How Marketplaces Evolved To Dominate Business
By: Alexej Pikovsky
Tags: Cbd, Marketplaces, E Commerce Solution, Cannabis, SaaS

The marketplace framework is surprisingly simple, yet it is one of the most powerful business models in existence. We only need to think of the most successful companies to have flourished in the last 20 years to begin to appreciate the beauty of the marketplace model: Amazon, Airbnb, Farfetch, Etsy, Uber, Lyft, Fiverr, Alibaba, eBay, and more recently private companies such as Leaflink, The Hut Group, Vinted, Floom, Provi, and Alphagreen.

Looking at the number of billion-dollar companies by sector, there are 22 marketplaces worth more than a billion dollars. The only industry which has more unicorns is the Enterprise Software space according to GP Bullhound’s Titans of Tech 2020 report.

All marketplaces are fundamentally similar. They match demand directly with a source of supply, via a financial transaction. Marketplaces can aggregate suppliers to provide consumers with a centralised place to compare goods and make an informed purchasing decision. For enabling commerce, marketplaces are rewarded with a cut of the profits.

What makes marketplaces so successful?

Marketplaces do more than just marry demand and supply. Their unique traits make them fearsome competitors and long term winners.

We’ve taken deep dives into the most successful marketplaces, analysed their financial statements and investigated their processes. Through our research, we found that there are ultimately six main factors that contribute to a marketplace’s success.

No inventory risk

Although marketplaces supply goods and services, they do not necessarily have to hold or manage these goods physically. Traditional businesses would spend time and resources undergoing product innovation, ordering raw materials, creating an end product, and managing inventory and distribution.

Marketplaces, on the other hand, tend to focus on the end of the supply chain and deal with finished goods. For example, consider takeaway marketplaces such as JustEat and Deliveroo. They don’t store ingredients, cook or clean. Instead, they manage the process of food delivery from the restaurant to the consumer. It’s incredible to see that JustEat’s growth has been continuous and consistent, they were the UK’s leading food website in 2012, and seven years later still grew their revenue by 25%. JustEat continued to reinvest their profits and were unhampered by capital expenditure concerning kitchens, meal creation and inventory.

Holding inventory is cumbersome and expensive, especially if the goods have a short shelf life. Marketplaces shine in this scenario. They de-risk themselves from the chance of having to dispose of the out-of-date stock. Simply put, marketplaces benefit from a reduced fixed cost overhead and in turn, are resistant to economic downturns and favourites in the eyes of investors.

Scalable

Traditional business models are constrained by the raw resources and fulfilment capacity. Consider a cake shop. If they were to see a sudden influx of customers, the majority would have to be turned away. It may take weeks to hire staff, train them to an appropriate standard, and organise delivery vans. By the time the cake shop has the processes in place to meet this demand, potential customers have already found alternative solutions. However, even if the cake shop did manage to increase capacity and serve these new customers, what if they suddenly disappeared? The cake-fad may have ended, or a dessert parlour opened up next door. Now, the cake shop would be left with large overheads and an overstaffed store.

There are only a limited number of business models that can meet abrupt changes in demand without requiring hefty one-time costs and changes to infrastructure. These are scalable businesses. Most scalable enterprises are powered by some form of software application. True tech-enabled marketplaces consist of an advanced technology stack to maintain scalability and deliver a highly personalised service. In the event of an influx in demand, a tech-enabled marketplace creates more supply by striking supplier partnerships and simply uploading more digital stock to their website. In the event of a dramatic decrease in demand, the marketplace doesn’t need to adjust supply reactively.

This scalability has been reflected in marketplace valuations in the last six years, an increase of 4.1x for the marketplace cohort.

Highly cash generative

Sitting in the middle of transactions has worked exceptionally well for banks and payment providers. Stripe closed a $600 million funding round in Q1 2020, valuing itself at $36 billion. They act as a service provider for marketplaces and take a cut of ~3.3%. With some back of the envelope calculations, you can peg their revenue at $3.4 billion. Marketplaces operate under a similar revenue model and can take up to 30% commission fees for facilitating transactions, offering ~10x upside to payment processing companies.

