kennethCreating a liquid and vibrant marketplace is already hard enough; fine tuning a business model, and eventually getting paid for the value that has been created by the marketplace is just as complicated and perilous. There has been a lot of talk on the “take rate” a marketplace business can eventually sustain and justify. In general, there is a direct and positive correlation between the strength of network effects achieved and the take rate that can be sustained, as well as a negative causation between initial take rate and subsequent network effects that can be realized. As a result, it is better to achieve network effects first before trying to optimize for maximum take rate/commission in a marketplace. (Note to VCs: don’t judge the revenue potential of a marketplace business based on its initial take rate.) In fact, at eBay it was common practice to launch a commission/fee free marketplace in a particular geography and wait for liquidity and network effects before imposing any type of fee structure on the business.

The more complicated part of the equation rests on the fact that there are other non-industry driven factors besides liquidity that contribute to the steady-state take rate of a marketplace.  Without some clear and strategic planning it is extremely easy for a marketplace to be unable to capture the value it has created regardless of liquidity. Even eBay, with its massive network effects, a deep history of take rate optimization, and long list of value capture features and policies, by some estimates, has created a gray market economy equivalent in size to its on-marketplace business. Said another way, eBay is only able to monetize about 50% of the value that it has created via its marketplace. How do you plan to do better?

When people think about a marketplace, they typically think of the first two components of a typical marketplace infrastructure — Product/Service Discovery and Price Clearing. Discovery is about finding the product or service you desire, typically through some sort of inventory driven search engine OR a wanted/request-for-quote functionality. Price clearing can be as simple as a listed price or more complicated auction mechanics, and/or a negotiation workflow. The problem is that in many marketplaces the incentives for sellers and buyers to circumvent the fee schedule and take the transaction offline is often very high (resulting in the marketplace losing out on charging a commission on that transaction.) This incentive is even higher in relationship driven transactions (e.g. violin teachers, baby sitters, etc.) and high price-point products/services (e.g. cars, construction equipment, etc.).  One solution is to charge only for listing, subscription and/or premium placement fees (like what eBay does for cars) but that can potentially bring into question the eventual revenue scalability of the business. (In fact, is it really a marketplace or just a directory?)

One core strategy to maintain and increase take rate, is to focus on building post-transaction services into the marketplace that give both buyers and sellers features they would not otherwise have access to unless they complete the transaction on the platform.  The goal is to provide buyers and sellers services they deem so valuable that they are willing to pay the transaction fee in order to leverage those features to either facilitate the completion of the transaction itself, or to help build future scale on the platform. In fact, I would argue in many of the most successful marketplaces in the world, the majority of the transactional value-add is actually post-transaction rather than pre-transaction features most commonly associated with the features of an marketplace.

Settlement (payment and logistics, etc) – One of the most common and fundamental marketplace post-transaction features is payments. It might be hard for someone to envision the fact that, at one point in eBay’s life, it was up to the sellers and buyers to figure out how to pay each other over email after an auction had ended. Today, almost every single marketplace has built in payment infrastructure to help buyers pay and sellers receive payments promptly and securely. Thinking more broadly, any services that help buyers and sellers “settle” the agreed upon transaction are critical to the success of a marketplace. It not only decreases gray market activity, but actually reduces transactional friction/conversion and reputational uncertainty (e.g. “I know I will get paid,” “I know it will get delivered”). For physical goods, shipment tracking and logistics integration are great examples. (eBay has an underappreciated partnership with USPS that should really be a case study.) For financial products, integration with clearing houses is the norm, as well. Take rate optimization should always start with a fast and easy to use settlement functionality.

Trust and safety – I personally believe the most important eBay innovation is its feedback system. On eBay, sellers with a higher feedback score can often command up to 40% premium for the exact same product. As a result, sellers have an incredible financial motivation to build up their reputations on the platform. If they choose to circumvent eBay, they do not have the option of having the buyer rate the transaction – and, as a result, lose the opportunity to build their reputations, and eventually increase their profit margins. Of course, trust and safety is more than just a feedback/review system – it could be marketplace policies, manual policing, spam control, fraud monitoring, and anti-counterfeit measures. All these services add a layer of trust and transparency to the platform that reduces gray market incentives for both buyers and sellers.

Collaboration and workflow – Probably one of the least understood and underutilized value capture tactics for a marketplace is to build collaboration functionality into the platform. Sometimes it is counterintuitive because many marketplace entrepreneurs do not want to be in the business of building (and giving away!) “saas” products or offering a “software-like” value proposition to their users. The reality is that, especially for service or B2B oriented marketplaces, the line between “saas” and “marketplace” is extremely blurred. In certain marketplaces, for example, a freelancer marketplace like odesk, there is no getting around building collaboration features to help buyers and sellers COMPLETE the delivery of services purchased. These features enable the proper settlement of a transaction, provide an audit trail for trust and safety, and increase the success and eventual satisfaction of the buyer.  They are an integral and embedded part of the entire marketplace infrastructure for take rate maximization.

Building a marketplace is not just about getting a list of products and services up on a webpage and hoping that someone will eventually hit the “buy” button. Lots of strategic thinking is required to build the optimal set of products and services in order to maximize value creation, as well as value capture. Every industry and its corresponding marketplace is unique, and there is no formula that will guarantee success. However, by looking at the features and functionality that many existing successful marketplaces have already built and reverse engineering their motivations, we can get directional feedback on how best to reduce gray market transaction, increase value creation, and eventually extract the highest take rate possible.

The reality remains that despite the seemingly impossible task of launching and building a marketplace, marketplace businesses are one of the most financially lucrative, indigenously unique, scalable, and defensible business models on the Internet. If swinging for the fences is in your DNA, find a large, fragmented market, and go build a marketplace. The risk justifies the reward — especially for those that do their homework.