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How marketplaces that begin with a narrow focus end up ruling the world
No matter how powerful, influential, larger-than-life and ubiquitous companies become, many share the same humble origins: they start with an unknown founder and an idea that was often aimed at serving a niche.
Mark Zuckerberg started “The Facebook” initially as a way for fellow college students to list what classes they were taking. Netflix started as a DVD-rental-by-mail business; Amazon debuted as an online bookseller; Twitter started as an SMS service; Airbnb was an online Bed and Breakfast, but mainly renting out extra couches, not even bedrooms.
As Richard Branson said, "start small, but always think big."
That’s easier said than done. Particularly for online marketplaces where exponential value is created for each incremental addition of supply and demand. Being big is essential to value creation, but starting small is a necessity and getting from small to big is no easy feat.
If demand doesn’t show up without ample supply and supply won’t participate without clear demand, where do you begin? And once you begin, how do you take a narrowly-focused service and evolve it to be a game changer for an entire industry? Philosopher Arthur Schopenhauer aptly pointed out that talent is hitting a target that no one can hit, and genius is seeing a target that no one can see. So how do we see a big marketplace opportunity while it’s still a niche and its true potential has yet to be realized?
The value in marketplace models
Firstly, why focus on marketplaces at all? Simply put: the successful online marketplace is one of the fastest-growing, most defensible business models there is. Online marketplaces have only been in existence in the last couple decades, yet they’ve achieved some of the world’s largest market valuations: Alibaba ($454 billion); Amazon ($711 billion); Uber ($72 billion).
What makes them special? Done right, the marketplace model has the ability to unleash powerful network effects, a phenomenon where adding more users to a service improves the experience for everyone.
“Whether it’s an Uber, Airbnb or Opentable, historically marketplaces are really fascinating because once you get them going, runaway network effects, such as viral adoption enable you to scale very rapidly and create a lot of lock-in,” said Ilya Fushman, General Partner at Kleiner Perkins.
Think about a company like Facebook, which is a marketplace in a sense that it connects people to communicate with one another. Despite the data-breach overhang that has investors spooked, Facebook isn’t seeing an effect on its user numbers because of the power of its network. In other words, it has "lock-in" with its users. Facebook is where everyone is and so that’s where everyone wants to be.
This “lock-in” is hard to dismantle and can create massive economic benefits that enable companies to scale efficiently, making these models extremely compelling. In Facebook’s Q4 earnings, the company, which reaches 2 billion users each month, said it made $6.14 on each one, up from $5 earlier only a few months earlier.
Start small and find your 10x value proposition
It’s sometimes hard to remember, but at its start, Uber had a very narrow focus: black cars in San Francisco. Yet even at that early point, it was clear Uber was onto something.
"Pre-Uber, the number of times you stood outside waiting 15 to 20 minutes for your cab to show up was a pretty terrible experience," said Michael Smerklo, Co-Founder and Managing Director of Next Coast Ventures. Uber seeded its initial market with ample supply, paying drivers to be available. The fact that the solution was 10x better than customers’ current experience made the solution compelling and able to scale.
Conversely, "you can make a marketplace for everything, but if the current consumer experience is pretty good, it really makes any new product tough to scale." Smerklo pointed to the lawn business as an example. He passed up on startups trying to match people with gardeners since he believed the market size was too small and the pain point wasn’t crucial.
"The market is limited as two-thirds of the country has seasons. If I live in Ohio, I don’t need a yard guy all year. Plus there’s a large percentage of people who live in apartment buildings with no yards," he said, adding that the experience for those who have gardeners or are looking for them didn’t seem all that terrible.
"If you don’t like your yard guy, is it a real problem to find a new one? There are some nice businesses being built, but I’m not sure they’re going to be huge because the friction point isn’t that dramatic."
By contrast, Smerklo pointed to TaskRabbit which started by tapping into a market pain point that almost everyone can relate to. “Everyone has that Uncle Fred who’s really good at putting Ikea furniture together, and then you have guys like me who are absolutely horrible," Smerklo explained. "It takes multiple hours, and the thing probably isn’t going to stand after I build it someone can come over and build it within 30 minutes, that’s a good solution. Will I seek out an expert for this service? Absolutely, because my alternatives are pretty low."
And if a TaskRabbit can build my Ikea furniture, there are a whole host of household and other chores that I can employ them for. That first pain point is just the beginning on a road to a highly scalable business.
What it really comes down to is: what is the value proposition for the customer?
