The Evolution of Marketplaces

Over the years, I’ve come to understand that not all marketplaces are created equal. They have undergone significant transformations. As the VP of Marketing at Luxe, an on-demand valet service, I was involved in launching six new markets for a two-sided marketplace connecting valets and drivers. As a co-founder of Pared, a market network focused on hospitality workers and operators, I’ve spearheaded growth and marketing initiatives since inception.

It’s a common misconception to reduce all marketplaces to mere supply and demand dynamics. Initially, marketplaces served as physical venues for transactions (think Wal-Mart or Costco). The advent of the internet shifted these interactions online (like Craigslist, eBay, or Amazon). The rise of smartphones further changed the landscape, enabling individuals to earn through various tasks (e.g., Uber, Lyft, TaskRabbit). Today, we see trained professionals monetizing their skills through market networks (like Pared, Atrium, and Incredible Health). Each of these stages represents a viable business model that can coexist in today’s economy.

The evolution of marketplaces is closely linked to distribution and bridging the information asymmetry gap between supply and demand (a.k.a. lead generation). Technology and innovative business models have fostered greater transparency regarding opportunities. The first evolution transitioned from traditional brick-and-mortar transactions to online exchanges. The second evolution created scalable networks for simple tasks such as grocery shopping or taxi rides. The third evolution enabled transactions traditionally mediated by agencies for skilled labor (like moving companies or childcare). The final evolution is replacing the lead generation roles that professional services brokers typically fulfill, allowing supply sides to retain a greater share of profits.

Having experienced different stages of marketplace evolution, I believe it's valuable to categorize these stages. This post will explore:

1. Differences between two-sided marketplaces and market networks
2. The varying benefits of network effects across marketplaces
3. How different types of inventory can influence marketplace defensibility
4. The significance of repeat transactions and reputation within marketplaces

Marketplaces vs. Market Networks

James Currier, co-founder and partner at NFX Guild, offers profound insights into marketplaces and networks. He has invested in or advised companies like Honeybook, Houzz, and AngelList. Currier coined the term "market network" in a TechCrunch article titled "From Social Networks to Market Networks," defining:

• Marketplaces: Platforms facilitating transactions among multiple buyers and sellers, such as eBay, Etsy, and Uber.
• Networks: Platforms that allow users to create profiles and communicate freely with others, like Facebook and LinkedIn.

What distinguishes market networks is their ability to combine essential elements of both networks and marketplaces while utilizing SaaS workflow software for long-term project focus, beyond mere transactions.

Currier emphasizes that a market network requires SaaS workflow software to promote sustained interactions over fleeting transactions. I would argue that similar effects occur with repeated engagements on marketplace platforms. For example, in cleaning services like Handy or dog-walking platforms like Wag, customers often prefer repeat engagements with trusted providers.

In the context of Pared, for instance, a restaurant may need a cook for several shifts. Various qualified cooks will fill those positions, but a restaurant's reputation plays a crucial role in attracting talent. If cooks receive negative feedback from restaurant operators, their future opportunities could diminish. In a true market network, every participant can offer valuable feedback, enhancing interconnectivity.

Here, the unique identities of participants matter. A strong network effect can drive economic returns based on incremental utility.

Benefits of a Market Network

Over the past decade, we've witnessed an extraordinary rise in marketplaces, backed by substantial investments. Scaling a two-sided local marketplace like Uber or Airbnb is costly and competitive. As markets saturate, customer acquisition costs (CAC) can soar. For example, acquiring a new driver in San Francisco now reportedly costs rideshare companies around $2,000 due to market familiarity.

Conversely, market networks, where existing relationships thrive, often experience organic growth and lower CAC. At Pared, over 50% of our new users come from word-of-mouth referrals. In contrast to generic marketplaces where drivers have no prior community, our professionals have established connections within the hospitality industry.

