Lead Edge Capital

Online Marketplaces: Our Perspective

This was featured in our Quarterly Investor Update Letter from Q3 2014.

Breaking Down Online Marketplaces

One of the most exciting areas we’ve examined over the past few years is online marketplaces. It is our belief that part of Alibaba’s success came from the fact that it was a scalable, low touch online marketplace that could command highly attractive unit economics. To that end, we made it a point to spend significant time in 2013 and 2014 building a further perspective on online marketplaces, with the intent of deploying capital into these types of businesses. As such, in early 2013, we brought on Lorrie Norrington (ex-President of eBay) as an Operating Partner and have since completed multiple marketplace investments. Over the past 18 months we’ve gathered significant thoughts which we wanted to share with you.

How do we segment the market?

We split online marketplaces up into three buckets:

  • Services Marketplaces – Marketplace where suppliers in the transaction are spending their time to provide a service in exchange for payment.
  • Examples include: oDesk – provides freelance IT developers; Homejoy Handy – provides home cleaning services; Uber – provides an alternative for taxis and BlaBlaCar – provides ride sharing services.
  • Experience Marketplaces – Marketplaces that contain a menu of events or reservations for consumers to evaluate.
  • Examples include: Opentable for restaurant reservations, Golf Now for golf tee times, Stubhub for event tickets or Airbnb/Homeaway for home rentals.
  • Product Marketplaces – Marketplaces where buyers can purchase physical products or browse to purchase physical products offline.
  • Examples include ebay for general goods, Etsy for crafts and Zillow for real estate.

How do online marketplaces generate revenue?

  • Take Rate Model – Marketplace takes a percentage of all money spent through the system
  • Seamless BBC
  • Transaction – Marketplace takes a flat fee per transaction OpenTable
  • Supply Side Subscription / Listings – Suppliers pay a fee to list products / services on the platformhomeaway and vivareal
  • Advertising – Suppliers pay to achieve higher rankings on search listingsTaobao and Zillow
  • Demand Side Subscription – Company charges users a subscription fee to join a siteSitter and Care.com

What traits do we look for in online marketplaces?

Not all online marketplaces are created equal. Through evaluating hundreds of online marketplaces, we’ve identified certain characteristics that make some more attractive than others:

  • Large Addressable Markets – Vertical platforms must be targeting segments that will be large enough to make for a billion dollar business. We frequently come across marketplaces that are attacking a small market, and whose growth plan includes offering ancillary services or moving into newer offerings. As we evaluate investments, we look for opportunities where what the marketplace is providing today is large enough to compound for years to come.
  • Fragmented Suppliers – If the suppliers in a marketplace are fragmented, it is likely that customers will shop around for providers. Providing a platform to allow for this type of behavior can lead to a better transactional experience. In certain markets, where supply is concentrated, marketplaces simply don’t work. For instance, there is a huge market for cable television, but given that each geography has a monopolistic provider, the idea of a marketplace to price out services isn’t attractive.
  • Frequency – If customers purchase products or services on a regular basis and ideally from different providers, they will continue to come back to the marketplace. The best example we’ve seen of this is food ordering. Seamless /Grubhub is a marketplace in the US which allows people to order meal delivery from thousands of restaurants. Given that an average person eats 1,000+ meals per year, the company has a significant opportunity to build a brand built on repeat customer economics. To that end, these companies can spend more to market to customers because the customers have a higher lifetime value.
  • Basket Size – The importance of basket size is very much related to frequency. If the average transaction size is high, customers can transact less frequently, yet the marketplace can still be successful. Airbnb is a perfect example of the type of marketplace where consumers may transact 1-2 times per year, but pay a significant amount for each transaction. The best marketplaces have high average basket sizes and high frequency, but typically there is a trade-off between one and the other.
  • Technology improves experience – Sites such as Opentable simply make the transaction better for the consumer. Instead of calling restaurants and talking to people who are answering from noisy locations, Opentable affords the user all the information they want at their fingertips from their smartphone or computer. The process is simple and elegant, reducing the time and effort of the consumer.
  • Variety – Great marketplaces are ones where the demand side prefers variety from the supply side. If a person is searching for a vacation property on Airbnb, I might be searching for rentals in different locations each time they use the service. When requesting a driver on Uber, a person simply wants the driver closest to them. In both cases, the diversity of supply continually improves the experience, and creates legitimate barriers to entry for competitors.
  • Inexistence of “Winners Curse” – In certain online marketplaces such as online dating sites, the marketplace is no longer needed once a connection is made. One of our team members also recently used care.com to find a nanny. Immediately upon finding one he liked, he cancelled his subscription. This leads to inconsistent usage and severely limits market size and are more like lead generation businesses than true two sided marketplaces. We look for marketplaces where users can be acquired for life, and create repeatable patterns.
  • Superior Economic Proposition – Great marketplaces offer buyers the opportunity for cheaper alternatives to the status quo, or opportunities to take part in a service that otherwise might not have existed. They also might offer suppliers the ability to earn money that they wouldn’t have otherwise enjoyed. Airbnb and BlaBlaCar are two such examples of companies where the demand side is offered new inventory often at a cheaper rate, and suppliers earn a new income stream.

When marketplaces exhibit most of the traits above, they become sticky, and ultimately, highly profitable. Suppliers stay on the platform because they see a positive ROI in their ability to find buyers. Buyers go on the platform because it is the best place to find what they are looking for. Due to the fact that both parties continually see such benefit, there is no need to circumvent the platform, and all constituents are satisfied.

The lock-in described above creates wide moats around the platform and meaningful barriers to entry. Once dominant, many of these businesses have monopolistic characteristics, which can lead to superior long term economics due to the minimal costs of running the platforms. The best ones are simply technology platforms, extracting a large piece of the pie on a repeatable basis, and can run at 50%+ operating margins. Needless to say, these are the types of businesses we like!

Where do we see opportunity?

  • Shared Economy – These marketplaces are ones that address a super economic equation for both the supply and demand side of the market. Additionally, they use resources that already exist and create opportunities for suppliers to turn dormant inventory into income, thereby potentially expanding the market. Examples would include Airbnb and BlaBlaCar.
  • International Replication – We have always been a global firm, and believe that often times marketplaces are large local monopolies. These marketplaces are hard to build and often take time to develop. Once a marketplace takes off in one geography, followers will copy the business models in other geographies to try and achieve market dominance. We believe there is meaningful opportunity to back businesses replicating proven models from other geographies. The chart below depicts just some of the attractive areas where we’ve seen such situations arise: