Five Greatest Myths Killing Your Marketplace Startup

The other day I came across my notes from one of the best seed round pitches of 2016. The pitch was for a farmers marketplace, a hot topic back in those days. The founder was clever, charismatic and had a successful exit under his belt. The pitch was brilliant. The investors were excited. The tick boxes were checked. Fast forward 14 months and the marketplace failed.

Why?

At MARKETCUBE we work with hundreds of marketplace startups and we see many stumble over the same pitfalls. They are a result of believing highly publicised but erroneous marketplace myths. Today I will decode the top five so you can avoid them.

Myth #1: Being “hands-off”

One of the most frequently evangelised beliefs about marketplaces is that they require little to no “physical” involvement. Many first-time marketplace founders get very excited about this idea and defer operational and fulfilment duties to their vendors or other 3rd parties, not realising the havoc and suboptimal experience this might create for all parties involved.

Before deciding on the operational and fulfilment models for your marketplace make sure you think through all of the following

• Customer Impact:

1. What will your customers’ shopping experience be like? what will their returns, exchanges and refunds experiences be like?

• Supplier Impact:

1. What will your vendor onboarding and management process be like? how will you manage any problems (ie sold out items, late deliveries, quality issues)? how and when will you pay your vendors?
   If your marketplace has 3 or more sides you need to assess the impact for all other sides as well.

• Inventory management & Fulfilment:

1. Who will manage stock? who will deliver orders? who will set and pay delivery charges? who will cover import/export costs? who will manage returns and exchanges and cover associated costs? what are the acceptable timelines and other T&Cs?

• Technical Feasibility:

1. Can you implement and support the model? when thinking through this I strongly encourage you to evaluate manual, off-the-shelf and bespoke built options.

• Costs:

1. How much will it cost you, both to set up and to maintain?

• Scalability:

1. Can the model scale to other markets or verticals, depending on your business?

When choosing a fulfilment and operational model for your marketplace look at other marketplaces for inspiration and learning. For instance, looking at two leading marketplaces of today, Amazon and Alibaba, we can learn that managing fulfilment not only puts you in control but it also empowers you to a) provide powerful value-add for suppliers to stick with you versus other similar products and b) deliver excellent customer experience, improving retention rate and LTV, both critical metrics for marketplaces.

Myth #2: Overlooking payment gateway, tax & duty fees

For most marketplaces the average order value is between $50 and $75. This means that with an average sales commission of 20%-25% the marketplace only makes $10-14 in revenue and much less in net profit. As a result, most marketplaces have relatively thin unit margins. Payment gateway fees, as well as tax & duty charges can eat heavily into them. (By the way this is not to say sales commission is the only marketplace business model, most marketplaces adopt multiple ones, I’m just using sales commission as an example). Regardless of your business model, for your marketplace to work at scale you need to understand all associated payment gateway, tax, duty, currency conversion and other fees. You might find out that your marketplace is only viable in certain countries or currencies, or you can only work with vendors from selected regions.

The very crude example below illustrates how 20-23% of your marketplace sales commission can be easily spent on payment gateway fees alone.

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Myth #3: Underestimating customer support required

There are millions of reasons why customers might be dissatisfied and unhappy with products or services they buy. Wrong products, bad quality, poor delivery experience, late delivery, etc.

Many first-time marketplace entrepreneurs believe that they can put up robust T&Cs and be done. Whereas you should certainly have robust T&Cs, if a customer has a bad experience with your marketplace, T&Cs won’t save you. Regardless of what went wrong, a bad experience is always marketplace’s fault and responsibility.

If you’re ever in doubt, think about the reputational and financial damages AirBnB incurred because of trashed homes or accidental deaths; and Uber experienced because of violent drivers.

When things go south customers, press, and investors don’t turn to individuals, they turn to marketplaces.

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Myth #4: Revenue = the North Star

Many VCs and coaches advise startups to think of revenue as the single most important metric (aka the North Star). Whereas revenue is always important to track, for multi sided platforms and marketplaces it’s hardly the one metric that captures the underlying health of the business and its potential, especially early on.

Optimising solely for revenue might push you to overcharge or not provide enough value to one or more sides of your marketplace, resulting in high disintermediation and lower uptake. Moreover, depending on where you are in your marketplace journey, you might need to optimise for different metrics (ie for new marketplaces acquisition is the most important; for more mature marketplaces retention and resurrection take precedence.)

So what should be your North Star then? There are two things you need to remember. First, marketplaces only work if they create substantial value for all sides involved. Second, all good marketplaces have network effects (meaning the business gets more valuable as more users use it).

As a result, the metric that does reflect marketplace’s health the best is normally engagement. However, the right way to track engagement for marketplaces is not by simply looking at how many minutes/hours users spend on your platform. A better way is to cohort analysis and review cohort curves religiously. As a minimum, add users joining each week into separate cohorts and track their engagement over time. Soon you should be able to see patterns and can start comparing weekly cohorts to each other. What you are looking for here is whether your newer cohorts perform better than your older ones (meaning are they more engaged.) If they are then it means your marketplace consistently adds more value to its users and moreover, it demonstrates network effects potential. If not then you need to take a hard look at what’s happening.

Myth #5: Marketplaces are easy exits

First-time marketplace founders often think that since marketplaces can be started with little upfront costs and don’t bear inventory overhead, they can be scaled fast and are easy exits. What they don’t realise is that the multi-sided nature of marketplaces adds complexities and costs, making it hard to get things right quickly.

As a consequence, marketplaces quite often take longer to reach product-market fit, liquidity, scale, and are often 7-10 year ventures before any material exits. OpenTable took 11 years before it IPO-ed in 2009. Alibaba went public after 15 years in business. Etsy was founded in 2005 and only looked to IPO 10 years later. Even the favourite poster child of marketplace economy AirBnb took 5 years to reach its unicorn status.

Trying to push for higher valuation and optimising for an exit before the marketplace is ready is one of the deadliest mistakes for marketplaces. Beepi, an online peer-to-peer marketplace for buying and selling used cars, had amazing traction early on and quickly became a Silicon Valley darling, raising close to $200M in venture funding. Less than two years after that the company ceased operations and was sold for parts. “They were running the business to raise money, and then to get someone else to take it on,” was how one person described it. One investor in the startup said that the founders were too aggressive in pushing for higher valuations. Indeed, co-founder Alejandro Resnik, the CEO, told the WSJ in 2015 that it was looking to raise a “monster round” of $300 million at a $2 billion valuation to fuel its national expansion.

I hope you find these insights useful and remember marketplaces are a long-term game. They are incredibly rewarding when they work but you need time, stamina, focus and patience to get there.

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