How to build a two sided marketplace

May 01, 2013

Table of contents:

Tactics for building two sided market places
Conclusion

Two side marketplace businesses are possibly one of the holy grails of online business models. In a two sided marketplace, buyers and sellers conduct transactions through a centralised platform. Both sides of the marketplace are self organised and so, the platform owner is able to take a transactional “rake”.

These types of businesses are extremely defensible because of the network effects of marketplaces and the high switching costs of moving to another marketplace. For each new buyer or seller that enters the market, the market as a whole becomes stronger and without the dense population of an existing marketplace, users will not switch to an alternative.

Two sided marketplaces are the holy grail because they are incredibly difficult to pull off due to the Chicken or the egg dilemma. Without buyers, you won’t attract sellers, and without sellers you won’t attract buyers.

Some of the most prominent and established online giants maintain a healthy competitive advantage over rivals and newcomers because they have cracked the two sided marketplace problem. Companies like eBay and Craigslist continue to dominate their respective industries because both buyers and sellers won’t leave without the other side of the market.

Whilst taking on a giant like eBay can seem like an impossible task, there are plenty of other marketplace opportunities that have not yet been explored. If you can find uncharted territory, and build a two sided marketplace, you can create a very defensible and strong online business.

Tactics for building two sided market places

In this post I’m going to look at the tactics for building a two sided marketplace. I’m keeping this pretty agnostic in terms of industry and exact business model, so whilst not every tactic will work for your specific situation, hopefully you will find some that do.

Start with a niche

Probably the most important overall strategy for building a two sided marketplace is that you must start with a niche. Trying to target a market opportunity that is too big, or take on a competitor head on is a recipe for failure. If you try to appeal to everyone, you will end up appealing to no one.

The first thing you need to do is to pick a very specific target market and completely dominate it before expanding into bigger or adjacent markets. You need to become a household name within that tight niche market because you need the recognition and momentum to move into bigger segments.

For every opportunity, there will likely be hundreds of possible niches. For example, you might target a specific geographical location, demographic or niche interest. You can’t really pick an opportunity that is too small at this stage, but it’s important that you can envision how you will be able to logically expand into adjacent areas.

Starting with a beachhead is one of the key take aways from Geoffrey A. Moore’s, Crossing the chasm. By establishing yourself within a niche, you begin to create leverage for your company and momentum for attacking the wider mass market.

If you are looking to take on an established incumbent, it is imperative that you focus on a single niche that the incumbent is either over-serving or under-serving. When an existing incumbent is over-serving a market segment, there is an opportunity for you to enter the market with a much lower cost product. When the incumbent is under-serving a market segment, there is an opportunity for you to enter the market with a differentiated, more focused product that better meets that customer’s needs. You can read more about this strategy in my post, How to find disruptive opportunities.

Creating a community through content

When you start on day one of building a two sided marketplace business, no one will know who you are and they won’t care about what you are trying to do. In reality, it will probably take a long time for anyone to really care about what you are building, even if you are incredibly passionate about solving their particular problem.

I’m a big fan of online businesses that utilise content for growth. Whilst the majority of people view content as a throwaway commodity, I believe it can be a huge driver of growth and loyalty and a much better way of marketing your company and creating inbound demand.

One of the main problems with building a two sided marketplace is lack of traction and demand. When you open your door up on launch day, you need to have an already engaged audience who are already actively using your product.

It’s very difficult to find this type of audience for an unreleased and unproven product. However, I think producing quality related content is the best strategy for building that kind of initial interest.

I’ve recently wrote about Why groundswell is critical to building successful online products as well as a deep dive on The intersection of content and commerce.

What it all comes down to is, producing content enables you to build an engaged audience around a topic. If you want your product to be successful, you need distribution and marketing. Instead of launching on day one into the abyss, you can create a engaged following by creating content and a community long before your launch.

Single player mode

Up until now I’ve mostly talked about transactional two sided marketplaces. But there are many other types of business model that favour the dynamics of a two sided marketplace.

For example, any product that connects two users together through social or utility type features will benefit from the network effects and switching costs of a two sided marketplace. However, even in this situation, the model can be a difficult one to build.

Fred Wilson wrote an interest blog post on Single user utility in a social system. Basically, this means that you can create a two sided marketplace by first building traction of your product around single user usage. For example, if a user can use a product by themselves, without the other side of the market, you can gain the benefits of a two sided marketplace once you open up those features that require traction on both sides in order to add value.

A good example of this would be any type of utility application that allows a user to derive value from usage. If the user’s usage can be opened up to benefit them as well as the wider marketplace, you can hack your way into a two sided marketplace by focusing on the single user utility. For more on this, read my post Moving your product from a fad to a utility.

Find a big supplier (established company) for one side of the market

An interesting application of the two sided marketplace is where you connect a buyer to a seller where the buyer is an already established company. Although ideally you want both buyers and sellers to be decentralised and self organising, by using an existing company as your “supplier” you are able to build a two sided marketplace by concentrating on only one side of the market.

I wrote about an interesting real life case study of this opportunity in the post, Adding a service layer to incumbent industries through discovery and curation. In that post I looked at competing mobile music discovery services WillCall and Jukely.

Both WillCall and Jukely are building services that connect passionate music fans with live music events. Users can discover new events in their area and purchase tickets straight from the app.

This would seem like the perfect opportunity to create a two sided marketplace by using an existing supplier on one side, whilst you build an engaged audience on the other. In this case, the seller side of the marketplace could be the monolithic ticket seller that is able to provide access to the majority of all music events. However, because the service is able to build the demand side of the market, the incumbent established ticket provider can be replaced with smaller, more decentralised ticket sellers who want to connect to that audience.

Start with non-scalable things

The ultimate goals of creating a two sided marketplace is that it is a business model that scales indefinitely. The real beauty of two sided marketplaces is the power of the network and how each side self organises around the platform.

However, at the outset you are a long way from building a completely scalable model, and so, you should not be scared of doing non-scalable things in the short run.

For example, say you are connecting two established but non-connected existing systems. It is likely that in order to make the connection work early on, there will be some manual work. This often means instead of directly connecting the two sides of the market, you have to act like a middle man to make the connection. Whilst this setup won’t scale with usage, it can mean you get the foothold you need to start connecting the two sides directly.

For example, say you are building a resource allocation marketplace around power tools within a local area. You could facilitate the early growth of the market by directly reaching out to owners of power tools and new homeowners who require them in order to connect the two sides of the market. I’ve already wrote extensively on this opportunity in the post, The huge opportunity of resource allocation in connected marketplaces.

Piggy back off someone else

If you are solving a real problem, it is likely that at least some of your potential audience is already solving the problem in some way or another.

A good real life example of this is how Airbnb got it’s early traction. For a long time, Craigslist was the established leader in short term apartment rentals. Craigslist already had the demand on both sides of the market, but it was hard work to create listings using the Craigslist interface and the anonymous nature of the system meant it wasn’t the best way to find reputable people. Nevertheless, the demand on both sides of the market were at Craigslist despite these drawbacks.

Airbnb created their system which allowed people to post to Craigslist as well as Airbnb at the same time. This meant that it’s early users had a better experience when posting listings and they could benefit from posting to both marketplaces at the same time. Craigslist was a much bigger market, and so it would of been extremely difficult to convince users to switch to a different marketplace cold turkey. But by building a tool that made the switch easier, Airbnb was able to piggy back traction from the established incumbent.

Conclusion

Two sided marketplace businesses are very attractive because they are defensible and able to scale with a clear repeatable business model. Whilst it can be extremely difficult to get to post-traction, once you reach that stage you have often captured almost the entire market.

I’m really interested in the transactional nature of these types of businesses. When you, as the platform owner, can generate revenue by facilitating and connecting both sides of the market, you can build a very exciting business. Prominent Venture Capitalist Bill Gurley recently wrote a fantastic article on Optimal Platform Pricing Strategy for these types of marketplaces.

Building a two sided marketplace is widely recognised as a difficult, but potentially lucrative opportunity. If you are interested in reading more about how others have achieved traction, or more ideas for building a marketplace for yourself, have a read of the following posts:

What have you found to be good strategies for building two sided marketplaces?