IN THE PREVIOUS ARTICLE, WE WENT OVER WHAT MAKES A GOOD MARKETPLACE IDEA. THIS TIME WE ARE GOING TO FOCUS ON MARKETPLACE BUSINESS MODELS.
Marketplace businesses are long-term initiatives. To build a sustainable and successful marketplace, you need to find a marketplace business model that will finance its operations.
If you are running a non-profit or a hobby project, funding the development and maintenance of the site can be done through donations or from your own pocket. However, in most cases, funding eventually needs to come from the community you are serving—the users of your site.
One of the most common reasons why startups fail is that they pick a business model that does not scale to ensure long term sustainability. In this article, we review the different options for marketplace monetization, and give guidance on how to choose the right marketplace business model for your idea.
The most popular business model for modern marketplaces is to charge a commission from each transaction. When a customer pays a provider, the marketplace facilitates the payment and charges either a percentage or a flat fee.
The biggest benefit of this model is that providers are not charged anything before they get some value from the marketplace. This is really attractive for the providers. At the same time, from the marketplace’s point of view, this model is usually the most lucrative: you get a piece of all the value that passes through your platform. The best known marketplace platforms—like Airbnb, Etsy, eBay, Fiverr, TaskRabbit and Uber—all use commissions as their main business model.
The biggest challenge in getting the commission model to work is to provide enough value for both the customer and the provider. If your users do not get enough value from your platform, they will find a way to circumvent your payment system, and you will not get paid. How do you provide this value? We’ll dive into that question in our next article.
Another challenge with the commission model is pricing. How big should the commission be? Should it be the same for all users? Should I charge the customer, the provider, or both? Should I first have a lower commission to get people to join my platform, and raise it later on? We’ll dedicate another article to pricing later on.
My recommendation is to use the commission model as your main revenue stream whenever feasible. I anticipate more and more marketplaces adopting this model in the future.
There are, however, scenarios in which it is not feasible for the marketplace to facilitate payment transaction. In these cases, the commission model does not work. Examples include:
· When the size of the typical transaction is huge. With car or real estate sales, for instance, it’s difficult for the marketplace to justify the commission.
· The marketplace has lots of different types of offerings. It becomes impossible to design a transaction process that provides value for all of those cases. Traditional classified ads are a good example of this.
· The invoicing process is too complex for the marketplace to facilitate it. This is common in business-to-business (B2B) and some business-to-consumer (B2C) marketplaces.
· Money is not exchanged at all in the marketplace. For instance, if the marketplace is about dating, finding people to hire, bartering, or sharing something for free, there’s no monetary transaction involved, and thus no way to charge a commission.
In these cases, you need a different type of business model.
2. Membership / subscription fee
A membership fee (sometimes called a subscription fee) is a model where either some or all of a marketplace’s users are charged a recurring fee to access the marketplace. With this model, the typical value proposition for providers is that the marketplace helps them find new customers. For customers, it helps them save costs or find unique experiences. The membership fee is a good choice if the value you provide is high and a typical user will engage in several transactions, but facilitating a payment is challenging or impossible.
Typical examples of consumer-to-consumer (C2C) marketplaces with membership fees are home swapping sites (Love Home Swap, Home Exchange) and dating sites (OkCupid, Match.com). Oftentimes, these sites vet all the subscribers in order to guarantee quality matches and create a sense of exclusivity that justifies the fee.
In the B2C market, the membership model is common in recruiting. For instance, LinkedIn and StackOverflow Careers charge companies a subscription fee to get access to their talent pools. Studiotime, an “Airbnb for record studios”, is an example of another niche where membership fees work as the main business model. With B2C companies, the platform is typically free for customers, but requires a paid subscription for providers.
A membership fee can also be a good initial business model for B2C marketplaces that eventually want to charge a commission but don’t yet have the tools in place to facilitate transactions in their particular niche. Venuu, an “Airbnb for event spaces”, started with the membership model in order to get revenue upfront, even before launching their site. Later on, when they had validated their business plan and had the resources to build an invoicing system, they moved to the commission model—a model that was much more lucrative for them.
The challenge with the membership fee model is that it makes the “chicken and egg problem”—how to find providers without customers and how to find customers without providers—even worse. You need to have enough users on your platform to make it valuable for both providers and customers, and a mandatory payment discourages users from signing up. One way to get around this is to offer heavy discounts for early adopters, or even lifting the fee completely to build the initial user base.
3. Listing fee
Some marketplaces charge a fee from providers when they post new listings. This model is typically used when providers get value based on the number of listings they have on the site, and the potential value per listing is big.
This model is quite common with classified ads. The value proposition of the website is really simple: it aggregates a massive volume of listings to a single online destination, and guarantees lots of visibility for those listings. Classified ad platforms typically don’t even try to facilitate the transaction.
Perhaps the most well known example in this category is Craigslist. It is a collection of local sites where people can post listings about anything they want; whether it’s about selling goods, services, jobs, finding an apartment, dating, or something else. Generally, posting a new listing to Craigslist is free—this is how they managed to reach critical user mass—but in certain categories (namely, job and apartment listings in some cities) they charge a fee for each listing.
It can sometimes be useful to use several business models on the same site. For instance, Etsy is an example of a B2C marketplace that uses the commission model, but also charges a fee to post new listings. Etsy’s reasoning for this is likely that its liquidity (the probability of a certain item being sold) varies a lot. While there are some hugely popular items on Etsy, most items probably never get a single sale because Etsy’s total volume of listings is massive. By using both the commission model and the listing fee model, Etsy gets revenue from both popular and not so popular items.
