How do service marketplaces make money?

Against the talking power of money, eloquence is of no avail.

Erasmus, Adagia.

Introduction

Even twenty years after their first successes, not everyone understands how these platforms make money. – “It’s just a website, right? Why talk about money?” Because, as always, money talks louder than the rest.

In our article on Platform capitalism, we’ve explained that the sharing economy wave is, in fact, double: the first wave saw the emergence of non-profit sharing platforms, concerned with monetizing underused assets, and with earning additional income in an eco-friendly way. At first, platforms can be non-profit or for profit. Non-profit platforms tend to evolve into marketplaces.

It’s important to stress that marketplaces are, strictly speaking, for-profit platforms. To fit and thrive in a highly competitive environment, marketplaces must develop their own business models. How do they make money? A most intriguing question indeed.

Commissions or membership fees are the most obvious examples that come to mind when you think about platform monetization. Looking closer, though, they’re just the tip of the iceberg. The bulk of the matter lies deep down below. Do entrepreneurs need to elaborate refined pricing and payment strategies to monetize their platforms or is something else at stake?

Platform monetization is complex, and marketplaces constantly imagine new and on the long-term viable revenue models. To become lead players, they must face several challenges, amongst which scaling and pricing. Marketplaces, in fact, haven’t invented new ways of making money. Not really. What they’re inventing, again and again, are ways to retain users on the platform. But that’s for a future article.

First, this article compares marketplaces to traditional businesses in order to highlight the complex ecosystem they create to survive. This allows to set up a marketplace taxonomy using Web 2.0 sophistication as a differentiation criterion. Finally, it will proceed to examine different platform monetization methods.

Marketplaces vs. traditional businesses

Traditional businesses use the two-sided business model. Most marketplaces use the three-sided business model. They don’t create communicate, deliver, and capture value the same way traditional businesses do. While the latter basically sell services to a buyer, marketplaces comprise three or more groups of actors.

Basic distinctive features

How are marketplaces different from traditional businesses?

1. As mentioned earlier, traditional businesses are two-sided, whereas e-commerce marketplaces are three-sided: they need to secure both the provider and the customer sides.
2. Traditional businesses sell goods or services, transferring, in the process, ownership to buyers in exchange for money. Buyers buy the right to use the suppliers’ asset or time for a limited duration, via the marketplace. They don’t become the owners of what they have purchased.
3. Traditional businesses tend to have a more hierarchical structure than marketplaces, more flexible.

Further Comparison

What are marketplaces?

E-commerce services marketplaces aren’t just virtual platforms. They’re businesses creating value. They also highly dependent on the Web 2.0 revolution.

At first glance, each individual firm seems to invent its own platform business model. Classifying digital marketplaces business models isn’t easy. The most common approach is to represent client segmentation (B2B, B2C, and C2C). Another approach consists of studying how platforms create value. The most interesting angle in our view is to schematize the degree of technological sophistication to discriminate between marketplaces types.

Marketplace classification schemes

Figure 1 represents a general marketplace classification scheme by which marketplaces are classified according to the degree of Web 2.0 technological sophistication.

Figure 2 focuses on e-commerce platforms business models.

Marketplace monetization: quick overview

Experts don’t agree on the exact number of revenue streams available to marketplace entrepreneurs. Most use empirical observations. There are basically three revenue models, declinable in various ways:

1. In a commission model, the firm receives a fee for every completed sales transaction. Both can comprise variable and fixed fees.
2. The advertising model builds on fees that are paid for an opportunity to access potential customers by firms that are not direct users of the marketplace.
3. In a subscription model, the firm sells a service contract with recurring fees that is automatically continued.

According to Karl Täuscher, SaaS-enabled marketplaces are part of the subscription model. Services can be an extra revenue scheme when the marketplace proposes non-standardized services.

Marketplace data selling. More rumored than proven, this is currently the newest monetization strategy.

Rochet and Tirole’s analysis of two-sided marketplaces

To understand how marketplaces make money, classic platform literature and related business blogging have provided insights on two-sided platforms in abundance, insisting on the chicken-and-egg analogy.

According to Rochet and Tirole, the theory of two-sided markets is related to the theories of market externalities (that is, charges or fees) and of commoditized services pricing. On the one hand, platforms tend to outsource the services they provide. On the other, if services are interconnected, a change in the price of one service affects the demand for another.

