It is cliché to talk of Airbnb as the hotel company with no properties, or Uber as the taxi company with no cars. In 2018, marketplace platforms – products or services that mediate transactions in other products and/or services between two or more groups – are ubiquitous in many industries.
Marketplace platforms create value by facilitating transactions that would not have occurred otherwise, and are rewarded with a slice of this new economic activity. While marketplaces are expensive to build and scale – Airbnb took nine years to turn a profit – successful platforms can generate enormous economic value.
Achieving and maintaining scale is difficult. Successful platforms must solve the ‘chicken and egg’ problem: attracting users on both sides of the marketplace.
In this article, I explore two methods of achieving scale: building compelling marketplace features and services, and cultivating a desirable userbase (or at least, the appearance of one).
Solving the chicken and egg problem with features
Marketplaces use features to improve user experience and attract certain types of users, who may in turn attract new sets of users. However, introducing features is a balancing act: some features may harm one type of user. For example, introducing advertising to a marketplace may attract online advertisers but degrade the experience of other users.
A common marketplace feature is an auxiliary service that supports transaction activity (for example, Amazon’s Prime delivery and returns service). Services can help a platform operator differentiate their marketplace from competitors, and also lock in users. Services may also provide the basis for innovation: generative marketplaces such as app stores attract third-parties to build features that in turn attract users, ultimately benefiting the marketplace operator.
Two simple economic rules should guide feature addition. Each new feature must:
- Generate more value from users who stay than it loses from users who leave as a result of its introduction, and
- Attract enough users to ‘pay off’ the cost of developing and launching the feature. In practice this is difficult to achieve, and platforms often struggle to strike the right balance of maintaining existing users and attracting new users.
To solve the chicken-and-egg dilemma, some platforms subsidise the use of certain features for certain users and may gradually raise the price as the platform develops. For example, social media networks and search engines are free for users, while advertisers are brought in as the marketplace develops.
Solving the chicken and egg problem with users
Features are only useful insofar as a marketplace has a userbase. Marketplaces rely on direct and indirect network effects to attract users. With direct network effects, the platform becomes more valuable as the number of users increases (for example, a social network). With indirect network effects, one type of user (for example, iPhone app developers) values the platform more highly when another type of user increases (for example, consumers).
Just having users isn’t enough – there must be enough users on each side of the marketplace. Imbalances on either side may lead to marketplace failure. Therefore, marketplace operators require strategies to grow either side of the market to maintain equilibrium, whether launching or scaling.
Marketplace operators can employ a range of growth strategies, which aim to mitigate demand or supply shortages on either side of the marketplace, or reduce the downside risk to participating.
One step at a time?
The relative growth of each side of a marketplace may occur incrementally, or in steps. A ‘zig-zag’ strategy builds each side of the userbase in small increments, relying on organic growth from indirect network effects. Or, a two-step strategy may cultivate one group of users before attracting another group, such as social networks attracting users before advertisers.
Sequential or simultaneous growth?
Different types of users may join the platform sequentially or simultaneously. Some business models necessitate one user type joining first: a platform reliant on advertising must attract viewers before it can attract advertisers, for example. Simultaneous entry suits platforms where different types of users seek each other at the same time: for example, a dating app.
All users are equal, but some are more equal than others
A platform operator may directly or indirectly attract new users by incentivising influential users to join, in the hopes they will attract other users. For example, food delivery platforms such as Foodora and Deliveroo often compete for exclusive agreements with leading restaurants.
Risk mitigation
A platform may also give pre-commitments to one or both sides of a marketplace to ensure that all types of users will show up to participate. For example, Groupon allows customers to buy discounted deals from retailers which only activate if enough customers purchase them – guaranteeing the retailer a minimum level of success. A platform may also mitigate risk by directly providing supply, spurring growth (usually) on the buy-side by artificially providing users. For example, the dating website Ashley Madison provided supply of female users by faking interactions with men.
In conclusion:
- Marketplace platforms can generate enormous value, but must overcome the chicken and egg problem in order to scale successfully
- Platforms can attract and retain users through superior features and services that support transactions
- The userbase itself can attract users through network effects, but only with the right balance of users on either side of the marketplace.
Sam Smith worked in a top-tier management consulting firm for two years before taking time out for study. They write under a pseudonym to bring you honest reflections and insider information.
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