1.

2-SIDED MARKETPLACE

The two sides of a marketplace are buyers and sellers. Successful 2-Sided
Marketplaces like Craigslist are very difficult to disrupt. To break them
apart you must have a better value proposition for both parties
simultaneously, or else nobody moves. Customers are there for the
vendors, and vendors are there for the customers. One won’t leave without
the other.

With a 2-Sided Marketplace, the network is what provides the majority of

the value, not the app or website itself — which explains why marketplaces
products like eBay and Craigslist can afford to look essentially unchanged
after 16 years.Marketplaces come in more shapes than we might think.

Media companies, for example, are essentially 2-Sided Marketplaces.

Audiences (supply) come to the marketplace and sell their attention for
content experiences. Advertisers (demand) on the other side buy the
attention of the audiences. The greater the audience of a media company,
the more likely advertisers will be to spend any money on that media
company at all, and then the more money they will be willing to pay the
company when they do. “Sellers” i.e. readers/viewers have a direct positive
network effect for “buyers”, i.e. advertisers. And vice versa, because (in
theory) more advertising revenue gives a media company the resources to
produce better content.
2. N-SIDED MARKETPLACE

Marketplace participants don’t always fall neatly into two categories.

Often there are multiple participants on one or the other side of the
marketplace that perform different functions.

For example, in a food delivery marketplace, you have one side that is
clearly the supply (restaurants), one that is clearly the demand
(customers). But what about the drivers? They help fulfill the supply, but
they have different incentives and monetization than the restaurants.True
n-sided marketplaces, however, tend to be market networks.

They help coordinate many suppliers/vendors around a complex, multi-

step process (such as wedding planning) using a SaaS workflow tool. For
example, HoneyBook allows a florist, venue, caterer, photographer, and
event planner to coordinate to supply the wedding. In a market network,
transactions happen in a 360-degree pattern like in a network, but with a
transaction in mind.

3. MARKETPLACE NETWORK
EFFECT TYPES

Not all marketplace network effects function the same way.There are
broadly three different types of marketplace nfx. They differ in how
marginal supply-side users on the network impact the value of the
marketplace to demand-side users.For a typical marketplace like eBay,
there is a direct correlation between the amount of supply/ inventory on a
marketplace and the value of that marketplace for demand-side users.
Each new eBay seller adds value to all the eBay shoppers.
By contrast, delayed marketplaces like OpenTable take a long time to get
to a critical mass of supply before the marketplace is very useful for
demand side users at all. If only 1 out of every 100 restaurants in your city
is on OpenTable as a restaurant-goer, the value of OpenTable does not
increase by 100% if that increases to 2 out of 100 restaurants. It’s still
negligible and makes no real difference to you. But when OpenTable
approaches a critical mass of restaurants in your area, it becomes
exponentially more valuable.

Asymptotic marketplaces are the inverse of delayed marketplaces. Uber

and Lyft are prime examples of asymptotic marketplaces, where the
threshold for a critical mass of supply is easily reached, but the added
value of marginal supply after that point quickly reaches diminishing
returns.

4. DISINTERMEDIATION

Disintermediation is a vulnerability that mostly applies to marketplaces

and market networks. It happens when, after initially connecting through
a marketplace or market network product, users take future transactions
off the product and transact directly. This is a significant problem because
retention leading to repeat purchase is the name of the game in most
transactional networks.

To help prevent disintermediation, you can provide tools, reputation,

insurance, compliance, leads and other incentives. There is an extensive
playbook about the many things you can try if your marketplace is
challenged with this problem. Some never overcome it.
5. MULTI-TENANTING

Multi-tenanting is when demand or supply-side users use multiple

competing marketplaces to sell or buy products. It usually happens when
there are low switching costs to listing products or buying them across
different marketplaces. This is fairly common; many people on both sides
of the marketplace often use both Uber and Lyft, both eBay and Craigslist,
both Etsy and Amazon Marketplace.

