Despite some very noticeable global success stories – some of which have gone beyond household names to become verbs – building a marketplace is a notoriously difficult model to get right. Sometimes that’s as much to do with founders’ attitudes as it is the struggle of starting up such a financially risky prospect.
While no right-minded entrepreneur would pitch a hardware business without mentioning the projected cost of goods sold (COGS) and selling price, for some reason, founders often describe the mechanics and features of their marketplace at length, without ever mentioning how they will actually make money.
We see this a lot.
With heady projections of exponential user growth and a subsequent increase of money flowing through the platform each month, it is easy to lose sight of the importance of the core driver of profitability; the unit economics. That is, how much will it cost to acquire customers, and how much money will be made from them after they sign up?
Measuring and managing the cost of acquisition (CAC) is difficult for a marketplace, especially at an early stage, when both buyers and sellers must be developed in tandem, and before network effects (kick in (dramatically reducing the cost of acquisition).
Measuring and then managing the monetisation of the customer is somewhat easier. From the company’s perspective, the levers that can be used to increase the average revenue per user (ARPU) are simple: more transactions per user, higher value transactions, or an increased share per transaction. Any or all three of these can drive profit.
With the growth of the sharing economy, we see a lot of consumer marketplaces emerging, often seeking to tap into seldom-used assets and match with users that have an intermittent need for these assets. Think power tools or lawnmowers.
It is absolutely critical that founders of these companies are thinking of the unit economics. For instance, if the asset is of relatively low value, like a lawnmower, what impact does that have on the unit economics? What is that transaction value likely to be, given it might only be required for 30 minutes?
The beauty of modern tech businesses is that no problem is insurmountable and no business model is impossible
Likewise, what about
the CAC? If the need is intermittent, how cost-effectively can you
capture the demand side within a narrow window of need? How many
owners will really think the money is worth the effort?
If it’s a higher value transaction (or asset) like Airbnb (or Outdoorsy, which recently raised $25 million), the frequency with which the demand side users make a purchase can be lower. If it’s a low value transaction like Deliveroo, the frequency needs to be higher, unless of course you have a really low acquisition cost like Amazon.
Outdoorsy’s significant investment round is not an outlier, it’s a necessity. Building marketplace businesses, even as successful as Outdoorsy, needs significant capital early on to help drive customer acquisition, long before the potential profit from their trading on the platform can fully take hold.
We invested in HousemyDog in 2016, market place for dog sitters. While this sounds like a cute business, the numbers this company is hitting prove it is anything but a pet project. From the outset Timothy and James have been focused on delivering a great service to their dog owners, ensuring the sitters can make money (one of whom has made more than €40,000) and crucially, making sure that the unit economics work from the outset, which is ultimately what makes this type of business sustainable and indeed investable.
The beauty of modern tech businesses is that no problem is insurmountable and no business model is impossible. But problems are only solvable when founders are aware of them and focused on them. So if you are founder pitching a consumer marketplace without being able to speak about your plan to make the unit economics work, then it may mean an early Uber for you.