For investors, the commission fee (also called take rate), is incredibly important and is one of the key metrics one should evaluate a digital marketplace by. The more value a marketplace provides, the greater the commission fee it can charge. Hence, over time you would expect a marketplace’s take rate to increase. You can quickly work out a marketplace’s revenue by multiplying their take rate by their Gross Merchandise Value (GMV).

In summary, marketplaces are cash cows. They are highly profitable and generate consistent revenue month on month. Moreover, a marketplace can benefit from supplier terms and ensure a strong balance sheet to fund growth ambitions or weather storms.

While it is important to note that initial investment is required to get to a critical scale, once scale is reached the business benefits from organic growth with very low overheads. A great example is Booking.com which has a very healthy balance sheet and is exceptionally well-positioned, even in times where there are minimal bookings such as the Covid-19 pandemic.

Network effects

Once a marketplace has overcome the initial barrier of bringing suppliers and customers to their shopfront, they can leverage network effects to accelerate growth. In simple terms, network effects exist when a company’s product or service becomes more valuable as usage increases.

Consider Google’s search engine. The more we use it, the more data Google acquires and the better the search results it provides. As an aside, approximately 60% of total online web traffic begins with a Google search — that’s why Alphagreen is investing in SEO.

Network effects can also drive increased traffic and customers to a business. We can consider Booking.com again.

Founded in 1996, they had zero bookings and were only available in one location. After perfecting their host acquisition and customer acquisition funnels (both supply and demand), they were able to kickstart their flywheel. Today, they operate in 147,000 destinations across 229 countries and territories worldwide. They dominate the accommodation and travel industry through the sheer volume of listings which attracts the majority of their customers.

Network effects drive market share, influences pricing power and increases profitability. This is incredibly valuable for marketplaces. The more visible a marketplace, the more it can benefit from the self-feeding flywheel. Network effects are so influential, and they are said to account for 70% of the value created in the technology industry. In fact, network effects drive more than the topline — they provide defensibility. Once the network flywheel has started spinning, it is increasingly difficult to stop. The bigger the marketplace gets, the more resistance to new entrants it gains — just ask Amazon. We highly recommend you read nfx’s commentary on network effects for a more detailed analysis.

Monopolistic pricing

Interestingly, even though marketplaces can create venues of near-perfect competition between suppliers, the marketplace itself possesses monopolistic features.

The most powerful marketplaces have strong pricing power. They can influence commission rates and dictate supplier terms. Consider Etsy, a marketplace that completely dominates the market for handmade or vintage items and craft supplies. They deliver a unique service that is difficult to copy. They see significant traffic to their website and are an integral part of supplier revenue models. In turn, they are rewarded with pricing power over their suppliers. They can push commission rates higher and dictate harsher terms. We recently saw Amazon flex its muscles in early 2020 by dramatically cutting affiliate rates. Outdoor product rates fell by 62%, and health and personal care products fell by 80%. However, influencing pricing is a difficult line to tread. If the terms are too aggressive, suppliers are inclined to list on other marketplaces, opening up the field to competitors.

High barriers to entry

Marketplaces that carry no inventory, build off a scalable infrastructure, generate lots of cash, capitalise on network effects, and take advantage of pricing power are rewarded with an impenetrable moat. They become profitable and defensible companies.

All the features discussed feed into and complement each other. Not holding inventory reduces capital expenditure. This additional cash can be spent on acquiring customers and kickstarting the flywheel. Once a marketplace starts seeing traffic, they can fuel their growth using the cash generated from sales. Increased growth creates a greater demand for their services, and this demand can be easily met by capitalising on a scalable infrastructure.

Over time, a fully-fledged marketplace controls a supply and demand balance which gives them monopolistic pricing power. By this point, a marketplace has consolidated multiple supplier relationships and negotiated lucrative commission fees. They see large amounts of traffic and have built a loyal fan base. For any new entrant, an incumbent marketplace has built high walls and a deep moat.

One significant asset of marketplaces is the diversity and quantity of products and content. Google loves unique content. While it is possible to get a lot of traffic by spending a lot on Paid Google and Facebook, it is not very sustainable. Once a marketplace ranks highly in Google and drives a lot of the organic search traffic, it is challenging for new entrants to come in and compete with the marketplace. Bessemer recently published its investment thesis behind their Fiverr investment almost ten years ago. 100% of Fiverr’s traffic was organic (no ads), allowing them to grow cost-effectively into what is now a £3bn+ business.

Evolution of marketplaces

Digital marketplaces, which first appeared in the 1990s, have dramatically evolved over the last 30 years. They have grown from glorified lists to managed platforms that provide SaaS tools, vet suppliers, and enable instant messaging. We’ve expanded upon a16z’s marketplace observations to account for our research and experience.

Listing marketplaces and unbundled Craigslist era

The first true marketplaces were simple directories, such as the Yellow Pages or Yelp. They serviced demand by providing consumers with options to choose from. However, these marketplaces failed to monetise their audiences and quickly became obsolete as on-demand search engines grew in popularity. They succeeded with the rise of the internet into companies such as Fiverr and TaskRabbit. At their core, they are a 2-sided marketplace. Freelancers can offer their services, and consumers can scroll through lists of options and make their choice. Generally speaking, the services offered are simple and of low difficulty. There is a lot of competition, and suppliers struggle to differentiate their offerings.

One-service marketplace (also known as the Uber era)

The marketplaces of the uber-era realised that the idea of not holding inventory could be extrapolated from physical products to fully-fledged services. Companies such as Lugg, DoorDash, and GlamSquad focused on creating an asset-light business model with low overheads. One-service marketplaces are exciting as they decentralised supply and allowed anyone with the required assets to earn money. However, they do not deliver highly complex services, leaving a significant hole and obvious Achilles heel. Savvy entrepreneurs quickly created copy-cat companies of the likes of Didi, Lyft, Bolt, Ola, Viavan, Kapten, and many more. With a rise in competition, commission fees are dramatically falling, and one-service companies are beginning to lose out on the features that once made them such useful marketplaces.

Managed marketplaces

Managed marketplaces presented an opportunity to increase consumer interaction; something that was missed by titans of the Uber era. The majority of marketplaces that exist today already provide consumers with a portal to discover goods, compare like-for-like products, and communicate with the service providers. Managed marketplaces take this one step further. They take on the hard work of vetting suppliers and constraining supply to deliver high-quality goods and services. This is an operationally expensive task but is highly lucrative. Consumers establish trust with the marketplace and consider them an authority in the industry. In extension, marketplaces offer guarantees and help facilitate customer disputes and refunds to support the consumer experience.

Managed marketplaces represent the leading marketplaces in today’s age. They are making it possible to deliver a complicated and superior service whilst still staying scalable. Sometimes, they have to take an additional risk by investing in supplier services or pre-purchasing goods. For example, we have seen Airbnb provide host protection insurance for every listing. However, in exchange, they can charge a greater commission fee than one-service or listing marketplaces. Luxe is a managed marketplace for drivers. Instead of simplifying providing a marketplace for car parking spots and drivers, they take the extra step to park a driver's car and deliver it at the destination at the required time. TechCrunch does a great job of analysing various managed marketplaces in great detail.

End-to-End Platform

The low hanging fruit has been picked, and most marketplaces for simple goods and services already exist. Globalisation and the advent of e-commerce have allowed for almost any demand to be quickly satisfied but has resulted in an oversupply of undifferentiated competing products.

We predict the next generation of marketplaces will instead focus on complex services and deliver a holistic experience for both suppliers and buyers, leveraging operations all the way to the final sale, a true end-to-end platform.

London’s biggest stock listing since 2017, will be an end-to-end platform called The Hut Group (THG). Having achieved more than £1.1bn in Sales last year, the valuation of this business is speculated to exceed £5bn. Apart from running the beauty marketplace Look Fantastic and myprotein.com, The Hut Group provides technology and logistics services to Nestlé and Procter & Gamble. The so-called THG Ingenuity helps third party brands to scale leveraging the resources and knowledge THG accumulated from running and building its own marketplaces and brands. The Hut Group offers brands the management of online operations, data analytics, logistics, hosting, security, customer service, translation services, creative and marketing, as well as trading & merchandising. These services have been extremely profitable for the business while also providing great value for leading FMCG powerhouses.

