You wake up in the morning and you are rushing to work, you book an Uber and you hope to reach work on time. Few hours later, you are hungry and you are trying to decide what to have for lunch, you order something on Swiggy. It is late in the evening and you are bored, maybe you are planning your next vacation and you are searching for a lovely place to stay on AirBnB.

Within a short span of time online ‘Marketplaces’ have become an integral part of our lives. So much so that for every critical product or service we can think of, there is a marketplace for that.

In a world where technology has brought people closer, online marketplaces serve by becoming the intermediary matching supply and demand. They help users find products or services that are right for them. They help businesses by connecting them to users who are looking for their products or services.

Having interacted with several marketplaces and having spent a good part of my career trying to build one, I couldn’t help but wonder: Is there a formula which makes certain marketplaces tick? Can marketplaces be grouped in some framework that can help us figure out the right strategy for a given type of marketplace? Can there be a way to evaluate the probability of success of a marketplace? Are certain markets more lucrative to build a marketplace?

What is a Marketplace ?

Fundamentally at its core, every marketplace connects a provider of a service or product (Supply) to someone seeking that service or product (Demand). There are several ways of looking at them based on the industry or market they serve, the use case or consumer problem they are trying to solve etc.

But at a very basic level, the problem a marketplace is trying to solve is to help a user (demand) arrive at a decision of purchasing a product or service, while helping the user identify the right solution from a wide spectrum of offerings that the businesses (supply) are willing to offer.

Demand Side of a Marketplace : Let’s Book a Cab…

Let’s try to go through the journey of a user booking a cab to understand in greater depth how the demand side interfaces with the marketplace.

Certain parameters influence decision making…

If a user is trying to book a cab, the decision a user needs to make is : “How to get from point A to point B?”. The parameters influencing the user’s decision could be :

1. Comfort/ Convenience : The level of comfort that is desired during the journey
2. Duration of the trip: The time by which the user expects to reach the destination
3. Cost of the trip

Users decide differently based on context and their inherent importance for different parameters…

Now, based on the use-case or scenario users might assign different weights to the above 3 parameters. If a user needs to attend an important meeting on time, then Duration of the trip might be the most important parameter influencing the decision. If a user is planning a long outstation trip Comfort/Convenience might be the most important parameter. If the user needs a reliable means of commute on a daily basis then the cost per trip might be the most important parameter influencing the decision.

Just like scenarios influence the weights of parameters, personality traits of users also infulence the weights. Some users might value Comfort/Convenience in most scenarios, whereas some users might cosider Cost as the most important parameter irrespective of scenarios.

User Problem at the Core on the Demand Side

Every marketplace is trying to address or solve a fundamental user problem on the demand side. Like

How do I reach from point A to point B?

What dress should I wear/Buy?

What should I eat today?

Where should stay during my next vacation?

Each of these user question/problem is characterized by an independent set of parameters that a user considers before arriving at a decision. Some questions have fewer parameters that a user considers and some are slightly more involved decisions and involve an elaborate decision making process.

Now, for any marketplace trying to tackle one of the above questions, it is important to know how many parameters fall under the consideration set of the users (demand). What parameters do majority of the users consider and what are the top parameters that matter to most users.

They can be identified with the following questions

1. Select all factors you consider when you buy the following product or service
   - Present an exhaustive list of factors and ask the user to select as many factors as they feel is necessary to make the purchase. This would give us a frequency distribution of users on the top factors (parameters) in decision making.
2. State the most important factor while making your decision to buy a particular product or service
   - Ask the user to select the most important factor according to them while making the purchase decision. Only one factor can be selected from the list of factors.

This would highlight the key factors (parameters) that matter to demand

With the help of the above, for every user problem a marketplace is trying to address, we can figure out how many parameters are important and which are the most important ones.

So in the cab example it might turn out that most users consider price and duration of the trip as important parameters while deciding. The marketplace would then have to figure out how best to categorize supply based on these parameters. Also, the information regarding these parameters (time estimate or price) should be clearly communicated to the user so that they can decide faster.

Degrees of Freedom

Demand is usually influenced by the current set of options available in the market and the independent parameters (factors) they consider while deciding is often a derivative of that. Now based on this markets can be classified into

1. Those markets where demand relies on higher number of independent parameters to decide
2. Those markets where demand relies on fewer independent parameters to decide

Let’s call the first type of markets as markets where demand needs higher degrees of freedom to decide, where degrees of freedom represents the number of independent parameters considered by demand before arriving at a decision. The second type of markets are the ones where demand needs lower degrees of freedom to decide.

