Your Complete Guide to Network Effects: Marketplace Business Models
I studied the economics of 35 marketplaces
Marketplaces are a beast. I should know - I tried to start one.
At the heart of any (highly functioning) marketplace you’ll feel the pull of network effects. The more users there are on the product, the more valuable the product becomes. For example, AirBnB’s value depends on the number of properties guests can rent. And it will become a better product (and business model) over time because more people will add more supply. The converse is it’s not valuable at all when there are no good places to stay.
Network effects are a prized competitive moat - there’s an obvious defensibility as you get bigger. You can’t just fast-follow a marketplace business once it picks up steam. While marketplaces are difficult to start, once they get to rippppin’, they actually get cheaper to grow.
Author’s note: It’s important to point out that marketplaces are a flavor of network effects, not the other way around (social media and collaboration tools are also driven by network effects).
Dan Hockenmaier (Thumbtack, Faire) points out this CAC to LTV inversion that takes place. Unlike software, where it gets incrementally harder to acquire new customers and grow them, with a marketplace you are actually acquiring the marginal good fit customer over time. It gets better as it gets bigger.
I studied the business models of 35 marketplaces.
Here’s what you can learn from this analysis:
I. The Economics: How take rates are determined + figuring out who pays
II. Key Insights from Research: Mistakes and unlocks from real companies
III. Ways to Increase Take Rate Overtime: Adding services and differentiating
I. The Economics
Marketplaces monetize through a take rate. If you’re talking the lingo, other common names for this type of middleman compensation include:
Commission
Vig
Rake
This post was originally inspired by a piece that Lenny Rachitsky wrote on choosing a take rate. As a finance and business model nerd, I wanted to expand the data set and go one step further to arrive at an estimated total effective take rate that marketplace businesses achieve.
Why? Well, it’s very common for one side of a marketplace transaction to not even realize that the other side is also being charged, allowing the business to double up or subsidize one side to make it more attractive and increase throughput volume.
Here’s what I found:
