Advice for marketplace startups

Marketplace businesses connect buyers and sellers, and they typically make money by taking a cut of transactions. Some of today's largest companies are marketplaces, such as Amazon, Airbnb, and Uber. I spent three years building a marketplace for software engineering gigs called Moonlight. It took us about two years of experimentation to make something that people wanted, then another year of growth to get acquired. Those two years of product development became a crash course for me in how to build a marketplace as we constantly experimented with our business until something worked.

For startup founders interested in starting a marketplace business, here is my distilled advice that I hope will save you two years of work.

Focus on demand. Many founders approach marketplaces from the supply side - a group of people looking for work. But, be careful - the actual group that defines the marketplace is the buyer. Ask yourself: who wants to buy this product, and what problem do they want to be solved? Does the buyer even have the budget to purchase what I'm selling?

What you sell is your product. That is where the market risk lies for your business. How you fulfill that product has operational risk but isn't typically where the "secret sauce" for a company lives. Uber didn't start their business by saying, "Wow, lots of drivers are sitting around with no work." Instead, they began with the ideal customer experience - on-demand rides. Over time, Uber grew the number of people working as professional drivers because they offered fair pay and stable work.

Why a marketplace business model? For a marketplace to work, you need to deliver ongoing value to both buyers and suppliers, and you need to have the supply work on multiple projects. Often, many different business models could apply to the same problem. If your supply prefers full-time jobs over gigs, then maybe you should monetize in contingency agreements where you earn a recruiting placement fee. If companies wish to work directly with suppliers, then perhaps you should be selling a lead generation service like Craigslist. If companies want to outsource projects, then maybe you should build a full-service agency.

Most marketplaces start as an agency where humans manage the entire process from end to end. Beginning as an agency proves that buyers want to buy your product and is an excellent way to get started. But, the difficult part is transitioning from a service business into a technology business. Some companies navigated this transition well, such as Airbnb, and others navigated it poorly, such as Gigster.

Think about commoditization. Are you selling the individual skills of each worker on your marketplace, or can any person do any job on the marketplace? There are some significant implications here for how matching works. If hiring is such a "considered purchase" for the buyer - how can you automate it enough to get buyers to make a decision instead of taking weeks to interview tons of people?

Airbnb successfully pushes customers to pick between drastically different listings at different prices. But, that same model doesn't work in every business. As a rule of thumb, every decision you ask buyers to make in a marketplace is an opportunity for them to drop off without making a purchase.

Sidecar was an early ridesharing startup that competed with Lyft and Uber. But, Sidecar let drivers set their price - and it turned out that customers were not equipped with the information or patience to choose the exact driver they wanted every time. Uber's innovation of constant pricing meant that every driver cost the same. So, they could route the closest driver to you, and if there was a problem - they could reassign the driver without your approval.

For your marketplace: does letting your customer pick the supplier and price improve or detract from the experience?

Beware disintermediation. Agencies have recruiters that make sure that the demand and supply follow the rules. Once you become too big to manually handle every deal (and truly become a marketplace), then you need people to follow the rules still. If people don't follow the rules, then you spend a lot of money acquiring customers and suppliers who cut you out of the deal.

The more a company thinks they've hired a particular person, instead of hiring your company - the more likely you will get disintermediated. Yes, you can write any rules into contracts about fees and needing to go through you. But, suing customers isn't a viable growth strategy. You can only get compounding growth if you can consistently grow the number of working suppliers. And, if you need humans to enforce the rules - then your business is an agency, not a marketplace.

The home cleaning startup Homejoy failed because their customers had a stronger loyalty to a cleaner than the Homejoy brand. So, Homejoy would pay for ads to get customers, but after a first cleaning - the customer would typically rebook directly with the cleaner instead of the app. Managed by Q innovated on this cleaning model and managed to make it viable. They sold cleaning services to companies who were less likely to form loyalty to individual cleaners, and they made their cleaners full-time employees with benefits so that they could rely on the company for all of their income.

The frequency of purchase will determine whether your marketplace can experience exponential growth in the number of active customers. So, ask yourself - why would a customer use this marketplace the second, third, or hundredth time? Also, can your suppliers rely on your marketplace for stable income?

Your pricing is too low. At a 5% take rate, you need about 20 full-time working placements to pay one internal employee. That's crazy. I always recommend that marketplaces aim for closer to a 50% fee. With a 50% fee, you only need one full-time working placement to support one internal employee. High prices might seem like a problem - but it's a competitive advantage. If you differentiate on nothing but the price, then your business is a commodity and can get replaced. The amount of money you make dictates how much money you can spend to acquire new customers - which drives faster growth.

Low fees can hurt your ability to pursue enterprise customers, too. Big companies will want you to invoice them with 90-day payment terms, but suppliers don't want to wait three months for payment - which means you're factoring invoices and taking on the risk of non-payment. High margins help make both of these risks more palatable.

Consider TAM. To raise VC, you need a path to $100m net revenue per year. (Probably higher because your revenue isn't recurring). How many suppliers could work on your site, and how much money could you earn? Is that even possible? And, why would that labor continue working through you instead of leaving the platform to go work for somebody else?

Small decisions in marketplace businesses have significant impacts on the viability of the business. So, be strategic about every detail, and focus on creating the ideal customer experience above all else.