Lower Degrees of Freedom marketplaces are easier to create but also easier to copy

So let’s say in the example of booking a cab, hypothetically most of the demand is looking at price as the only parameter to arrive at a decision. Then as a company trying to solve that problem, the strategy is to focus on aggregating a vast collection of supply that can transport the demand from point A to Point B in the cheapest possible way.

So in such an (hypothetical) environment offering services like shared rides which effectively reduce the average cost per riding user, but probably increases the duration of the ride per user, is a good strategy. Scaling a uni-dimensional supply fleet with very little selection in terms of type of cabs (for e.g. just hatchbacks, sedans and no SUVs, limos) might help companies acquire users faster, than trying to build a wide range of supply.

Since the demand side is fairly uniform and has minimal factors that influence the purchase, it’s a fairly easier marketplace to create and also an easily replicable model. The company that will eventually win in such a market is one that has developed high operational efficiencies, has managed to scale really fast and can transfer benefits of economies of scale to the demand side.

Note: Such an environment would also need high access to capital as the company will have to survive on very low margins while scaling up.

High Degrees of Freedom marketplaces are tougher to create but also have a natural entry barrier

If the users in the market are more evolved and typically need higher degrees of freedom to arrive at a decision, then it means the marketplace has to solve for multiple parameters on the demand side to effectively acquire users. It also means Demand usually seeks a greater selection / variety of supply and acquiring and maintaining a wide selection of supply might be difficult to start with.

However if the demand is trained to look for high degrees of freedom, then it also means that marketplace would invoke greater brand loyalty from the demand side due to the following reasons

1. Users get trained to interact in a certain way with the marketplace as they are now interacting with multiple parameters. The cost of unlearning existing habits and learning or adopting to a new UX is high
2. Selection of Supply: Demand gets used to a high and diverse selection of supply and it is difficult for such a marketplace to be displaced, unless the substitute also offers a similar wide selection of supply

So in these cases first mover advantage is really high and unless the late entrant has access to a large pool of capital it is very difficult to displace the incumbent.

Booking a stay while travelling is usually a very involved decision as compared to say booking a ride from work to home. Marketplaces such as AirBnB have successfully solved for most parameters: wide selection of hosts and properties, distribution across geographies, trust (by providing insurance to hosts). For any new entrant , the cost of solving for all the above parameters is really high and hence it is harder to find very successful AirBnB clones elsewhere.

Manipulating degrees of Freedom

It is important to note that while marketplaces start with an inherent set of parameters that are important to the demand side, these inherent parameters are derivative of the current solutions that exist for that service/product. Over the lifecycle of the marketplace different strategies can be adopted to increase or decrease the degrees of freedom on the demand side.

Adding Degrees of Freedom

So typically we see a lot of marketplaces solving a low degrees of freedom problem. They then try to add more degrees of freedom by training users to consider new parameters while deciding to make a purchase. Some examples where we see this at play are

Prime Play by Ola: Users are being trained to consider entertainment as an additional parameter while booking a mode of transport.

Swiggy Super: Free Desserts at partner restaurants, special discounts etc which are part of the Super program by Swiggy makes the users think of these two parameters as well before choosing a restaurant to order from.

Zomato Gold: Whether a restaurant supports Zomato Gold or not becomes an important parameter for all Gold Subscribers while booking a table at a restaurant. This becomes an additional parameter while deciding along with existing parameters like : Average Cost of dining, the menu/cuisine, the ambiance etc.

Masking Degrees of Freedom

This is the scenario where marketplaces can increase the perceived importance or relevance of one specific parameter. They can basically invest a lot in solving for one specific parameter and present it as the most important parameter to the user.

Some marketplaces are known to use discounting as a short term parameter to scale, while they focus on building efficiencies on other degrees of freedom demand wants. One such example where a marketplace has used low prices or discounts as a long term strategy can be seen in the case of Wish.

While Amazon, Flipkart and other ecommerce players are slowly trying to move away from discounting by introducing same/ next day delivery, exclusive launch of products, detailed product description and reviews etc. Wish as a platform has a core focus on driving the sales for cheap products which are mostly shipped directly from China. The emphasis on timely delivery etc is non existent as the products can take anywhere between 3–4 weeks to be delivered.

Supply Side of the marketplace: What can your cab driver do for you ?

