8 strategic hacks for building marketplace liquidity

William Hsu is the co-founder and managing partner of MuckerLab.

Many investors love “disruptive” businesses. This is in part because these businesses are unencumbered by legacy constraints that had previously been hardwired into the companies and industries these startups are trying to disrupt. One such business model is the “online marketplace,” an entirely new business category not possible (at scale) before the Internet.

During the first dot com era, marketplaces were all the rage – with eBay leading the charge. By the end, 99 percent of the B2B marketplaces had cratered and only B2C eBay was left standing and thriving.

The prevailing consensus at the time was that B2B marketplaces were too hard (e.g. it’s really a software business, not liquidity driven) and that B2C marketplaces could not be built under the giant momentum of eBay’s “network effect.” Investment stopped, and entrepreneurs focused on other categories.

It turns out that network effects can be broken — Amazon and StubHub took on eBay in the mid 2000’s. Today, Airbnb, oDesk and multiple second-hand fashion marketplace startups show that there are tons of untapped verticals where horizontal product platform cannot serve properly or where consumer simply prefer a more tailored brand.

Yet, even when e-tail businesses became a hot investment thesis around 18 months or so ago, a significant number of successful VCs continue to hold out from this category. They believe that e-tail does not benefit from increasing return to scale or barrier to entry because of the lack of network effects. The only way many e-commerce verticals can grab the attention of some of the very best VCs is to build a marketplace, not an e-commerce storefront.

However, one of the major problems for many “network effect” driven businesses is the “empty chat room” conundrum. Like a chemical reaction, a certain amount of activation energy, also called liquidity, needs to exist in the value network in order for the virtuous adoption cycle to take place.

With marketplaces, the entrepreneur has to worry not just about building supply and demand but that they also happen to exist simultaneously. As a result, marketplaces are geometrically harder to generate traction. As a rule of thumb, it is 10x harder for a marketplace to generate the first $1M in transactional value than a traditional e-commerce store.

Here are eight common strategies employed by successful marketplaces that can increase your chances of success of building liquidity:

1. Start with aggregating scarce and in-demand inventory

In markets where demand outstrips supply – collectibles, antiques, vintage luxury products – the two-sided marketplace problem can usually be solved by focusing on the business’ supply side part first.

Typically, demand and buyers can be found after supply liquidity has been achieved through a combination of word of mouth and SEO. eBay did a great job by building its initial marketplace around the collectibles category before expanding further.

2. Build “localized” network value

It is essential for marketplaces to focus on creating critical mass in one specific segment of the customer base via marketing and sales. Because users place different network values on others users based on their personal preferences, find a segment of the target market that values each other disproportionately higher than any other segments and concentrate on building critical mass in that segment before moving on to the next. (This is really an extension of Crossing the Chasm for network effects businesses.)

The Beanie Babies craze in the mid to late nineties, for example, essentially jump-started eBay. For many locally focused marketplaces, its significantly more valuable to dominate a single DMA than thinly penetrate multiple DMA’s given the same revenue traction.

3. Siphon off demand and/or supply from another destination

Paypal used a variation of this strategy to build itself under the nose of eBay. Even new companies like Pinterest, Instagram and Snapchat have become destinations where startups are hacking for users, traffic, inventory and demand.

The question is no longer “if” but “where” to go to siphon off demand or supply. In reverse, some companies with critical masses of users, such as Google, Facebook and eBay, have come to realize that “traffic” (which begets supply and demand) is the ultimate currency on the Internet. They have become platforms with enabling structured methods (often as APIs) to allow smaller startups to syphon off inventory or users in exchange for revenue, ad inventory, branding or even more traffic.

4. Leverage influencers for liquidity

One of the most important trends in how traffic is distributed on the Internet is that individuals are increasingly able to manipulate, control, even direct their personal network value no matter the platform in which they built their network. Startups building marketplaces even in closed platforms can recruit influencers who already have built a sizable personal network effect to help sell, purchase, market, and source inventory for their destination.

5. Create “point” product value

This strategy is probably the least understood and under-utilized in consumer driven marketplaces. In essence, the aim is to design marketplaces that have two components to its value proposition – point and network values. The point value is the value proposition for the product independent of the number of people in the network.

Point value is SAAS-like in nature – it allow users be more efficient, more accurate, and more productive. As a result, users are compelled to adopt the solution regardless of marketplace liquidity. The next, albeit, difficult step is to develop coherent synergies between the two components that encourage the usage of the network value once the user begins using the point value feature set.

6. Support series of one-to-many relationships

One way to build marketplaces quickly and effectively is to enable a series of connected but individual storefronts. Start by allowing a major buyer (more prevalent in B2B use cases) to more efficiently purchase from its existing supplier base, or as is more common in B2C, enable a single seller to sell to its existing or new customers.

The objective is to have a seller treat the personalized store as his or her own online presence and actively market it in existing marketing channels (social media, business directories, TV etc.). This strategy is especially effective in taking offline merchants online as they often lack sophisticated technology capabilities.

Furthermore, offline merchants already have captive customer bases to bring online, thus increasing marketplace velocity. Once multiple one-to-many networks are stood up, incremental tweaks to the inventory discovery experience can quickly turn the site into a full-blown marketplace.

7. Backfill with non-transactional listings to augment liquidity

In most marketplaces, demand is non-persistent and perishable, i.e. most people do not need to buy 20 of the same Beanie Baby continuously for the next three months. As a result, demand needs to be continuously generated.

Supply, however, is a different animal. Some supply is perishable such as one-of-a kind collectible baseball card because it’s not available for sale once it’s bought. Some supply is more persistent than others, such as plumbing services or commodity goods.

As a result, it is much easier to create liquidity in marketplaces where supply is persistent. Airbnb is a prime example of this phenomenon, where it only has to acquire the “seller” once and his or her room or house will be available for rent on Airbnb for a persistent period of time.

8. Time shift demand and supply

Many of the current mobile focused marketplaces do an incredible job in time shifting demand or supply so that they can artificially be matched. Based on preferences or expressed user behaviors, these apps would send SMS, app notifications and emails when either a product becomes available for sale or conduct flash auction events for a particular product category to pull supply and demand closer together.

Many successful marketplaces still use a technique called “manually making a market” behind the scenes to create liquidity. Like good commodity traders, they will take a “buy order” and shop it proactively across the market even if there isn’t a matching “sell order” listed in the marketplace to find latent demand or supply.

Many of the hottest scaling marketplace businesses have at least 1/3 of their workforce working the phones to help facilitate transactions. As a result, in the early days of a marketplace, don’t rely on the user to “find it” on your marketplace – use any channel or means possible to generate liquidity. If that means picking up the phone, so be it.

Image credit: oriontrail/Shutterstock