Jeff Jordan, General Partner at Andreesen Horowitz presented a talk on marketplace businesses. I summarized the highlights of his talk.
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Marketplaces (many to many) tend towards a single winner and enjoy moats* enabled margins. One to many businesses like retail typically experience perfect competition. Prices get competed down, there are no moats and as a result, there are no margins.
The moats in a marketplace is caused by the network effects. The entire network is more valuable when more people use it. Buyers benefit from more sellers, sellers benefit from more buyers.
When the wheel starts turning, it creates a virtuous cycle and becomes very hard to compete with. It is very challenging to achieve the network effect, but once you achieve it, you gain monopoly.
As explained earlier, marketplaces have margins.
In the graphic above, it is clear that Amazon’s growth margins as a retailer is just around 25%. Their growth margin as a marketplace is around 80–90%.
Some of the best businesses in the world are marketplaces.
Case Study on Failure:
Both Amazon and Yahoo launched auction businesses to compete with Ebay. And both quickly got a lot of supply because they had influence and they had no listing fee. But no consumers went to these platforms. And both businesses abandoned the idea soon. This shows the power of network effect.
This is an example of two massive companies with massive customer bases that failed because they could not generate network effects.
What makes marketplace business model so attractive?
- Typically demonstrates network effects.
- The community does much of the work
- No physical constraints on growth
- Often very capital efficient
*Moats: The term economic moat, popularized by Warren Buffett, refers to a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms. Just like a medieval castle, the moat serves to protect those inside the fortress and their riches from outsiders.
Marketplaces are a superior model for users
- Identity: Seller is building an identity over time.
- Reputation: You can see if they are a reliable trade partner in their past transactions.
- Payments: They enable online payments.
- Trust and safety: Because there is identity, you can track the payments and platform weeds out the bad actors regularly.
- Friction reduction: It reduces friction because you can transact in just one click.
- Transparency: You can see items, seller reputation etc.