Farfetch announced a partnership with Harrods, providing e-commerce management, operations support, international logistics support, and technical support for Harrods. Farfetch went from a marketplace to an end-to-end platform. In the flower industry, an exciting platform is Floom, helping florists with their pain points via its end-to-end technology.

These platforms show how providing value to both the supply and the demand sides of the business makes a lot of sense and enhances the business model exponentially.

On the supplier side, we’ll see marketplaces providing a host of free services and SaaS tools.

This can include free copywriters to optimise product descriptions on the marketplace and free photographers to create unique photo content. A raft of additional services will be provided under a contractual / subscription model which can include consumer behavioural insights, digital marketing services, and product placement opportunities. Brands that use the services benefit from a competitive advantage over their peers. Consumers will choose to purchase products with better content and description. In competition, other brands will also take advantage of these services. The end effect is a high-quality marketplace that is optimised for the consumer and has generated additional revenue through services.

Consumers benefit from all the services that the end-to-end platform delivers to brands. Consumers see standardised, high-quality product images, and detailed product descriptions that aid purchasing decisions. They also benefit from brands that have purchased paid services. These brands have access to valuable data, which they can use to tailor their product offering. The platform will also invest into personalisation techniques to deliver superior customer experience. These will include pre-sales chat function, forums, well researched informational content, manually curated product categories based on consumer needs and after-sales support. End-to-end platforms will likely target both B2B and B2C buyers. We already see the beginning of this with companies such as The Hut Group with its Ingenuity platform, Farfetch with its end-to-end platform for Harrods, and Ocado in the grocery segment. These platforms are providing a host of services for all audiences that can interact with their products.

The end-to-end platform extends beyond the managed marketplace. Instead of just vetting suppliers and providing rudimentary supplier software tools, the platform increases competitiveness and offers superior consumer support through a well-crafted range of services.

The Alphagreen end-to-end platform

Alphagreen provides an end-to-end solution for consumers and brands in CBD and alternative healthcare. We help consumers find wellness-solutions to chronic problems such as insomnia, pain, and anxiety. Our independently commissioned survey shows that only 55% of people believe there is a lack of reliable information on CBD. Consumers are overwhelmed by conflicting information and frustrated by current solutions.

The Alphagreen platform operates a marketplace (B2C and B2B) on the one hand and offers services to brands and businesses on the other hand.

How Alphagreen delivers a holistic experience

Alphagreen delivers a superior shopping experience. We vet top quality brands, onboard them free of charge, we invest in writing detailed information on every product and support their social media presence by generating original and unique content. We don’t charge brands to list on Alphagreen but are very specific about our selection criteria. We deliver additional paid services to brands including digital marketing services, advertising opportunities, and in the future, data analytics to help them grow their audience.

We’ve hired leading experts in CBD and alternative healthcare to deliver a premier consumer experience. Our experts manage our real-time online chat support to support consumers and answer any questions immediately. They create product categories based on consumer needs and collate suitable products to make a smoother customer journey. Finally, our experts dedicate time to research and write highly informative content to support consumer decision making through long-form articles that we deliver through our Academy and Blog.

No inventory risk

Alphagreen operates a dropshipping model to minimise inventory risk. When a customer or business purchases a product from Alphagreen, the brand fulfills the order. We track delivery from brands and liaise with customers to ensure the product meets their expectations.

Scalable

Alphagreen’s marketplace is built on the leading e-commerce infrastructure, Magento 2.3. We’ve taken a scalable approach to building a robust digital infrastructure that can serve B2C and B2B simultaneously. Having developed our tech stack further allows us to take API keys from any other e-commerce technology including Shopify, Woocommerce, BigCommerce, and many more providing a seamless order execution for both, consumers and brands.

Once internal systems and processes have been set up, it is straightforward to scale, both in terms of the brand acquisition, but also in terms of content marketing.

