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Will That Marketplace Succeed?
By Andrei Hagiu and Julian Wright | Harvard Business Review Magazine | July–August 2024 Issue
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Marketplace businesses can achieve some of the strongest competitive positions imaginable—think Amazon, Booking.com, Mercado Libre, Pinduoduo, and YouTube. The primary reason is that they benefit from network effects: The more buyers who join a marketplace, the more attractive it is for sellers to join, and vice versa. That’s why entrepreneurs are seeking to build, and venture capitalists are seeking to invest in, the next Airbnb, Uber, or Twitch. And it helps explain why marketplaces cover every imaginable sector. Many established companies are also building marketplaces around their successful products in order to catalyze growth and enhance defensibility.
But not all marketplaces have the potential to defend against wannabe competitors—a fact that is often not fully understood or appreciated. Some important questions to consider when hoping to build a large and defensible marketplace.
- How Significant Are the Potential Network Effects? Investors, entrepreneurs, and managers typically use a variety of metrics to track the progress of a marketplace. Those metrics should be part of the dashboard for every marketplace investor, entrepreneur, and manager. However, we need to ask a more fundamental question, which is also harder to answer precisely: Assuming that all goes well, how great are the network effects a marketplace could create? That’s why we should prefer to focus on a more direct assessment: How much additional revenue can the marketplace bring to sellers? Of course, a fundamental difficulty is that the revenue potential for sellers may be hard to evaluate, especially in the early stages. To get a sense of the long-run revenue potential created by a marketplace, the question to ask isn’t How much will buyers spend on the service as it is currently provided? Rather, it’s What might they spend if untapped supply is made available through the marketplace?
- How Fragmented Is the Marketplace? A marketplace’s value is not just proportional to the value of transactions; it also depends on the number of transactions and the number of participants that are being connected. The more participants there are and the greater the number of potential transactions, the more valuable the marketplace’s search and discovery functions.
- How Differentiated Do Sellers or Products Seem to Buyers? Network effects are stronger when sellers are differentiated in the eyes of buyers than when they are interchangeable providers of a commodity service. That’s because additional sellers and greater variety give buyers a better chance of discovering their ideal match. And if rival entrants can get started by drawing from the same pool of undifferentiated suppliers, the eventual result will be price competition, decreasing the incumbent’s defensibility.
- How Much Value Can the Marketplace Add? Marketplaces can add value in two basic ways: by enabling discovery (that is, when buyers find sellers or products they didn’t know about, and sellers find new buyers) and by making it easier, faster, and more reliable to complete transactions on the platform than it is on alternatives. The more discovery a marketplace enables and the more it improves transactions, the stronger its network effects will be. However, not all marketplaces have the potential to do those things.
- Are the Network Effects Local or Global? At first glance local network effects may seem preferable in building a marketplace. They make it easier to attract a critical mass of buyers and sellers within an area. By contrast, marketplaces with global network effects usually take longer to reach critical mass, but they are stronger and more defensible than city-level or local networks.
- How Difficult Is It to Switch Platforms? Marketplace network effects are less defensible when buyers and sellers find it easy to “multihome”—use multiple platforms for the same offering.
These questions are aimed at determining the potential strength and defensibility of a given marketplace’s network effects. Their answers can help investors and entrepreneurs determine which opportunities are best to focus on and which to avoid.
3 key takeaways from the article
- Marketplace businesses can achieve some of the strongest competitive positions imaginable. The primary reason is that they benefit from network effects: The more buyers who join a marketplace, the more attractive it is for sellers to join, and vice versa. That’s why entrepreneurs are seeking to build, and venture capitalists are seeking to invest in, the next Airbnb, Uber, or Twitch. But not all marketplaces have the potential to defend against wannabe competitors—a fact that is often not fully understood or appreciated.
- Some important questions to consider when hoping to build a large and defensible marketplace are: How Significant Are the Potential Network Effects? How Fragmented Is the Marketplace? How Differentiated Do Sellers or Products Seem to Buyers? How Much Value Can the Marketplace Add? Are the Network Effects Local or Global? How Difficult Is It to Switch Platforms?
- These questions are aimed at determining the potential strength and defensibility of a given marketplace’s network effects. Their answers can help investors and entrepreneurs determine which opportunities are best to focus on and which to avoid.
(Copyright lies with the publisher)
Topics: Marketplace, Technology, Startups, Competition