Network effects flourish in environments where connections exist between participants. Currier articulates the distinction between virality and network effects well: "Virality is about growth; people refer your product to others. Network effects are about retention and defensibility. Once you establish strong network effects, competition becomes challenging."

Marketplaces lacking beneficial network effects face a race for capital to capture market share while striving for positive unit economics. In ridesharing, escalating acquisition costs and driver churn require significant capital to buy time until self-driving vehicles can replace human drivers.

In contrast, market networks capitalize on identity, allowing providers to capture returns for incremental utility. For example, parents on platforms like Trusted are willing to pay a premium for a sitter they’ve previously hired. Such dynamics foster higher returns compared to marketplaces where identity may not matter.

Network Effects

Various marketplaces experience network effects differently, with the timeline for these effects also varying. NYU professor Arun Sundararajan categorizes network effects into five types:

1. Direct (Same-Side) Network Effects: Increased usage directly enhances value.
2. Indirect (Cross-Side) Network Effects: Greater usage drives demand for complementary goods.
3. Two-Sided Network Effects: Usage growth by one user group enhances value for another group.
4. Local Network Effects: Increased usage within a subset benefits connected users.
5. Compatibility and Standards: Adoption of one technology spurs the use of compatible products.

For instance, Instagram benefits from direct network effects as its value increases with more user-generated content. Google showcases indirect network effects, where increased use of G Suite enhances overall value. Uber experiences two-sided network effects, with more riders attracting more drivers.

Pared benefits from multiple types of network effects. As we expand our roles—like bartenders and baristas—we increase value for both operators and professionals. More restaurants and skilled workers attract each other, creating a symbiotic relationship. Local network effects are also evident as we penetrate new markets, with hospitality professionals moving between cities.

Leveraging Existing Networks

Launching a marketplace from scratch is challenging. During my time with Luxe, I learned the intricacies of building a network from the ground up. I helped establish markets in cities like New York and Seattle, where acquiring supply and demand required tailored strategies.

In established markets, brand recognition can ease the process, but in sprawling cities like Los Angeles, achieving similar recognition is challenging. Building a marketplace without an existing network can be daunting and expensive.

In contrast, Pared entered the hospitality sector with established relationships and networks. My co-founder Will Pacio’s background, including connections with top chefs, lends credibility to our endeavors. Social proof and reputation are vital in attracting both talented professionals and reputable restaurant groups.

Starting a marketplace is challenging, but leveraging existing networks facilitates growth. This strategic advantage allows market networks to tap into established relationships, driving down CAC and enhancing customer lifetime value.

Defensibility of Supply

A marketplace's essence lies in its ability to sell products or services through transactions. Most marketplaces evolve from offering a single item to a diverse array, using technology for expansion.

Marketplaces can be categorized by the nature of their inventory:

1. Commoditized: Products or services that are interchangeable, like rideshares.
2. Differentiated: Varied products that meet specific customer needs, like Airbnb.
3. Multi-Faceted: Diverse offerings with multiple dimensions, providing broader value.

Commoditized marketplaces grow rapidly but face challenges due to low barriers to entry. The electric scooter market exemplifies this, with numerous competitors emerging due to minimal differentiation.

Differentiated marketplaces, on the other hand, build loyalty through diverse offerings. Customers are less likely to churn when they rely on a platform for multiple needs. Multi-faceted marketplaces excel by providing varied skills and services, increasing supply value.

Repeat Interactions and Reputation

In commoditized marketplaces like Uber, repeat interactions are rare due to the nature of transactions. Reputation plays a crucial role in skill-based markets, where service providers must maintain quality for ongoing opportunities.

In market networks, repeat transactions lead to greater trust and loyalty. Professionals must perform well to secure future gigs, as reputation directly impacts their earning potential.

Quality verification is vital for skill-based marketplaces. Establishing robust screening processes enhances the likelihood of successful matches, which fosters customer loyalty.

The challenge of disintermediation—when customers bypass the platform to hire directly—poses a risk for market networks. Creating compelling value for both sides is essential to retain users within the platform.