Our data and analytics web-platform is in development and being built in-house to deliver consumer behavioural insights online. All the services we sell are SaaS-based on contractual / subscription revenue models.

Finally, having achieved critical mass in one language, one can start scaling and launching in another language and expand into other countries.

Highly cash generative

Alphagreen receives payment from consumers and pays out the sale price minus any commission. We can maintain a healthy balance sheet and serve our consumers with highly anticipated features.

In addition to the transactional revenue from the marketplace, our revenue streams from services are billed on a recurring basis allowing us to generate cash to support our growth.

Network Effects

We’ve designed our B2B, B2C, and services business model to capitalise on network effects.

Our B2C marketplace is a 2-sided network, balancing supply and demand. Every additional customer represents a potential sale to all the brands on our marketplace. Similarly, every additional product on our marketplace represents a possible purchase to our customers. As we see a greater volume of B2C sales, higher-profile brands are attracted to list on Alphagreen. Subsequently, this attracts an even greater number of customers which feeds the network cycle.

The subtle point to mention is that every additional brand also adds positive value to existing brands on the marketplaces. Although a new brand presents increased competition for existing brands, they also provide an influx of new customers. Therefore, new brands are indirectly beneficial for the supply side of Alphagreen.

We also leverage brand awareness (another network effect) from our B2C marketplace to kickstart our B2B marketplace. This is through publicity and our outreach efforts.

As Alphagreen sees an increase in B2C sales, we’re able to negotiate competitively on B2B wholesale rates. We can quickly hypothesise another network cycle which connects B2B sale volume, with high-profile brands and cheaper wholesale rates. We reward wholesale buyers by providing our ever-increasing B2B and B2C sales data. This will be presented in a dashboard to help wholesale buyers derisk purchasing decisions. The more sales we see, the more informative our customer behavioural analytics tool becomes.

Having solved a lot of pain points on the customer side, we are aiming to help shops to use the diversity and quality of products to buy directly from brands using the Alphagreen platform. The aim is to integrate with Point of Sale systems and provide a seamless experience for shop and restaurant staff.

Our B2B marketplace provides an additional revenue stream but also offers extra connections and nodes to our network, increasing our utility and accelerating our growth.

The network effects and aggregation potential to enter new services is really well illustrated when looking at a recreational Cannabis platform in the US. Leaflink started as a marketplace for dispensaries to buy cannabis from producers, evolved into an inventory and CRM system and recently raised $250 million in credit to provide loans to producers and dispensaries to help them grow in an environment where banks are not easy to deal with. Andreessen Horowitz published a note on how new fintech infrastructure companies make it possible for marketplaces and SaaS businesses to add financial services to their offering and create even more network effects and profitability.

High barriers to entry

We have invested a lot into content and technology, which is very visible, both on our Google search results and with our conversion rates. We work with more than 90 brands right now, and by year-end, there will be far more than 120 brands listed on Alphagreen, all curated and vetted by us. Customers have access to a lot of information: Certificate of Analysis Reports, Why We Love the Product, All Ingredients and How to Take it. We are rolling out many cool features such as Loyalty Points, Gift Cards, Monthly Subscriptions, Personalised Bundles and many more areas how to enhance the Customer Experience and also increase Retention Rates even further.

For brands, we are very simple to engage with. We sync the price, the inventory levels and write up unique content on each of their products after the review of materials and reports. We drive traffic organically and provide a unique growth opportunity for brands. Working with many brands on driving sales, we see how we can help them on other fronts such as their SEO, e-commerce operations, fulfilment, localisation and advertising.

Our combination of being able to generate sales for the brands and help them scale provides us with a strong Moat. With our rapid execution, Alphagreen is taking pole position as the leading global CBD and alternative healthcare platform.

Summary

Alphagreen’s business model was built to be durable and highly successful. We’ve utilised the playbook we’ve seen from e-commerce giants, marketplace titans and recent end-to-end platforms to build a sustainable and fast-growing business. We will deliver complex services and provide an end-to-end experience for both sides of the aisle, supply and demand.

Want to discuss further? Reach out — let’s have a chat.

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A Guide To Marketplaces — 2nd Edition

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