Online Marketplaces

We’re continuing to see tremendous innovation in marketplaces. The first generation of net companies saw a few big horizontal marketplace winners like eBay and Craigslist. But entrepreneurs are continuing to create the next generation of online marketplaces:

…A ton of very interesting net businesses are still being built by hollowing out Craigslist, targeting its key categories and doing a much better job of serving user needs in those categories( e.g., “sublets/temporary”, “vacation rentals”, “rideshare”).

…Mobile is enabling a new generation of “mobile-first” marketplaces that have dramatically superior ease of use, and enable constant grazing of marketplace content throughout the day.

…A specific category of marketplaces enabled by mobile are “people marketplaces” (which I’ve talked about before), where consumers can find highly tailored services and contractors can find opportunity.

…Marketplaces are being applied to new segments. One example is bringing marketplace dynamics to serve the needs of businesses, such as B2B rental of large construction equipment.

And this is just the beginning.

Despite all the new forms these marketplaces are taking today (compared to what I saw at eBay 10-15 years ago), I strongly believe that the same principles for managing them still apply.

Why? It has to do with “perfect competition”. Economics has typically presented this as a largely theoretical construct. But it is something I believe truly exists in the real world, based on my experience working for or with numerous online marketplaces.

Today’s new marketplaces must nurture and manage perfect competition to thrive

But first, what is “perfect competition”? Investopedia defines it as a market structure where the following five key characteristics are met — I’ve illustrated each using the example of eBay:

1. All firms sell an identical product. Not all goods for sale on eBay are identical, obviously. But there are precious few products for sale on eBay that are truly unique, “one-of-a-kind” items. Eventually competition with comparable products would bring marginal returns in line with marginal costs, essentially “competing away” surplus profits in that niche.

2. All firms are price takers. On eBay, every seller is forced to take the prices that buyers are willing to pay for that good. Some sellers could command a premium due to a stronger reputation built over trusted quality transactions, but it’s a small premium.

3. All firms have relatively small market share. With lots of sellers selling across lots of categories, no single seller approached meaningful market share within any single category. No seller on the entire eBay marketplace had anything approaching market power.

4. Buyers have complete information about the product being sold and the prices charged by each firm. The marketplace’s job is to generate transparency for buyers across all meaningful dimensions, including specifications, cost, and trust/safety dimensions for that product. If this is working participants will be fully informed; if it’s not working they will exit over time.

5. The industry is characterized by freedom of entry and exit. With very low barriers to entry (and exit), these marketplaces tend towards equilibrium and force efficiency. Competition in every eBay category was dynamic, but each of those categories gravitated towards equilibrium where marginal revenue equaled marginal costs over time.

The #1 job of anyone who manages a marketplace is to protect, maintain, and enhance these core principles. To achieve this at eBay, we abided by these mantras:

— Maintain a level playing field where every participant has the opportunity to succeed based on his or her individual efforts.

— Maintain complete transparency in the marketplace so that participants (especially buyers but sellers too) had perfect information on products and their pricing.

— Focus heavily on safety so the marketplace is as safe as possible to create the trust required on both sides.

— Promote ever-greater economic empowerment for sellers, and create an efficient structure where marketplace fees were at levels that allow sellers to achieve this. (When I was managing eBay, we estimated that over a million sellers earned part or all of their living on our platform.)

Nothing here should surprise anyone. But it is surprising how few marketplaces truly invest in these principles … and in all of them. [I’ll share how to manage tensions and build this trust in future posts.]

— Jeff Jordan