By Sergio Monsalve, Norwest Venture Partners
I have spent more than 15 years of my career building, investing in, advising, and studying online marketplaces. I am convinced marketplaces possess very unique and fascinating characteristics, which are often counter-intuitive and easily misunderstood. By “marketplaces,” I am referring to a central exchange of goods or services whereby a large fragmented supply/seller base meets in one concentrated place to sell to a large and fragmented demand/buyer base. Visually, this many-to-many model for commerce has been captured as a butterfly. Lots of suppliers (one wing) meet lots of buyers (another wing) in one central spot (the body). That “body,” the marketplace, typically has a lot of the concentrated control and power, which results in high equity values.
I contend that there are really five “uber” ingredients (pun intended), which – if present – create the recipe for the successful early detection of a winning marketplace:
1. Trading Liquidity: Methods for increasing and sequencing effective supply & demand “matches”
Marketplaces’ most important value proposition is to deliver high-quality demand to providers and high-quality supply to buyers in the most efficient and effective manner. In other words, a marketplace is only as good as its trading liquidity. When a marketplace first gets started, the suppliers often need to be patient and wait for the buyers to arrive, so the time to “match” (also called “conversion rate”) is slow. As the marketplace gains momentum, buyer demand increases and the time to match improves. Uber, for example, religiously focused on the time it takes for a driver to be matched with a passenger; response and pick up time is a critical liquidity metric for them. Many marketplaces measure this differently, but at the end of the day, a marketplace needs to do its primary job, which is to satisfy sellers and buyers by delivering liquidity.
2. Trust & Safety Focus
The other key value proposition a marketplace offers its participants is a transparent, well-behaving community of buyers, and sellers, who follow clear rules of engagement. Trust and safety is critical in any marketplace and early marketplaces have an advantage if they focus on it. A good example here is Lending Club. Very early on, Lending Club decided to do their own loan underwriting partially to ensure the quality of the loans offered to lenders was very high. This resulted in a very low loss ratio early on, which fueled very high trust among lenders and borrowers.
3. Habitual Repeat Usage
Another great sign of initial marketplace success is how the early cohorts of buyers and sellers stick with the marketplace over time and continue to use it more actively. I always focus very heavily on how early adopters have been retained over time. For example, I was very happily surprised to see that Udemy’s engagement with consumers of educational videos spans several years and every year its consumer base becomes more and more addicted to Udemy. Think about Uber and AirBnb as well. Many of their early adopters are even heavier users and stronger evangelists today. Marketplaces must master the “hook” and generate intrinsic triggers that get customers coming back again and again.
These five ingredients are not meant to be completely comprehensive. In each of our investments at NVP, we tend to look at dozens of other key ingredients that make a great marketplace thrive. More importantly, we use our knowledge and best practices to make sure our marketplace partners have a clear competitive advantage. We actively offer our expertise and guidance to help CEO’s and entrepreneurs achieve that coveted winner-take-all position.
Excerpted and republished with permission from the Norwest Venture Partners blog. Read the complete post here.
Author: Sergio Monsalve is a partner at Norwest Venture Partners where he focuses on early and growth investments in ecommerce, consumerized SaaS, consumer finance and educational technologies. Follow @VCSerge