Mighty marketplaces: how we evaluate marketplace potential

Marketplace platforms are booming business, even more so in the post-Covid era. However, not all marketplaces are created equal and make for sound investments. How do we assess the potential of a marketplace model? We’ll explain more in this article.

Differences in consumer behavior & monetization

Marketplace platforms bring together buyers and sellers and provide added value to each: the sellers in finding more customers and the buyers in finding what they need. Someone hunting for a handmade ornament for example may not find it in their local shop, but can find an artisan offering it on Etsy. The customer benefits from the hard-to-find product, and the artisan from finding a market for it. A viable marketplace monetizes this added value, and this is where things can get tricky. Consumer behavior and the way value is monetized differs across marketplaces. Platforms differ in their transaction frequency, from very occasional usage for sales or bookings to very frequent. Average ticket sizes also vary depending on what is sold, from about 20-40 euro for ClassPass for fitness classes, to hundreds of euros for hotels booked on Booking.com.

Sheer transaction revenue doesn’t have to make or break a company. Some platforms are used in a more exploratory way, for example to check out different restaurants or hotels. This means that a business could be used very frequently for discovery purposes while seeing a very occasional frequency of sales or bookings. That doesn’t have to be a problem: it all depends on the business model. For example, TripAdvisor earns revenue from hotel, flight and vacation rental bookings. The frequency of these bookings is very occasional, and it hasn’t been able to monetize the restaurant bookings it also offers. But because the site is so frequently visited for discovery purposes, it can rely heavily on traffic and engagement for advertising and still rake in hundreds of millions of dollars per year. Others depend more on transaction business, with revenue in the form of subscriptions, commissions or listing fees. These have varying levels of pricing power in relation to operators.

The Big Three: Demand, Transaction & Supply

We evaluate marketplaces across the three main building blocks of demand, transaction and supply. We’ll take you through the key questions we ask for each:

  • Demand: Is the platform solving an important consumer pain point?

We take a look at the target population, considering whether the marketplace has mainstream appeal and whether there is untapped consumer demand. We then look at the usage frequency in relation to ticket size. Finally we examine the take rate, analyzing consumer loyalty with regard to switching or exploratory behavior as well as the user experience: how much information, convenience or choice is provided? Are users willing to pay for the marketplace, and do they have quality alternatives?

  • Transaction: Does the exchange need to take place on the platform to build sufficient trust?

We look at what the added value is of the platform, and whether consumers trust using it above direct exchanges with operators. When it comes to the delivery of the product or service, the ability of a platform to perform instant transactions 24/7 for bookings all over the world is key. Once the product is booked, the marketplace is evaluated according to its ability to deliver the product or service completely via the platform, take online payments, and instill trust and quality in a way that furthers consumer intimacy. Finally, we look at reviews: what are the network effects and opportunities?

  • Supply: is the platform “mission critical” for successful operators?

Here we ask, to what extent does the platform consolidate a fragmented industry? Does it enable “dark” or mobile concepts that rely on an aggregator to sell? The digital readiness of an industry is also important, requiring a high tech adoption by operators and a lack of alternative ways to make sales. We also look at the SaaS-based components of the marketplace: what value-added services does the platform offer? Does it integrate easily into the back-office or workflows? Again, we’re looking at the user experience, but then from the operator point of view: which pain points does it address for operators? Their willingness to pay for the platform is dependent on the extent to which the platform is mission critical and boosts their marketing and optimal capacity.

Mighty marketplaces: all about ensuring trust

There are successful companies that aren’t strong in all three areas: some are strong in just one. That’s why we always have to examine companies on a case-by-case basis. In general however, the strongest marketplaces play a crucial role in ensuring trust between the two parties. Companies that fit this profile include Airbnb, ebay, Vinted and many others. These are all “pure marketplace” models which are ideal for products or discounted services. Their business models revolve around easily automatable transactions at high volume, on which they take a commission. Marketplaces where transactions entail risk rely heavily on trust. AirBnB has succeeded in this category because of its ability to curate users through a high review rate and strong verification measures.

However, the “pure marketplace” model is not ideally suited to every industry. Beauty services for example, are better titled a MaaS (Marketplace as a Service) model, which offers back-office integration and booking convenience to suppliers. Companies like restaurant booking platform OpenTable exemplify this model. In general, most “MaaS” models need develop strong software offerings to create pricing power towards their suppliers (with the marketplace as “cherry on the cake”).

These just some of the ingredients for success we look at every day at Verlinvest to select healthy growing companies to invest in. Check out our site to learn more about how we put our market and consumer insights to work to support iconic brands that fuel consumer revolutions. And get in touch if you happen to be building one.

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