Over the last 4 years as a venture investor, some of the most exciting moments include interactions with entrepreneurs hustling to launch & scale disruptive marketplace businesses. Each of these meetings have fundamentally revolved around two important questions for the entrepreneur – (1) The ‘Chicken & Egg’ problem, which is essentially asking the question – what to onboard first – ‘demand’ side or ‘supply’ side? (2) How to achieve ‘liquidity’ in the marketplace in the shortest period of time? Following is a summary of some of the key learnings from funding and watching closely some of the leading marketplace businesses.

Before we step into the answers, I would take a step back to define certain terms and relate to the importance of these questions.

Marketplace –

marketplaces facilitate dealings between two sets of users (often segregated as ‘demand’ & ‘supply’ side based on their roles in the marketplace) by providing a platform that in turn sets appropriate rules and regulations. The broader aim of these regulations is to reduce gap / friction that have hindered the users’ dealings primarily due to a poor transaction experience – for example lack of trust in transacting online with a stranger which ebay solved for or lack of information to decide which restaurant to go to which Yelp solved for.

Network effect –

the new experience provided by the marketplace results in massive adoption on both, demand & supply, sides. This rapid adoption is then self-perpetuating as both sides value the access to a bigger network of users (read ‘more choice’, ‘higher probability of finding a match’) coupled with the improved transaction experience. This self-perpetuating nature of these platform businesses is called ‘Network effects’.

Liquidity –

It takes time for network effects (the self-perpetuating mechanism) to kick-in as this is a direct function of two things – (1) a threshold population on both sides of the marketplace (2) the number of successful transactions. A marketplace is said to be liquid when it has crossed the critical number on both aspects and the marketplace is in self-perpetuating mode.

With the definitions out of the way, let’s talk a bit about the significance of these questions – as a startup you have limited resources and hence, focusing on certain vital aspects of the business is key to success during this stage – i.e. knowing which side of the marketplace to focus on is crucial (and I believe provides for competitive advantage in the long run). In terms of importance of ‘liquidity’, the first marketplace to achieve liquidity assumes leadership position and is most likely the winner! And hence, it’s important for the entrepreneur how to achieve liquidity much ahead of competition.

(1) The ‘Chicken & Egg’ problem, which is essentially asking the question – what to onboard first ‘demand’ side or ‘supply’ side?

In short – always start with the SUPPLY side (Counterintuitive? – please read on)

In the context of a B2C (business to consumer) marketplace, securing & retaining high quality SUPPLY is key to the success of the marketplace. To take one step further, I would say that the single most important factor that decides the strength of a marketplace is the barrier for the supply side to be present on multiple marketplaces. If the barrier is high, the market will lend itself well to a ‘winner takes all’ scenario, while if the barrier is low, the market will remain fragmented with multiple similar sized players emerging. As an entrepreneur, you want to be in a ‘Winner takes All’ scenario which in simpler terms means a disproportionately high market share for the leader and an obnoxious valuation multiple! (Salivating already…) In order to achieve this, you want to doggedly work towards creating & strengthening the barrier for the supply side to be present on multiple competing marketplaces. So what can you do to nurture supply side loyalty?

(1) Start by building the ‘best in market’ supply side tool

(yes you heard that right! – This might be counterintuitive as most entrepreneurs concentrate on building the best demand side product. However, as I argue below, building the best in market supply side tool is one of the most important factors in ramping up supply, retaining it, attracting demand side and hence, achieving liquidity earlier than competition).

Life on the supply side can be complicated – these businesses are either sitting on product inventory which they need to liquidate for profits and cash, or they are idling with perishable inventory (services businesses) which needs to be put to work. Each aspect of their business has some complexity and given their small size and lack of resources they do not have the hands to manage them all. For example, a travel agent needs to acquire leads, sort them, keep track of the progress on the right ones and finally close them out. Post sales, they need to be able to handle customer trip alteration requests / grievances. In this frenzy, their productivity is compromised and the core value proposition of offering a customized holiday is diluted! Travel Triangle (TT), a leading marketplace for customized leisure travel (Full disclosure – Bessemer is an investor and I a member of the board of directors of the company) built a deep travel agent product which the agents just love (& vouch for) simply because the product does most of their non-core work and hence has a multifold multiplier effect on their productivity. The product enables TT to further understand supply side behavior (at scale) and do a much better job of matching demand and supply and hence, control the customer experience. Uber has a great driver application which enables them to accurately pinpoint the location of the customer while Google offers both advertisers and publishers some of the best in class tools.

Accordingly, key advantages of the a strong supply side tool is as follows –

Supply side takes notice as the supply side product brings much needed credibility for your startup –

the supply side understands that you are serious about this business and are offering something tangible (rather than just a verbal promise) that will have a direct effect on their bottom line. An easy to use, high quality product that solves for their chronic productivity challenge handed over for free is just the right way to kick off this relationship.

Enables rapid scale up on the supply side –

The supply side is often a small world and the word can spread rather quickly! Assuming the product usage patterns for the product are growing to the top right of the chart, you should look to employ a scalable sales model to reach, train and onboard the supply side as quickly as possible. If you are a good negotiator (or just plain lucky) you could buy some exclusivity from the supply side for a period of time in return for the free product.

Improved supplier retention –

Most SMBs are relatively poor adopters of technology. While they can take some time to adopt the product, once trained and used to the product they won’t be ready to switch to a competitor product that easily. Allowing you ample time to upgrade the product or improve business to further strengthen barriers to adopt another platform.

Read it this way –

if you on-board and retain the best quality supply in the market, what option does the demand side have? Also, if you don’t build a supply side product or rather put in a feeble effort, you will actually leave the business open to competition.

In summary, if you have built a rockstar supply side product for your marketplace business, please do give me a shout!

(2) Incentivize supply side (incentives work well, actually work really well, but are a double edged sword)

Look to incentivize the supply side to use the product (A/B test with multiple forms of incentives and understand how long does it take for the product to become a way of life for the suppliers sans the incentives). Any incentive needs to be linked to a contra-incentive and in this case link these incentives to consumer experience (better the experience, higher the incentives and the promise for more business in the future). Publish the results! Make sure the supply side understands the importance and impact of the incentives. Incentives work well (actually work really well!) but is a double-edged sword. It takes little or nothing for competition to replicate/ better the incentive offer. If in such a situation, accept the fact that having deep pockets is the only way to survival and market leadership – raise capital quickly and ensure that you have deep pocketed investors around the table to fight and ward off any competition that replicates your incentive model!

(3) Build consumer experience & brand

This is obvious and a long term goal for your marketplace startup. Consumer is King and a brilliant experience is key for building consumer life time value. In a marketplace model, the consumer experience is dependent on the supply side (pretty much out of control of the platform). Money spent on brand building can only go a certain distance if the quality (& retention) of the supply side is not the best in the industry (which again leads me to the first two points). Finally, curate the marketplace through a strong feedback loop which allows you to cut on poor quality supply. Investing in training the supply side & setting up processes and systems for consumer interaction play an important role in improving consumer experience. In Summary keep the following ‘Marketplace Liquidity Map’ in perspective –

This article originally appeared in Raghav Bahl’s blog at The Networth Effect and is reproduced with permission from the author.

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