In classic multi-product pricing (and by extension, multi-commoditized service) literature, externalities are not allowed for the consumption of different (commoditized) services. By contrast, the authors argue, the starting point marketplace theory is that, although platforms rely on interaction, individual users do not “empathize” with other users. Benefits others might retrieve from the platform is of no interest to individual users. This is a paradox few have raised indeed.

Rochet and Tirole focus especially on how two-sided platforms charge users. They distinguish, to start with, between usage and membership fees. Usage charges, which are variable, impact the two sides’ willingness to trade. Membership charges, which are fixed, on the other hand, “in turn condition the end-users’ presence on the platform. The matchmaker model is only viable if both end-users do not negotiate off-platform the related usage and membership fees. These offline practices, in fact, constitute one of the reasons why platforms fail.

Pricing is an important part of the scaling process. When a platform starts, the biggest challenge is to a secure critical mass. The authors observe that “managers devote considerable time and resources to figure out which side should bear the pricing burden, and commonly end up making little money on one side […] and recouping their costs on the other side.”

In other words, generating traction and revenues often comes at the cost of charging one side and sparing the other. Of course, for such a strategy to be successful, a delicate balance is necessary for keeping the burdened side interested in using the platform. Entrepreneurs should consider carefully the distinction between price level (the total usage fee charged to both sides of the platform) and the price structure (the allocation of the total price between the buyer and the seller).

Solving the chicken-and-egg problem

Attracting both service providers and customers is hard. This problem is known as the chicken-and-egg problem. One type of end-users (say, customers) will join only if they are sure to find the other type of end-users (say, providers), and vice-versa. What’s the solution?

According to Sangeet Paul Choudary, the solution to this problem requires “to have a bait that can break the vicious circle of no activity.” The chicken-and-egg problem exists before a network reaches a critical mass. The longer a network takes to reach critical mass, the longer it must face the chicken-and-egg problem.

To solve the chicken-and-egg problem, Choudary proposes five solutions:

1. Breaking the vicious circle of no-activity. There’s no secret recipe for breaking into –namely, finding or forcing if need be a starting point– to the conceptual loop at the base of the problem.
2. Attracting positive feedback. Positive feedback emanates from the growing side of the platform. It attracts more of the other side, which, in turn, attracts more of the first side, and so on, Choudary claims.
3. Maximizing overlap. Maximizing the overlap between providers and consumers helps to reach critical mass.
4. Getting the harder side in first. This is the case for asymmetrical markets, as in dating websites.
5. Taking two distinct market on board. The typical user of content and transportation platforms plays only one of the two end-user roles.

Cocolabs’ solution to the chicken-and-egg problem: the “switch platform” functionality

As a service marketplace provider, Cocolabs has developed several successful “switch” platforms, such as Labtoo, a platform connecting labs and companies in need of outsourcing parts of their R&D to the right experts, Yakaygo, an outdoor adventure marketplace.

In a previous article, Cocolabs’ and ESSEC Ph.D. student Nina Schirrmacher analyzed the impact of platform users on the chicken-and-egg problem. She posited that allowing users to switch between sides is an optimal strategy to launch a platform, as users already know the platform.

On some platforms, user sides remain restricted to one side. […]

On other platforms, user sides can act both as producer and consumer. AirBnB and BlaBlaCar are examples of such platforms. Users can switch from one side to the other.

However, since both end-users are likely the same, gaining critical mass takes these platforms more time.

Conclusion

Entrepreneurs looking for advice online will find that there are three marketplace revenue models: commission, subscription, and advertising. For marketplaces to generate positive traction, experts insist on pricing and payment transparency. In practice, researchers can only guess how platforms monetize.

This article has shown how marketplaces differ from traditional businesses. Then, to understand how marketplaces monetized, a general classification scheme, follow by an e-commerce marketplace business model scheme was proposed. The criterion used was the degree of Web 2.0 sophistication. Finally, this piece points out that for their monetization strategies to succeed, marketplaces must solve the chicken-and-egg problem. In that context, Cocolabs’ switch platforms allow for users to become both services providers and consumers.

References

Marketplaces typology

Andreassen, Tor Wallin, et al. Business Model Innovation and Value-Creation: The Triadic Way. 2018, p. 26.

Friedberg, Malcolm. “Understanding Types of Marketplaces — A Mini Taxonomy.” Kahuna, 16 Apr. 2018.

Galston, Ezra. “Anatomy of a Managed Marketplace.” TechCrunch, 2017.