We started with the example of booking a cab and we went over the parameters that become relevant in a user’s mind while making that decision. Now let’s look at the other side of the equation, “Supply”. Once your cab is booked how can the cab driver control your experience and how does the level or degree of control the driver has on your experience influence the nature of the marketplace.

To start with the cab driver might have to be familiar with using the GPS so that he can arrive accurately at your pick up location. The cab driver can offer to adjust the A/C so that you are comfortable. The cab driver can offer to play some soothing music that you like along the way.

Basically the number of parameters under the cab driver’s control that can influence your experience brings us to the next definition: Degrees of Freedom Supply can offer. This essentially represents the different independent parameters on which supply can customize it’s offering to the demand side.

Higher the Degrees of Freedom Supply can offer, greater will be the impact on personalization available to users (demand) and that would in turn influence retention and brand loyalty of demand.

Scale versus personalisation (Degrees of Freedom Supply can offer)
By definition Degrees of Freedom Supply can offer seems to be inversely correlated to the scale Supply is managing. Your Cab driver is bound to be more accommodating, cheerful and vigilant on the first ride of his day than say his 12th ride of the day after he has spent around 12–14 hours on the road. Likewise a restaurant dishing out 100s of meals in a day is less likely to accommodate your request for low oil on chapatis or less sugar in some fruit juice.

While it might be impractical to go beyond a certain level of personalization as individual supply scales, it is very important to have a good mix of supply at different levels of scale. For e.g. AirBnb has listings from property managers who are managing 10–20 properties and have limited scope to offer personalized experience for their guests ( a stay in such a property could be similar to staying in a hotel). It also has listings where the host has put up a room or a guest house and the host is available to spend time with guests, share stories, double down as a guide for guests etc. The second experience is vastly different from the first and is probably the most sought after when you are visiting a new location.

So while the inverse correlation between scale and personalization can’t be directly fixed. A marketplace can do well to keep unique and differentiated supply also interested. Allowing demand the flexibility to identify and pick such supply (with high personalization) will improve the perception of overall degrees of Freedom Supply is offering.

Note: While prioritizing for scale it is easy to miss this and route most of the demand through supply that scales up fast. In the long run the rare and differentiated supply might eventually churn and make the supply look one dimensional.

Manipulating Degrees of Freedom on the Supply Side

A marketplace can effectively manipulate the Degrees of Freedom on the Supply side by doing the following

Matchmaking : If there are proxies (social cues) available that serve as substitute for greater trust or greater community bonding, those parameters should be used to match supply and demand as there is a high likelihood in such an environment that the supply actually cares about the user on the demand side and would go the extra mile to personalize their offering. For e.g. : Matching supply and demand in the same apartment society can allow more room for personalization as the sellers and buyers are likely to know each other and the seller might be willing to go the extra mile to make the experience better for the buyer.

Branding: A Supplier is more likely to care about the service they offer and will be willing to do just a little extra to keep demand happy if it is their brand value on the line. So having well thought out profiles with detailed information of various accomplishments and branding around the supplier will keep the Supplier motivated and invested in delivering high value and personalization to the Demand side.

Training :Train your supply to think about how in a 5 star world a 6 star service look like , how would a 7-star and a 10-star service look like (borrowed from one of Brian Chesky’s interviews, a 10 star reference for AirBnB has your AirBnB host arriving to pick you up at an airport along with Elon Musk in a Limo :P.) While this sounds hypothetical, it allows supply to push the envelope of thinking around what personalization can be offered to the demand side.

Ideal (Hypothetical) Marketplace: The Unicorn of Unicorns!

Now that we have summarized the nature of Supply and Demand for marketplaces, if there was a hypothetical marketplace that could be called as the ideal marketplace, what would the characteristics of such a marketplace be?

1. Demand wants High Degrees of freedom — most of your demand makes a decision on multiple independent parameters and that allows the marketplace to build a differentiated platform with high barrier to entry and high loyalty on the demand side
2. Supply can offer high Degrees of Personalization — Supply is diverse and there is enough flexibility in the marketplace to allow different levels of differentiated supply to thrive. Supply largely cares about the services offered to users on the demand side and is willing to go the extra mile to deliver personalized experiences
3. High intersection of degrees of freedom- what demand wants, supply can personalize. This means the parameters on which supply can personalize are also the top parameters on which demand decides. This creates a perfect marketplace with high retention on both sides

While different marketplaces might have different starts based on the current user behaviour and based on the practical limits imposed on the nature of supply. The endeavour is to try and replicate the above ideal marketplace. Such a marketplace would truly be the Unicorn of Unicorns!