On internet marketplaces....

I have written before about two-sided markets.Harvard Business Review has a phenomenal paper on strategies for two-sided markets. I have been observing the emergence of a large number of internet business that generate value by connecting two distinct user groups, and gathering my thoughts on it. Here is how I think about these businesses.

How does the business generate value?
One needs to think about how the business generates value for both groups of users. Value is generated by one or more of the following ways:

1. Lowering costs or effort: Let's take the case of TeachStreet, a marketplace connecting students with teachers. For students, it simplifies the process of looking for a class. For teachers, it lowers marketing expenses and effort; by creating one single site that lists all teachers, TeachStreet can perform SEO much better, ensuring that its pages show up near the top of Google search results.

2. A better match: The other side to the coin is how internet marketplaces can help create a better match.

Let's take the example of eharmony. While you would not see it as a classic 'marketplace,' it is essentially matching guys to girls. No, eharmony does not support men seeking men, or women seeking women (so I heard). Anyway, back to my original point - because of a large number of men and women on the site. EHarmony is able to leverage attribute based matching and proprietary algorithms to get a supposedly better match.

Another example is EBay - you can get the exact product you are looking for, down to model, version number etc. etc.

3. A unique experience: A number of marketplace-like businesses have started provide unique experiences, not available anywhere else.

Skillshare and Sidetour are the first two that come to mind. Skillshare is 'a community marketplace to learn anything from anyone.' Which means that people who were not sharing their knowledge before, are doing so, using the platform. Sidetour, a 'Marketplace for Authentic Experiences,' provide experiences that you cannot find anywhere else. For example. 'Visit NYC's Flower Market and Create a Bouquet with a Floral Designer' by the owner of a Floral Design Boutique who has a lot of knowledge about the NYC flower market (otherwise she would be out of business).

A challenge for these marketplaces is their uniqueness - particularly, how can they scale while maintaining their uniqueness and quality. It is completely possible that as these platforms get more and more popular, more people sign up to teach. But then again, would the quality of people signing up be just as good? That remains to be seen.

Value proposition

Similar to the point above re: value generation, Marketplaces need to have a clear value proposition defined for customers. The value proposition might emphasize comprehensiveness (eBaY - the world's largest marketplace for goods, so you can find anything here), uniqueness (other than the examples above, Etsy - the marketplace for handmade goods that you cannot find elsewhere), cost (one of the main attractions of AirBnB, though so is uniqueness) or quality (TakeLessons.com for example provides customized music lessons by handpicked teachers, to ensure quality).

One value proposition might affect another; for example, comprehensiveness = more buyers and sellers = more efficient marketplace = lower cost.

Revenue model
Several interesting revenue have emerged in marketplace businesses i.e., ways in which the marketplaces themselves make money

1. Transaction fees - from the days of eBaY, this is the most popular model. Fees might be percentage of final price plus flat fees (e.g., eBaY's listing fee, fee for using more than 5 images etc.)

2. Subscription fees - typically, one side of the marketplace is charged a subscription fees, while the other is free. Normally it is the service provider which is charged

3. Other - Some companies have other revenue models.

BetterFly.com, for example, has none :). My guess is that they are aiming to build a large user base at first, and worry about monetization at a later point. This might be a great strategy; once they have regular matches on the website and people contacting teachers, they can monetize by solving various problems for their clients. One might be appointment scheduling - if a user lookup the service provider's calendar, scheduling an appointment through the web and pay up front, this might save the teacher a lot of hassle, and reduce the risk of no-shows dramatically.

NextGuru.com asks all service providers to give a free first class, and charges $20 to the student for the class.

One of the most interesting business models is from restaurant reservation site Savored. Started by SLP fellow Benjamin Kean, Savored helps restaurants solve capacity management issues; essentially, you can reserve a table at a restaurant for an off-peak time, and get 40% off food and alcohol. You get money off the meal, and the restaurant gets to fill in idle capacity and generate incremental revenue. For this, you pay $10 to make a reservation through Savored. As of now, 635 restaurants have signed up for Savored, and the website is reportedly doing very well.

Success factors

So what determines success in this business? Simply put two things:

1. Are you able to build a large user base on both sides of the marketplace?

2. Is your customer lifetime value significantly higher than your user acquisition cost?

Let's look at both factors in detail.

1. Building a large user base: The first problem in building a large user base is getting the initial users. Marketplaces face the chicken and egg problem at first. Why would parties on one side of the platform sign up, without enough users from the other side?

Startups often give one side offers such as free trial period, in which they have no upfront costs, and won't see any costs until they see some sort of indication that they are benefiting from the marketplace. This indication could take the form of people signing up for their service, or even visiting their page.

Sometimes this trial is not enough, especially if it takes some effort to sign up, create a profile etc. Startups can further boost the initial signups by making the process as simple as possible, and providing some kind of value to the user immediately upon signing up. Betterfly for instance providers teachers a set of Marketing tools that allow teachers to market themselves in other venues such as Google Places, Craigslist etc.

Sometimes the trial is necessary for both sides. For example a site connecting buyers and sellers of goods could give the buyers $5 off first purchase etc.

The second problem in increasing the user base is capitalizing on the initial set of users to make sure that your business grows virally. Word of mouth marketing plays a big role in this. In the age of Facebook and Twitter, websites must make it simple for users to spread the word about their Marketplace. For example, if someone signed up for an event through your website? Share on Facebook. The next most emerging channel might be Pinterest



2. Making sure LTV>> CAC: Let's talk about both LTV and CAC with an example. Take the case of a marketplace that matches teachers with students. Let's say the cost of acquiring a student is a dollar through a combination of SEO/SEM/Social Media and Inbound marketing. What will determine the success of the business is whether LTV is much bigger than the the initial acquisition cost. Let's also assume that the revenue model is percentage of transaction - Let's say 5% of transaction.

Suppose the student finds a teacher through the website, and signs up for the first class online. If the cost of the class is 20 dollars, revenue generated is 5% of $20 or $1. Which is equal to the acquisition cost of the user.

The key question is - what happens next? Does the student meet the teacher, and decide to do more classes? If he/she does so, is the transaction through the website, or does the teacher tell the student to just email him/her directly next time, and pay in cash? Or does the startup have a way or controlling, or atleast influencing that the transaction continues through the website? Also, does the student continue to look for other teachers in different subjects? The key is to increase customer loyalty, and prevent leakage. Common ways of doing this are loyalty programs, email marketing.