry isn’t sexy), and they’re massively successful and profitable, is SpareFoot. Turns out the storage industry was ripe for a number of these market factors to be exploited.

    Reply
  17. M B NEACE April 7, 2013

    I concur, Bill – an excellent post. ‘Creating’ or ‘capturing’ digital (and other) marketplaces comes with skill at connecting the dots – the right dots – on both sides of the equation. When the right dots are connected then FLOW, that adds value, happens; and sometimes at increasing returns (scaling). Several commentators used the phrase – flow, which is necessary for increased value. The less bumps in the flows the greater the value for all in the system, from supplier through final user.
    I was first introduced to the ‘flow’ concept by Vaile, Grether and Cox in their text, “Marketing in the American Economy,” (1952). I’m an oldster. I’ve modified their flow model to reflect today’s world. For those interested check out my flow model, “Global Supply Chains as Complex Adaptive Systems,” at
    http://www.therainmakers-tbl.com. The flows go forward, backward and some in both directions. As implied, the several flows must be integrated to have an effective as well as an efficient marketing network platform: a holistic approach to platform integration. Thanks for the post and commentaries.

    Reply
  18. Iqbal May 2, 2013

    A very valuable post.

    I think “Opportunity for Technology to Add Value” can really be expanded to “Opportunity for intermediary to add value”.

    One example would be quality control of suppliers, another would be risk mitigation for both sides…

    Reply
    • bgurley May 20, 2013

      Agree.

  19. Alex May 2, 2013

    Thanks Bill, enjoyed the post. I heard somewhere that originally OpenTable had a simpler on-boarding process but had terrible response and engagement rates from the supply side. So, they sold the system for something like $5k and by doing so they were able to get commitment from small business owners (similar to what Hubspot does with their SaaS product).

    Factor #2 is easily underestimated. There’s serious leverage if supply and demand have no way of connecting without the marketplace (for many Airbnb listings it seems those places can only be rented via Airbnb and are otherwise undiscoverable).

    My great uncle owned an auction house in the Boston area in the early to mid 1900s. When he sold an item at auction, he’d always collect the cash from the buyer, remove his rake, then pay the seller, “I love auctions because when the auction is over…. I’m holding all the cash.”

    Another important factor is seed funding. I looked at about 30 marketplaces, including TaskRabbit, CustomMade, Airbnb, UShip, and Sparefoot. I found the average amount raised in the seed was $1.4mm and average time to A round was 19 months. The lowest amount raised was Airbnb at $620k.

    Reply
  20. Hector B. May 24, 2013

    Nice post ! Congrats

    Reply
  21. Rich B May 24, 2013

    Hi Bill, Regarding #2: Do you consider GrubHub’s market to be highly fragmented (especially in light of the merger with Seamless annc’d on Monday). In other words, there seem to be a lot of players, and even more globally, but only a few seem to be scaling in the US.

    Thanks for this post.
    -RB

    Reply
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  23. Bryant Jaquez June 26, 2013

    I like to tell business owners that they need to be relevant. As soon as you are no longer a “relevant options, ” you are irrelevant and you’ll probably go out of business.

    Keep tabs on where culture is going. It will help.

    Reply
  24. Srinath Rajaram September 16, 2013

    Great post. This is w.r.t #8 above. My comment may come too late but I was thinking about sites like Match.com and others where consumers enter in to monogamous relationships with suppliers. In these cases, would you agree that the overall rate of transactions would make more sense than the rate at which an individual re-enters the marketplace?

    Reply
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