How to Overcome the Challenges and Reap the Benefits of Two-Sided Marketplaces
Some of the most successful companies in the world today are two-sided marketplaces: Consider those which are household names, such as Amazon, Uber and Airbnb, as well as niche power players, like Zenefits, Upwork and Seamless. All have had a disruptive impact within their respective industries.
So, what is a two-sided marketplace?
Unlike a one-sided marketplace, where a single supplier interacts with many buyers (hence, one-sided), two-sided marketplaces are a modern business model that connects multiple individuals with common interests on both sides: merchants and buyers, drivers and riders, hosts and travelers.
Today’s two-sided marketplaces are almost exclusively organized as digital platforms powered by technology, which is why many of the most recognizeable technology companies follow this model. Yet building one is extremely difficult, which is why there are also many failed companies that attempted this path.
My co-founder, Brew Johnson, and I thought long and hard about building our company, PeerStreet, as a two-sided marketplace, and we’ve learned many lessons about how to build one along the way. Below are our thoughts on how to properly start a two-sided marketplace, and the magic that happens when you get it right.
It is immensely difficult to start a two-sided marketplace due to what is known as the chicken and egg, or cold-start problem. If the supply side depends on the demand side to function -- and vice versa -- how do you get both sides of your marketplace up and running simultaneously? In fact, there are several steps to take here:
One solution is to manage expectations by limiting access while conveying a sense of exclusivity. This entices early adopters, who will be more forgiving and patient until you achieve scale. A strategy of this type proved tried-and-true for social networks like Facebook -- essentially a two-sided marketplace of information -- which limited access to university students before it opened itself up to the public.
Another viable solution is to limit the scope of what your marketplace is trying to do. While your vision may be grand, it’s often advisable to start with a small piece of the space you’re trying to change.
Amazon started with books; Etsy offered handcrafted or vintage goods only; Kickstarter focused on digital art projects.For one thing, you carve out a more niche-type, unique space from your competition's and allow yourself time to grow.
For another, you'll be able to build and test your platform, strengthening the infrastructure to ensure that it can handle more volume and traffic. Reducing the scope to the MVP (minimum viable product) allows you to focus on the real problem and target your resources in answering the true customer need.
Both solutions suggest a similar approach, which is to start with a very specific subset. If you try to take on too much up-front, you will almost always fail. Why? As my old Google colleague Wesley Chan used to say, “You can’t boil the ocean.” You need to minimize scope so you can build the technical infrastructure, operational efficiency and foundational elements of the business, all of which are hard enough to do. Then you need a sequencing plan where you take your big-picture vision and break it into reasonable next steps, all building off of the foundational beachhead you started with.
The important thing to remember is that two-sided marketplaces must align interests on both sides, matching supply and demand in the easiest and most direct way possible. In this regard, there's an anecdote about eBay losing market share to Amazon because Amazon factored shipping time into its merchant ratings. This was smart because shipping time remained (and remains) important for customers, no matter how many new merchants a platform onboards.
There’s an important lesson here: Take the time to strategize and identify the needs of each side of the marketplace, and actively make sure that the other side represents the solution.
The benefits: network effect
Once you’ve successfully built the core of your two-sided marketplace, the two sides can be infinitely scalable; the cost of adding another user or vendor, on either side of the marketplace, gets very close to zero.
From there, you’ll see that the sides truly gain a life of their own. They become self-sustaining, scalable, value-creating businesses, whose presence empowers an entirely new ecosystem.
Other players in the ecosystem now depend on the marketplace to function, making it all the more essential. Think of how necessary the App Store was for iPhone users and developers. As more users join the marketplace and participate in the ecosystem, the network effect kicks in. And marketplaces that get big enough to experience the network effect become increasingly useful, efficient and better for everyone in them.
The benefits: social impact
As my co-founder Brew Johnson likes to say, “A one-sided marketplace builds one business; a two-sided marketplace scales thousands of businesses.” This is the social impact element of two-sided marketplaces and one of its defining advantages.
A cab company is just one business, but Uber empowers thousands of individuals to become independent entrepreneurs. A hotel chain is a single business, but AirBnB allows many individuals to make a living hosting travelers. YouTube allowed countless independent content creators to become influencers and filmmakers.
In other words: hundreds of thousands of small businesses have been created because of a handful of well known two-sided marketplaces. And consumers have been given a dramatically larger pool of options that improve their lives. In short, not only does the ecosystem win when these businesses are established, but when they're done right, society as a whole benefits from them as well.
The two-sided marketplace is a powerful business model. Once you have the initial users on board, once you’ve achieved enough inertia to get the marketplace flywheel turning on its own, and once you’ve mastered your particular corner of the industry and turn your eyes to the rest of the pie, the potential for growth and transformation can be profound.