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We're sharing a guest blog post from our community EIR Blake Hirt on the anatomy of a successful marketplace, which covers some of the specific criteria for some of the most successful marketplaces. This was previously shared as a post in the community here.
Hey EM, I’ve been working on a deep dive post that I wanted to share here with everyone. This should be a helpful starting point for learning what goes into making a successful marketplace, some of the specific criteria, and even questions to ask when you’re building one.
A marketplace business idea can come from a million different experiences or angles. However, the criteria for a winning marketplace is fairly uniform. There are certain "must haves" regardless of the type of marketplace, which can help founders ensure they’re on the right track.
Fortunately, these criteria can be evaluated before even launching your marketplace or writing a single line of code. This can help ensure you don’t waste weeks, months, or even years building a marketplace that is destined to fail.
For any marketplace company I chat with, these are the building blocks that I narrow in on to determine if they have the ingredients for success. Of course, there is much more that goes into the long-term success of a marketplace, so I consider these criteria necessary, but not sufficient.
Let’s dive right in. Below is my equation for the dream marketplace:
Solves a persistent, painful problem + network effects + high frequency or AOV + demand-side promiscuity + sustainably low CAC = dream marketplace
Any founder or investor would love to find a marketplace that is 10/10 on each of these criteria. However, that is rare. And I often find that founders overestimate or misjudge how their marketplace stacks up against each of these components.
In the rest of this post, we’ll go through each part in more detail in terms of what it is and why it’s important.
One of the biggest mistakes I see early-stage founders make is not thinking deeply enough about the problem they’re solving.
Just because you built something “cool” or you have a novel set of features does not mean that you have a good business idea. You need to solve a persistent, painful problem for both sides of the marketplace.
A persistent problem is important to solve because you need marketplace participants to keep coming back to your platform. A one-and-done transaction type business has a much lower ceiling in terms of growth potential.
And the problem must be painful, otherwise solving it won’t be a priority for users. You want to be a pain killer, not a vitamin. Or as others have put it, a "hair on fire" problem. Something that will cause users to drop what they’re doing and beg you for your product.
Network effects is a term thrown around a lot when it comes to marketplaces, but they truly are important and a sign of a great marketplace.
So, what does it mean? Basically, more participants in the marketplace should make the marketplace more valuable to future participants.
Network effects could be same-side or cross-side. Same-side network effects means that as more demand joins a network, the marketplace gets more valuable for the demand side. Cross-side network effects means that as more supply joins a network, the marketplace gets more valuable for the demand side (and vice versa). A dream marketplace would have both!
For example, Facebook has same-side network effects. As more friends join, the network becomes more valuable to users. Alternatively, Uber has cross-side network effects. The more drivers available in the area, the better the experience for riders in the form of lower ETAs.
A successful marketplace must have either high frequency or high average order value (AOV). Both would be ultra-dreamy!
High frequency and high AOV demonstrate that you’re providing real value to users. Both increase LTV, ensuring your unit economics are healthy.
With a high frequency product, you may not make much money on each transaction, but the user will transact enough times on your platform that they add up to great unit economics over time.
With a high AOV product, you can oftentimes have positive unit economics on the first purchase, reducing the need for high frequency. However, you still want users coming back, even if it’s on an infrequent basis. A prime example of this is Airbnb, as travelers may only use it once a year, but they do come back. If users only come once and never again, that’s a recipe for disaster. Companies like Casper, Away, and 23&Me have learned this the hard way.
As salacious as it sounds, you want your demand to be highly promiscuous. In other words, the demand side should not care about interacting with the same supplier over and over again. Monogamy is not your friend.
This is because users are then incentivized to leave the platform. Why would I keep paying a platform to connect me to a specific supplier that I have a relationship with? Maybe you have some features to keep them on the platform, but it’s often not enough.
This is the primary reason why certain types of marketplaces will never become massive: home cleaners, therapists, and financial advisors are all prime examples. After a user finds their supplier of choice, network effects disappear and they leave the platform.
I've never seen a single successful marketplace where the same supplier and customer consistently and exclusively transact, yet I see many founders creating marketplaces whereby exclusivity is often a feature and not a bug from the perspective of the customer. This is a big mistake.
Some of the most successful companies of all time spent $0 on marketing in the early days. Starbucks, Facebook, Google, Uber, Zoom, and ChatGPT are all examples. They grew organically from word-of-mouth because they were simply really good products that solved a persistent, painful problem.
Virality is the best way to have sustainably low customer acquisition costs (CAC), but there are alternatives like SEO. Whatever it is, you want to make sure your CAC stays low for the long-term. B2B companies will tend to have higher CAC, but it should still be manageable and well below your customers’ lifetime value (LTV).
From my research, the largest public tech companies that didn’t have some sort of virality are Lemonade (people don’t really share their rental insurance provider) and NerdWallet (personal finance is still fairly taboo) and both are only at a $1B market cap. Marketplaces that don’t have at least some virality have a tough hill to climb.
Paid marketing may give you a quick growth spurt, but it’s rarely sustainable. It becomes harder and harder to target users, resulting in lower conversion and higher CAC. Additionally, if you are having to spend money on paid marketing in the very early days to drive growth, you probably don’t have product-market fit. This is especially true if you believe that your product should be viral.
By now, I hope you’ve asked yourself if your marketplace delivers on each of these criteria.
Does your marketplace:
If the answer is no to any of them, your chances of building a huge marketplace business are limited. It may be time to make some tweaks or go back to the drawing board.
If the answer is yes to all of them, amazing! You have the right initial formula. Now, it’s all about execution.
You can connect with Blake to discuss this post in the Everything Marketplaces community here. A big thanks to Blake for also being an active EIR in the community, where he is often sharing his marketplace experience, insights, and helping early stage founders.
