Thirty years ago, the ability to sell something when you have nothing would have sounded like a koan presented to business school students on their first day of class. Now, it is a winning online strategy. From Lyft to AirBnB, marketplace platforms allow for businesses to make a lot of money by acting as middlemen, pairing buyers with sellers.
The allure of being a billion-dollar business that does not require inventory to be purchased and maintained can be compelling. Entrepreneurs looking for that big first payday might think that a marketplace startup is a good first play. But potential profits can blind new founders to common mistakes that many new marketplaces make.
In this post, we provide an overview of the startup mistakes to avoid when building a marketplace. We begin by discussing what separates market platforms from other online offerings and consider the customer service elements you need to put in place to assure success. We discuss how to treat the buyers and sellers on your platform to ensure your positive reputation. Finally, we discuss where your marketplace can go and when and how you can exit with that billion-dollar payday.
First, you need to know some basic definitions. An online marketplace startup is focused on pairing buyers and sellers of goods and services. Marketplaces make money by charging a fee for every transaction that takes place on their platform. This business model has the advantage that it doesn’t have to carry inventory which drives down the startup costs.
An e-commerce store is where you exclusively sell your products and services to the general public. While you must pay the fees to make and store the products, you have more control over quality of what you are selling. Instead of receiving a fee for each transaction, in an e-commerce store you receive the entirety of the purchase price. Both strategies are a sound basis for a business, it is just important to know which type you wish to pursue. Learn more about the difference between a multi-vendor marketplace and single-vendor e-commerce.
One of the greatest downsides of running a marketplace platform is that you have limited control over the goods and services provided via your website. When you run a marketplace startup, you run the risk of the consumer getting subpar goods and services for which your site will be blamed. Let’s go one step further; at some point you WILL have a seller on your site that WILL provide a buyer with a less than spectacular experience. The problem with many new marketplace platforms is that they do not have procedures in place to address these situations when they occur.
When you develop your platform, you need to have an arbitration process in place to address any poor transactions that occur on the site. This includes determining what happened and a series of potential responses to make the situation right. Remember, a bad transaction might not always be the fault of the seller; buyers could try to take advantage of the system to enrich themselves to your detriment. This arbitration process should result in weeding out “bad actors” on your platform and ensuring your good reputation. Trust in your marketplace is the one thing you will never be able to buy.
No one likes confronting problems in public. For most, our instinct is to fix things in private so that we can present an air of infallibility to the outside world. This is especially true in professional matters. If your marketplace is fallible, many new entrepreneurs assume, then customers will lose trust in your business which will translate to lost revenue.
This fallacy is one of the top 10 startup mistakes, marketplace or not. Your business is going to run into problems, come across bad actors that game your system, or one of a hundred other problems that you can’t anticipate. Consumers expect that to happen. What interests them is not that the problem happened but how the business went around solving it.
Covering up an issue is often worse than the issue itself. If you have a positive result in resolving an outcome, it should be publicised. If you position your platform as a place where problems are promptly and fairly resolved as they arise, the sales will come. Follow through, not perfection, is what makes a marketplace platform thrive.
This is another problem that easily makes it into the list of top 10 startup mistakes. One thing that every startup needs to be concerned with is product-market fit. Essentially, this concept describes whether an entrepreneur is selling something that addresses a problem that the target set of customers would pay to resolve. It is all well and good to build something works and that people can use but if customers do not see the point of the product, you do not have a business.
Now this might be confusing because in this case the product is a market. The assumption might be that the by the very fact that you are building a market, there is an implied fit. That will get you into trouble.
Marketplaces are meant to address a very specific sort of problem; in a certain niche customers and buyers have must have a hard time finding each other. If your marketplace makes it easy for these two groups to find each other and participate in a transaction, then your marketplace has found its fit. If customers and buyers can easily find each other without you or there is not enough interest in the niche your marketplace occupies, you need to pivot and try again.
In the early days of the internet, it was enough to provide mere functionality to achieve profitability. It was unnecessary to do any additional positioning because it was about efficiency. However, now everyone is efficient at processing orders and pairing buyers and sellers; these characteristics are required for businesses to have a chance with marketing platforms but are not enough to guarantee success.
In this new environment, market platforms can compete one of two ways. First, they could compete on price alone, continually cutting their prices in an effort to beat their competitors in a race to the bottom that will result in razor-thin profit margins that will leave all of the businesses under constant threat. Only the largest market platforms will be able to survive because they would make up for lost revenue through volume.
The smarter way to compete is to provide a key feature or benefit that will motivate buyers and sellers to choose you over the scores of other options. The best way to do that is to focus on a subset of your customer base and provide an additional service or feature that will appeal to them. While this will cut down on the volume of your business, if you choose the right service to provide your customer base will be more loyal and willing to pay higher prices. Lower but steady, consistent revenue is preferable to higher possible revenues but with dwindling margins.