A listing fee is better than a membership fee in cases where providers don’t want a continuous subscription, and only want to sell certain items. This is the case with Mascus, a B2B classifieds site for expensive machinery.
The challenge with the listing fee model is that it doesn’t guarantee value for providers, and thus the fee cannot be too high. This results in the marketplace being able to capture only a relatively small portion of the value going through the site. A sustainable business model that depends solely on listing fees thus requires a very large volume of listings. Additionally, since paying a listing fee does not guarantee that the item is sold, the marketplace will have a harder time proving that it provides actual value to its providers.
4. Lead fee
Lead fees are somewhere between the listing fee and the commission models. In a typical lead fee model, customers post requests on the site, and providers pay in order to make a bid for these customers. The model gives a better value proposition than the listing fee model: you only pay when you are put in touch with a potential customer.
The lead fee model only works if the value of the lead is high. For this reason, this model is not common in C2C marketplaces. A typical use case is B2C or B2B services, where each new lead can lead to a long-lasting customer relationship with multiple deals. A recent well-performing example of this model is Thumbtack, a B2C marketplace for all kinds of local professional services, from plumbers to guitar teachers. The fast-growing startup was recently valued at more than $1 billion.
However, while Thumbtack has been doing well with the lead fee model so far, their problem is that the providers no longer use Thumbtack with existing customers—instead, they build the relationship outside the platform once they have the lead. This is why Thumbtack is currently building invoicing, payment and scheduling tools for professionals. They’re likely moving towards the commission model to extract more value from the transactions they help facilitate.
How can you monetize a marketplace where people share low-value items for free? The Dutch startup Peerby has built a C2C platform where people can borrow things from each other at no cost. The basic experience is free for all the users of the platform. Peerby has decided to monetize by offering premium services. They have two main offerings: insurance (the provider can request that the customer, while getting the item for free, pays an insurance fee that guarantees the item will be replaced if it is damaged or stolen) and delivery (the customer can pay a small fee to get the item delivered to their door instead of having to go pick it up from the provider).
The logic behind the freemium model is that the core offering is free, but after you get your users hooked, you offer paid value-adding features. The challenge with this model is that these paid services need to provide enough value to be tempting to a good portion of your users. If only 1% of your users are interested in your premium offering and everyone else uses your site for free, it’s probably not enough for a sustainable business model. Coming up with a premium service that is interesting for a wide enough audience can be very tricky. Because of this, many platforms use premium services as additional revenue streams. For example, Mascus offers premium web page services to its customers to complement its listing fee based business model. Etsy complements its transaction and listing fee based model by offering premium services like direct checkout, listing promotion and shipping labels to its power sellers, and has recently seen strong growth from this revenue stream.
In some cases, a marketplace can start offering premium services as an add-on, but eventually shift its entire business model to focus on the paid services. Vayable started as a pure peer-to-peer marketplace where individual people offer unique experiences to others, but after failing to get enough traction, decided to pivot to build a concierge service for custom vacations. The downside of this approach is that premium services are often be a less scalable option when compared to the pure commission model. This is often due to the amount of staff that is required to provide the premium services. Vayable only made the shift because they were not able to get the commission model working well enough.
6. Featured listings and ads
Featured listings are a way for providers to buy more visibility for their offerings. If this model is used, listing on the site is typically free, but providers can pay to have their listing be featured on the homepage of the site, or at the top of a certain category. An example of this model is Gumtree, UK’s most popular classified ads website. Etsy provides featured listings as one of its premium services.
This model is relatively close to pure advertising models—ones where you show ads (such as Google AdSense) to your users. Featured listings and ads are both popular revenue streams for classified ad sites. They are often seen on real estate marketplaces (like Zillow) or free sharing marketplaces (like Freecycle).
The challenge with these models is that, again, they require a significant amount of users to generate meaningful revenue. When you’re in the business of selling eyeballs, the revenue you generate per user is likely a lot less than if you can extract value from your transaction process. Moreover, when you’re placing ads on your site, you’re serving two audiences with conflicting interests: from a user experience point of view, ads are almost always a hindrance, and your users would generally be happier without ads. If you want to offer the best possible experience for your users, this business model is not your best option.
Ad-based models work best when you have a really specific niche, and there are commercial providers that are interested in tailoring their offering for that specific audience. For instance, Häätori, a Finnish wedding marketplace for used wedding dresses, lets individuals use the site for free. They monetize by allowing wedding planners, photographers and other providers of wedding-related services to buy ads on the site. The content of these ads is very relevant for the users of the website, making them more relevant and less annoying.
Putting it all together
Modern marketplaces employ many different business models. In general, the best option for most marketplaces is to “own the transaction” and charge a commission from all purchases made through the site. This approach is very scalable and oftentimes quite lucrative.
However, in some cases, the commission model does not make sense, so alternative models are needed. Trying out multiple business models to find the best option for your concept might be a good idea. In the beginning, you should have only one revenue stream in use at a time to avoid diverting your focus. Eventually, when your site grows, it might make sense to combine several revenue streams to build a marketplace business model that takes into account everything that is happening on your site.
ARTICLE BY:Juho Makkonen
He is a Co-Founder of Sharetribe and currently serves as the CEO of the company.