"The customer needs to feel like they are getting something incredible out of this new solution. If so, then it is possible to grow a company from filling a niche problem to solving a bigger problem," said Rishi Garg, General Partner at Mayfield Fund.
"Companies with a marketplace model are no different than companies that are appealing to consumers without a marketplace model - they have to create a product or service that’s so much better and so much more impactful than the competition that customers are willing to pay more to use the service," Garg explained.
"It’s worth noting that on-demand food delivery is not necessarily a bad business, but it’s notable that the most effective model in that category is the marketplace model –Seamless/GrubHub," he said, referring to the proliferation of on-demand food-delivery marketplace startups in the last five years. "But there were just too many of these services. A lot of them failed because they didn’t provide such an essential incremental value to the supplier or customer to become must-have subscription-like services."
This compares to Airbnb, whose value proposition was so dramatic because the rooms they were renting were often far more reasonably priced than hotels, even motels. "If you’re sleeping on someone’s couch or even in their room, it could be a far superior experience to something like a roach motel," Garg said. "Plus, that relative quality was coupled with a real substantial cost savings for those early users."
Importantly, Garg points out that it wasn’t just the renter who found value, but the rentee.
"On the supply side, it was found money. They were filling idle time or idle space. If you put those two compelling value propositions together, even if it’s a small niche, then you can see the potential for growth."
The hardest thing to do is to get a lot of users loving your product” but that is exactly what Airbnb managed to do.
Identifying the right customer
Businesses fail often because they target the wrong customer. Some customers are too large and slow in adopting new innovations; or they’re too small -- individuals or small businesses that are not economically viable to serve. Finding the right customer segment to start is essential to getting a marketplace off the ground.
"Historically speaking, if you think about doing anything with large enterprises, it takes a while," said Kleiner’s Fushman. "Large enterprises, depending on the industry sector, have compliance requirements, procurement cycles, and budgeting cycles. Starting with enterprises, unless you have a clear way to get in the door is just going to take a lot of time."
To this end, most companies start with the consumer or SMB (small- to medium-sized businesses), he said. "Once you’ve built up and proven out the dynamics of the marketplace, and are ready to scale it, you can go up market into enterprise as a core part of the scaling process."
"Certainly if Airbnb started by trying to work with large property owners, rather than with individuals, it would have been a much harder story," said Fushman. "Getting individuals to opt into a marketplace and bootstrapping it that way enhances your ability to experiment and get transactions going in the marketplace very quickly with limited capital."
There is another critical element required for marketplace success: customer fragmentation. Marketplaces add the most value when both sides - customers and suppliers - are highly fragmented and have no other way to efficiently aggregate supply or demand. In the flatbed trucking market, where my company FR8Star.com plays, there are potentially millions of customers and at least 50,000 suppliers and no real aggregators. Customers are forced to sift through many possible suppliers (truck fleets) to find a vendor, while the suppliers are in a constant struggle to find the next customer. Both sides have quickly flocked to our marketplace as it greatly simplifies price discovery, matching and booking for both sides relative to their current experience.
"If you have an industry where you have, let’s say, a couple of buyers or suppliers, then it becomes very hard to create enough aggregation value where everyone wants to be part of the service," notes Mayfield’s Garg. "So try to look for fragmentation on both sides of the equation, where software can organize information, provide transparency or access--all things that the Internet is really great at doing."
Such is the case with Opentable, which started as a physical computing device and software that helped restaurants manage their seats. But the software unlocked new data: the number of empty seats across restaurants, which pre-Opentable were highly fragmented, explained Kleiner’s Fushman. On the other side are the fragmented group of diners seeking to book reservations. Hence the marketplace for restaurant reservations was born.
Marketplaces have the ability to be transformative, economically scalable and extraordinarily efficient. They can revolutionize the world, like Uber and Airbnb have done by upending two huge industries: personal transportation and lodging.
They address real pain points. They’re first and foremost amazing services that are far superior and often more affordable than the status quo, unlocking 10x value to buyers and suppliers.
They expand the addressable market outside of their initial audience since a larger user base can typically be drawn into the service once they see the exponential value that service is delivering. And ultimately, strong network effects can create a winner take all, or at least winner take most, market.
Said Mayfield’s Garg: "If you are able to tap into that flywheel and create strong network effects, you’re able to produce an unusual amount of market power and economic advantages for creating enterprise value."
(Image source: thesherwoodgroup.com)
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