Another approach to the chicken and egg problem - Intro
How to convert a first party business to a marketplace
A marketplace is a platform that connects the two sides of a market - supply and demand - with a goal to facilitate a transaction. Marketplaces have been around for a while, but have also evolved a lot in the recent years. If the volume of Google searches gives any indication of a term’s popularity, then the trend is very clear.
Image - Google trends
Marketplaces have many benefits as they can create a moat through network effects, scale fast, and are hard to replicate. However, marketplaces are messy. They are much harder to manage than other businesses, as they are an ecosystem of several parties with sometimes conflicting incentives. There are many challenges that marketplaces need to solve but the main ones stem around how to start a marketplace and how to solve the chicken and egg problem, i.e. scale supply and demand at the same time.
The conventional wisdom is to start small and scale up. Most marketplaces focus on some niche and initially serve a limited geography. Launching across the US at once is an almost impossible task so the likes of Uber or DoorDash prefer to initially launch in one city like San Francisco (a good market for early adopters) and then expand to other large and dense cities until eventually being able to serve a large amount of a country’s population. In parallel, some of these companies also plan their international expansion.
Marketplaces also need to initially decide on which of the two sides to focus on: supply or demand. In most cases, supply is the side that marketplaces prefer to start with. There are many reasons for this but the most important is the difference in the amount of total expected value. Good marketplaces solve a problem for both parties, otherwise there wouldn’t be any transactions as there wouldn’t be any price the two parties would agree on. Every time you buy an item on an online marketplace, take an Uber ride, or book your next vacation on Airbnb, you agree on a price set by the supplier (or the marketplace itself in the Uber case). While both parties gain value as they are willing to transact, the total amount of value accumulated by each supply participant is much higher as on average supply takes part in more transactions. Think of how often you take an Uber or Lyft ride vs. how many rides your driver is completing in a given day. This is also evident by the number of unique supply and demand participants; for example as of December 2018, Uber had 91MM active monthly riders and 3.9MM drivers or one driver for every 23 riders. The supply side is expecting much higher value from participating in a marketplace, and as a result they are more willing to tolerate a half baked product and wait for demand to show up. Think of Uber for example: no rider would spend time on a new app with no drivers, while drivers are more willing to install the app and wait for the first request to come.
A lot of articles have been written about how to seed supply. Direct sales, SEO, performance marketing, referrals, and several liquidity hacking techniques are some of the well known ways to get started. While sourcing external supply is the most common way to go, there is an alternative: to build your own. What this means is to start as a “traditional” first party business and eventually convert to a marketplace. In essence the approach is the same: start from the supply side and then scale up demand. The difference is the way this supply is created. While in most cases marketplaces pitch their idea to supply providers to convince them to start using the app or service (think Uber with drivers or OpenTable with restaurants), this way supply is created through a first party model based on the company’s resources. The equivalent would be Uber to start as a first party taxi company or Open Table to start as a restaurant chain. Note that this is not applicable to every business.
This article outlines the main principles of this approach through an Amazon case study. Most of the insights and observations come from my experience working as a product manager with Amazon Marketplace and Prime Now teams. While the focus is on Amazon, these principles and underlying tactics can generalize to any business that can scale a first party supply side.
Amazon started as a first party business, buying books from suppliers and selling online to customers. If you exclude the technology innovation, this is the same business model followed by booksellers for hundreds of years. At some point Amazon started experimenting with a different model, allowing other sellers to list products on the Amazon website. Amazon would offer sellers access to its customer base, complementing web traffic with add on services (e.g. payment processing) and in exchange would receive a commission from each sale. In hindsight this was a great move, but this was an unpopular decision that didn’t make sense for many at the time.
In this article among other topics we will cover:
Why do customers and sellers love marketplaces?
Why would a retailer allow other sellers to compete against them on their own website?
What strategies and tactics do marketplaces employ to scale supply and demand?
What is a marketplace flywheel?
How do marketplaces mitigate the risks of scaling supply?
What considerations should sellers take into account before signing up in a marketplace?
This article is broken in six parts: