An Intro to (Digital) Marketplaces

People are trading in a marketplace

I promised it back then and now it’s the time! Today we’re going to discuss (digital) marketplaces!

I should have covered this one a long time ago. For some weird reason – I didn’t…

Anyway – better late than never, I guess.

I wrote a post back then about defensibility (here) and later took a deeper dive into network effects (here). I strongly recommend reading those before reading this post.

 

As many smart people see it (and I totally agree with their view) – having marketplace dynamics in your product can significantly increase your defensibility and growth for various reasons that we’ll cover in this post. And hence I give you the bottom line of this post already – if you can shape your product to become a marketplace with true marketplace dynamics – you must prioritize doing so.

 

But as always, first things first:

What does it mean to have a product which is a digital marketplace?

 

The main characteristic which is common to all marketplaces is that they have a demand side and supply side.

The other characteristic which must be true if your product is a marketplace is that any business transaction that takes place between the demand side and the supply side goes through your product.

 

The classic marketplaces that everyone loves to mention are Uber and AirBnb. But there are quite a few other examples out there. Let me do some name dropping here: eBay, Upwork, Fiverr, Etsy, Opentable, Booking.com and more…

The best marketplaces out there are actually platforms. They are not limiting themselves to oversee and manage the business transactions. They also offer complementary services such as reviews, discovery mechanics, transaction warranties and refund policies (for increasing trust), guides, planning tools and more.

 

What makes marketplaces so powerful?

By definition a marketplace is a network. And a network is usually where you want to be with your product. Why? Because of network effects (see post linked above). They will provide you both with growth and defensibility.

As the supply grows – the demand (usually the consumers) have more variety to choose from. As the demand grows – the suppliers have more buyers.

Thus – it’s in the best interest of everyone to keep using your product (assuming you have a big enough supply and demand participants).

 

Any downsides to consider when transitioning my product to a marketplace?

Well, I wouldn’t say ‘downsides’ but rather challenges.

The first and main challenge is the obvious one – 

What if the core essence of the pain your product is solving is not a marketplace by nature?

That’s probably your main challenge. The idea here is to think like an entrepreneur and be creative. Is there any natural way to transition your product to a marketplace? 

There are plenty of similarities with the challenge of embedding network effects to a business which doesn’t have network characteristics by nature (for example – selling a financial system to banks). I provided several examples on how to tackle it in the post I linked at the beginning. The sad truth is that sometimes you just can’t. The product you own can’t be converted to a marketplace in any natural way.

However, like I wrote in that article – you owe it to your business to give it a honest attempt.

Let’s see what we can do with the example above:

So let’s say that your company sells a ‘loaning system’ to banks. A classic B2B business. Your product is solid, your company is cash-flow positive and the business is progressing ‘fine’. A sale-by-sale.

You want to accelerate the growth and want to see if you can evolve this product to a marketplace so you can be ahead of the competition by a margin and also support accelerated growth.

You know banks. Giving loans is their most profitable business. They are always interested in more customers who need a loan (and can pay back…). On the other side – borrowers are always interested in getting the loan with the most convenient terms.

What if you evolved your product to be a platform that matches lenders (banks or others) to borrowers? Now, this is a much more interesting product. Wouldn’t you agree?

Of course, this introduces a whole new set of challenges. But if you are able to tackle them – it might be very valuable for your business.

So if you managed to find a natural way to evolve your product into a marketplace then you are off for a great start. You managed to tackle the big and most important challenge. 

The next challenge you’ll need to tackle is the ‘chicken-and-the-egg’ problem.

 

Which part of the marketplace to grow first? The supply or the demand?

When zooming in on our example above, it’s very clear that a marketplace with no lenders is useless to borrowers and having only lenders with no borrowers is not very attractive as well. So… how do you start?

You can’t keep addressing this problem with the conservative method of a sale-by-sale approach. You need enough participants to make it interesting and get the ball rolling. What should you do then?

Most marketplaces I can think of should try growing the supply side first. For example – if I’m eBay I will first get eCommerce stores on my platform, before getting buyers. If I’m AirBnb then I’ll first make sure I get houses listed on my platform before I’m asking travelers to look for their dream vacation… and so forth.

Of course, it’s easier said than done. On the first days of your marketplaces your company will be selling a dream. Your company will promise to various banks and lenders that the borrowers will show up once the lenders have registered with your platform. They need to believe your company can pull it off and they need to believe the reality you describe is actually more beneficial for them than the current state. 

And it’s not only one you need to convince. You need to get a critical mass on board, before dealing with the other side of the platform. 

Quite a challenge, eh?

 

The challenges do not stop here sadly. There are more to overcome. The next one can also be considered a basic one:

Is there enough value for each participant?

Ideally – the value grows for everyone as more participants are joining the network, but this is not always the case.

For example – with AirBnb – the more apartments listed in a specific area – the more competition each owner has, and therefore more likely to lose potential revenue from each deal. 

Thus, the supply side doesn’t necessarily benefit from growing its size.

However, no matter how you look at it – at the end of the day – it must be worthwhile, when looking at the big picture, for your participants (on each side) to be on your platform rather than not to be there. Meaning – everyone needs to gain something, even if the value is starting to diminish given some conditions.

In our example lenders may indeed earn less from each loan they are selling due to increased competition, but overall – given the big increase in deal-flow – it’s still worthwhile for them to be listed on your marketplace.

As for the borrowers – your marketplace needs to provide better loan terms than they could obtain by themselves. This should be achievable given a big enough competition.

So when designing a marketplace you should always focus on the value of each participant.

 

There are other challenges waiting for you (even though if you manage to overcome the ones I mentioned then you really have something here). I won’t list all of them here. If you want to go deeper – I highly recommend the NFX article about the marketplaces scoreboard (here). You’ll find there all main marketplace challenges and you will also understand how you can ‘rate’ the quality of your own marketplace.

 

Turning my product into a marketplace sounds like a lot of work, and it’s certainly above my pay grade…

Well… clearly evolving a product which is directly sold to a customer into a marketplace is a great fit, and a huge project. Certainly, this decision needs to be taken by the CEO, and agreed upon by the board of directors, because it’s a significant pivot and it involves all-hands.

It can never be done by you alone, but it can certainly be envisioned by you alone. I mean – you could be the one to come up with the idea, design it and come up with a plan.

Of course, you will need to do a hell of a lot of research and address all the challenges I listed (and the others in the reference I provided). You need to have a solid plan and once you have such a plan – you’ll need to get the buy-in of the whole chain above you in the hierarchy

But imagine what happens if you do manage to pull this off:

  1. You are going to be much more valued
  2. You are going to manage a much more interesting product
  3. You are going to learn so much more
  4. Hell.. you might evolve yourself to become an entrepreneur 🙂

 

That wraps up the post for today.

If you found this post/series useful – let me know in the comments. If you think others can benefit from it – feel free to share it with them.

 

Thank you, and until next time 🙂

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