Multi-tenanting can harm the defensibility of a network and mitigate

network effects, but only up to a point. Ultimately, the bigger network will
win out because it will have a higher profile for potential new customers
and will be more likely to retain existing customers, even if those
customers occasionally multi-tenant. Because the network is bigger, the
number of options will be greater and people will only turn to competing
networks in moments of dissatisfaction or as a supplement for the value
provided by the larger network.

For example, people who use Snap stories may use Instagram stories to
reach a different audience. Usage of one service may serve to reinforce and
increase usage of the other service as people become more habituated to
using both and see greater value from the broad category of “stories”
shared on both.

Customers of eBay or Amazon might look to Etsy specifically for vintage

products, and although this is a case of multi-tenanting, usage of one
reinforces the other because the greater the variety of goods consumers
buy online, the more likely they are to shop online.
6. THE CHICKEN OR EGG PROBLEM
(COLD START PROBLEM)

The “chicken or egg” problem refers to the problem of getting enough

critical mass to trigger a positive feedback loop. If the people on a network
produce the majority of value for other users, how do you get the first
users to join?

This is an especially big problem with 2-Sided Marketplaces (and to a

lesser extent with 2-Sided Platforms) because there are two types of users
— buyers and sellers (or developers and users) — and one needs to be in
place before the other one will have an incentive to join. Kickstarting 2-
sided networks requires giving some sort of initial value to the users on
one side or another, which is independent of the complementary value
that results from the other side of the network being there.

There are at least 19 specific tactics we know of that can help solve this
problem. Several of them involve creating a single-player mode product
that provides value to one side of the marketplace even without a network
in place. Others involve attracting one side of the marketplace with
compensation, such as cash or leads.

7. SUPPLY-SIDE MARKETPLACE

A supply-side marketplace is simply a marketplace where it’s harder to

attract the supply side. Many marketplaces are like this — it is very
difficult to attract the initial supply without any demand, but once a
critical mass of supply is reached, demand comes on its own. Often with
supply-side marketplaces, companies will spend the majority of their paid
user acquisition budget on the supply-side.
8. DEMAND-SIDE MARKETPLACE

A demand-side marketplace is the inverse of a supply-side marketplace.

Owning the distribution is what matters for a demand-side marketplace
because if you have enough demand, the suppliers will join on their own.
Most marketplaces are not “balanced.” One side is much harder than the
other. Which side is harder might change over time, but even that is rare.

9. FINTECH-ENABLED
MARKETPLACE

Fintech-enabled marketplaces are marketplaces with tech-enabled

financial services built directly into the platform. Recently, we’re seeing
marketplaces begin to offer services like:

- Insurance: In-house insurance products made possible by better

underwriting models
- Financing: Non-traditional financing options such as rent-to-own or
income-sharing
- Banking: Novel and customer-specific solutions to manage transactions,
deposits and payments.

AI and data advances are enabling all three of these buckets, because
models for underwriting debt, insurance, and loans are becoming
increasingly powerful thanks to AI and increased data exhaust. A number
of B2B companies have also been popping up which leverage the growing
amount of data available to be sourced or scraped from public sources and
package it together to underwrite risk for their customers.
Leveraging new data sources and AI reduces the cost of underwriting via
automation and improves loss ratios relative to more traditional
underwriting or credit models. As a consequence, insurance and
alternative financing options are becoming cheaper and more broadly
applicable, expanding accessibility and giving rise to new use cases for
debt and insurance that marketplaces can tailor to their specific needs.

10. FRAGMENTATION VS.

CONSOLIDATION /
CONCENTRATION
In any particular market or vertical, the number of players and the
amount of market share owned by the players can differ widely. In winner-
take-most markets, the few biggest incumbents have the majority of
market share and are often highly consolidated. In more commoditized
markets, either the supply or demand might be fragmented into many
different players, each with their own small piece of the pie. For new
marketplaces, fragmentation in a market vertical usually signals
opportunity.