Hedman, Jonas, et al. “Taxonomy of Payments: A Repertory Grid Analysis.” International Journal of Bank Marketing, vol. 35, no. 1, Feb. 2017, pp. 75–96.

Holland, Christopher P., and Manuela Gutiérrez-Leefmans. “A Taxonomy of SME E-Commerce Platforms Derived from a Market-Level Analysis.” International Journal of Electronic Commerce, vol. 22, no. 2, Apr. 2018, pp. 161–201.

Leguillon, Stephen. “The ‘Taxonomy-Driven Marketplace.’” Stephen Leguillon, 18 Sept. 2015.

Rappa, Michael. Business Models on the Web. 2010.

Täuscher, Karl. “Business Models in the Digital Economy: An Empiraical Classification of Digital Marketplaces.” International Management and the Knowledge Economy, 2017.

—. Uncovering the Nature of Platform-Based Business Models: An Empirical Taxonomy. p. 10.

Täuscher, Karl, and Sven M. Laudien. “Understanding Platform Business Models: A Mixed Methods Study of Digital Marketplaces.” European Management Journal, 2017.

Wang, S., and N. P. Archer. “Electronic Marketplace Definition and Classification: Literature Review and Clarifications.” Enterprise Information Systems, vol. 1, no. 1, Feb. 2007, pp. 89–112.

Zheng, Weijun. The Business Models of E-Marketplace. Vol. 6, no. 4, 2006, p. 19.

Marketplace monetization, revenue models and pricing

“5 Types of Ecommerce Business Models That Work Right Now.” Ecommerce CEO, 11 Aug. 2017.

“The MultiMerch Guide to Online Marketplace Monetization.” MultiMerch Marketplace, 28 Mar. 2018.

“Why Structure Is King: The Art Of Proper Pricing In A Marketplace Platform.” Marketplace Platform, 12 Apr. 2018.

Bayerque, Nico. “The Rise of the Three-Sided Marketplace.” Medium, 27 Oct. 2016.

Choi, Hana, and Carl F. Mela. Monetizing Online Marketplaces. p. 64.

Cocoman, Michael, et al. PSD2: Implications for Marketplaces and Platforms. A Stripe guide for navigating th European regulatory changes. Accessed 2 Jan. 2019.

Dholakia, Utpal M. “A Quick Guide to Value-Based Pricing.” Harvard Business Review, Aug. 2016. hbr.org.

Globalluxsoft. “Choosing the Right Business Model for Your Marketplace.” Medium, 20 Mar. 2018.

Gurley, Bill. “A Rake Too Far: Optimal Platform Pricing Strategy.” Above the Crowd, 18 Apr. 2013.

Hagiu, Andrei and Silverstone, Sean. New Research Explores Multi-Sided Markets. 12 Mar. 2006.

Logan, Kate. “Startup Series: How to de-Risk a Two-Sided Marketplace.” Medium, 13 Nov. 2017.

Makkonen, Juho.“How to Set Pricing in Your Marketplace.” Marketplace Academy, 19 Jan. 2016.

Makkonen, Juho. “How to Choose the Right Marketplace Business Model.” Marketplace Academy, 29 Dec. 2015.

Mann, Sarab S., Data Exchange and Marketplace, a New Business Model in Making. Accessed 21 Jan. 2019.

Schirrmacher, Nina. “How Platform Users Impact the the Chicken-and-Egg Problem.” Cocolabs, 14 July 2017.

Sethi, Parth. “Marketplaces and Pricing.” Hacker Noon, 29 Oct. 2017.

Singh, Charanjit. Journeying into the Online Service Marketplace.. Accessed 2 Jan. 2019.

Vdovychenko, Helena. “How to Monetize a B2B Marketplace: Most Popular Revenue Models.” Blog, 17 Oct. 2018.

Wang, Helen H. “How EBay Failed In China.” Forbes, 12 Sept. 2010.

Other

Ammer, Christine. The dictionary of clichés. New York: Skyhorse. 2013

Erasmus, Desiderius. Adagia, 1532.

At Cocolabs we’re working on the standardization of services. We build custom service marketplaces. Each new project is an opportunity to further our reflection and refine our understanding of what is at stake: human interactions, set in a given time and space dimension.Las Vegas, USA: December 25, 2011- A man impersonating Rich Uncle Pennybags, aka as Whiff or more recently as Mr. Monopoly, performs on the Strip (Las Vegas Boulevard). If people give him money, they can be photographed with him.