If you choose to pursue a strategy in which you are focusing on a smaller subset of customers by providing a unique feature or service, education is absolutely necessary. You cannot assume that everyone is going to see your platform and understand its unique value proposition. You need to demonstrate how these new features provide a value to your customers, especially if you are going to expect them to pay more for the privilege of using those features. This is all the more complicated since most customer will not have the patience for a prolonged explanation online.
The key is getting the right early adopters, demonstrating your value to them, and letting word of mouth carry your message to a larger audience. The easiest way to do this is by not taking the easy route. Instead of focusing on digital marketing and SEO, you are going to have to get out of the building. You need to find where people who are active in your marketplace’s niche meet. You need to go to those places talk to your potential customers face-to-face. Make the early sales one-on-one, convey an experience to your earliest customers that is so rich and fulfilling that they become your ambassadors and expand your brand.
Rules can be restraints, or they can be supports; it all depends on application. If there are too many rules, people will feel restricted and burdened, resulting in a lack of activity. If there are too few rules, people will feel like they are at risk, resulting in a lack of activity. Rules are also important for the entrepreneur that is building a market platform. If structured correctly, rules and the mechanisms meant to enforce them can provide a feedback loop that can inform the founder of a possible problem situation before it becomes disastrous.
For example, a common problem that marketplace managers have is that they don’t pay attention to poor customer reviews of vendors on the platform. The assumption is that the “market” will correct it; bad reviews will translate into poor sales. However, the reputation of each vendor on the site influences the platform’s reputation. Their failures are your failures.
But you also succeed when they succeed. If you put into place a rule related to vendor reviews, you can be notified when vendors are doing poorly. This allows you to intervene in the situation earlier so that you can help the vendor determine with is going wrong and help them fix it. Properly structured, a rule related to reviews can help you rehabilitate most poor performing vendors while allowing you to eliminate the truly bad sellers. The result will be a strong reputation with buyers and sellers.
When drafting the rules for your marketplace, don’t envision it as a means to “crack-down” on the guilty but as a way to build a system to notify you of a problem before it can hurt your reputation. The right balance of rules and leniency can make your market attractive to buyers and sellers alike.
In marketplaces, a significant problem is disintermediation. The concern is this; a first-time customer purchases a product or service from a vendor and loves it. Instead of making subsequent purchases through the site, the customer reaches out to the vendor and finds a way to execute the sale offsite. Since the marketplace charges a fee for processing each transaction, the customer and vendor split the difference for not having to pay the fee. This allows the vendor to get a little more and the customer to pay a little less. The only loser is the market platform who relies on the consistent payments to support their enterprise. Any market platform that only captures value from first purchases between buyers and sellers is not going to last long.
Many marketplaces try to combat disintermediation by creating a series of rules that allow for legal repercussions or other harsh penalties for vendors who sell off platform. As discussed in the rule section, this can alienate vendors. It can also be incredibly difficult to enforce because the effort and expense required to determine if a vendor is selling off platform make it prohibitive.
The best way to discourage disintermediation is to provide value to each transaction beyond merely pairing customers and vendors. A marketplace can do this by identifying elements of the transaction that would be costly or difficult for a buyer or customer to do on their own and provide it as part of the service. Amazon does this with their warehousing and shipping function. If your marketplace can find a way to make each transaction easier and cheaper, buyers and sellers will continue to transact on the marketplace because the cost will be worth it to secure those benefits.
All entrepreneurs love the businesses they start, but when they are putting in their eighth 19-hour day in a row what gets them through is imagining themselves on a beach after selling off the startup for a massive return. Most startups are built to be sold. But finding that exit for a marketplace is not easy. It is a time consuming, long process. For example, it took Etsy 10 years to go from launch to IPO. AirBnB was founded in 2008 and they still haven’t been bought out or gone public, despite their $25 Billion valuation.
The best way to get to that beach with a marketplace is to do what Warren Buffet advised the AirBnB guys to do: get rich slow. You can’t rush to cash out because if you do you won’t build a sustainable business that will be worth buying. If you are going to build a marketplace it requires more than just an investment of money and effort; it will require years of your time. If you stay patient, put in a lot of effort, and avoid the mistakes listed above, you will get to where you want to be.
One way to help you avoid these mistakes and a few others is to work with someone who has been there and done that. Partner with someone who can help you create feedback loops and infuse value propositions in your platform so that your customers and vendors wouldn’t think about going somewhere else to do business.
Originally published February 9, 2018, updated June 11, 2020