11. LOCK-IN
One of the reasons why 2-Sided Marketplaces are so defensible is because
of the “lock-in” created by cross-side network effects. If you’re a supplier,
you can get locked into a marketplace because there is too much demand
to leave, and vice versa. Neither side can move, once the marketplace nfx
get going, without sacrificing access to the other side.
12. CRITICAL MASS
The critical mass of a network refers to the point at which the value
produced by the network exceeds the value of the product itself and of
competing products. This can happen at different times depending on the
type of a network.

For example, physical direct networks such as telephones gain critical

mass quite early on. As the chairman of AT&T pointed out back in 1908, “a
telephone — without a connection at the other end of the line — is not
even a toy or a scientific instrument. It is one of the most useless things in
the world.” Since one telephone without any connections is utterly
worthless, a telephone network with even two users has sufficient value to
exceed the inherent value of a single product on its own.

Contrast that with a platform network like Windows or iOS. The value of
the Windows operating system, even without any programs or
applications, is quite high on its own. Only after the network of users and
developers has grown quite large does the value of all the third-party
programs, plus the value of the interoperability with other users, exceed
the value (for users) of the Microsoft programs by themselves.

Most products with network effects must ultimately reach critical mass in
order to fully take advantage of the defensibility provided by their
network effects. Before the size of the network reaches critical mass, the
product remains quite vulnerable and may not have much value to users.
For such products, the challenge is often to build enough initial value to
incentivize early adopters to start using the product even before the
network effects value has kicked in.
13. SAME-SIDE NETWORK EFFECTS
Same-side network effects are direct network effects that occur on the
same side of a multi-sided (2-sided or N-sided network). Same-side
network effects refer to the change in value that occurs for users on the
same side with the addition of users on that side.

For example, Uber actually has negative same-side network effects or a

congestion effect. That’s because at any given time, a greater number of
riders means a higher price point or a higher wait time per ride. The same
is true for drivers — more Uber drivers mean more competition for other
drivers.

Same-side network effects can also be positive, however. This is the case
for Windows users, who benefit from the addition of new Windows users
because of file compatibility. Two Windows users can easily share files
amongst themselves, and the number of people you can share files with
grows with the number of people using the same platform.

14. CROSS-SIDE NETWORK EFFECTS

Cross-side network effects refers specifically to the direct increase in value
to users on one side of a network by the addition of users to another side.
Cross-side network effects are direct network effects that arise from
complementary goods or services in a network with more than one side.

So to take the example of Uber yet again, there are large positive cross-side
network effects because each additional driver adds direct value to all the
users on the passenger side (up to a point) and vice versa.
15. RAKE / TAKE RATE
Marketplaces usually monetize by taking a percentage of each transaction
that occurs on the marketplace, known as the take rate or rake. This can
eat into the margins of suppliers on a consumer marketplace or on both
sides of a B2B marketplace, which can be an incentive to disintermediate
the marketplace. Pricing strategy is therefore a key part of the formula in
getting marketplace nfx going.

16. SWITCHING COSTS

Switching costs refer to the costs in time, effort, or money that arise when
you switch from using one product to another incompatible product.
When switching costs are high, it tends to create customer lock-in because
the customer has more of an incentive to stick with the same supplier
throughout their life cycle.

Network effects heighten switching costs. Not only is it costly from a

compatibility perspective to switch products, but when the product has
network effects, switching costs are heightened on a group as well as an
individual level. For example, on a 2-Sided Marketplace like Craigslist,
there are high switching costs for apartment renters as a group, because
unless apartment seekers all move to a new marketplace at the same time
as the renters, it’ll be too prohibitively costly for the owners to leave.
Therefore the two sides of the marketplace lock each other into place.

NFX is an early stage venture firm based in San Francisco that is

transforming how true innovators are funded. As founders ourselves,
we built ten network effect companies with more than $10 Billion in
exits across multiple industries and geographies.