By: Matt Young, Ryley Campbell, Jeana Kerr
The growth of the digital economy has put it on course to account for 25 percent of the entire world economy by 2020, up from 15 percent in 2005, according to recent findings from Accenture’s Digital Economic Value Index. As a result, more companies are turning to platform-based business models to capitalize on the unprecedented opportunities today’s digital economy offers . In fact, the growing influence of the digital economy is largely related to the growth of two-sided market platforms.
In this blog post we will provide a broad overview of two-sided market platforms and provide a guide to successfully creating your own two-sided market platform.
Two-sided markets, also called two-sided networks, have two distinct user groups that each provide the other with beneficial network effects.
Most markets are one-sided in nature: a product is created by a supplier and sold in the market to create value for a customer. In a two-sided market, both parties play a role in creating value. An intermediary brings together these two parties who need each other for the transaction . Two-sided market platforms act as the intermediary between the two distinct user groups referred to as buyers and sellers. These markets have one objective in mind, making life easier for the parties involved.
What comes first: The Chicken or The Egg? Does a platform first need to have lots of customers—the installed base—which provides the incentive for the suppliers to serve those customers? Or does a platform first need to have lots of suppliers to ensure convenient availability for customers? For example, Uber’s chicken or egg question was: should the company attempt to sign on lots of available drivers at the outset, or should the company try to secure lots of riders first? Clearly, both are important, and the proportion of buyers to sellers is an important issue for the marketplace to function properly.
When looking at the growth of two-sided markets and their platforms, one thing that is for certain is that with more users comes more benefits for everyone. Known as a network effect, as more and more people join the platform, users get more and more value. In turn, as more users are on the platform, it provides an incentive to suppliers to join the platform as well, in order to serve the growing user demand. The increasing number of suppliers perpetuates the virtuous cycle, further generating increase value for users and attracting still more.
The Sharing Economy. These two-sided markets are also based on the new market concept, the sharing economy. This is an economic system in which assets or services are shared between private individuals, either for free or for a fee using a platform or the Internet. Some of the most well-known examples of companies capitalizing on the sharing economy include Uber and Airbnb.
These companies offer platforms that align perfectly with the three main objectives of the sharing economy: to reduce customers costs, creatively pool together resources between firms and customers (both B2B as well as B2C), and promote the growth and building of communities.
Steps to Establish a Two-Sided Platform Business
Our research on the rise of two-sided market platforms focused on the case studies on Airbnb, Etsy and Uber. These case studies identified five key steps firms face in starting a two-sided market: 1. Select a business model; 2. Focus on either a vertical or horizontal growth strategy; 3. Recruit quality users (both suppliers and customers); 4. Build credibility with those users; 5. Establish good word-of-mouth effects. The graph below shows these steps. By following the five steps a firm can create a self-sustaining two sided marketplace that benefits users and generates profits.
- Select a business model. The first step in creating a self-sustaining two-sided market is to select a business model that will fit with the objective of the platform. In a traditional one-sided market, the price affects the volume. In a two-sided market, it is the pricing structure rather than the price level that is crucial for the use of the platform: which side(s) of the network will pay for the service . This difference between one-sided and two-sided markets has created a range of different business models. These include familiar business models like pay per service and newer models like free service plus advertising and freemium.
The freemium/membership model is where users get basic features at no cost (free offering) but can access richer functionality for a subscription fee (premium offering). If you’ve networked on LinkedIn, shared files through Dropbox, watched TV shows through Hulu, or searched for a mate on Match, you’ve experienced the model firsthand . Examples of the advertising plus free service business model include Facebook and Google. Facebook, for instance, had more than 1.7 billion monthly active users in September 2016, none of whom paid anything to enjoy its services. Facebook makes money by allowing businesses access to users’ newsfeeds, through advertising and business pages. Google and all its services–from the search engine to Street View, from Translator to Google Scholar– operate in the same way: advertisers pay the cost of making those services available to users . The pay per service business model is based on users performing services for other users. A user from the buyer side of the market will request a certain service. Then, the platform acts as the middleman in the transaction by bringing the two user parties together. The platform then takes a certain percent of the transaction as revenue, while allowing the seller side of its user base to complete the service. Examples of the pay-per-service model include Uber and AirBnB.
- Focus on either a vertical or horizontal growth strategy. In the second step, the business must choose to target either one specific market (a vertical strategy) or a spectrum of markets (a horizonal strategy). By focusing on a growth strategy, the company is better able to create business models that accomodate the types of users they are aiming to please. Because both growth strategies have advantages and disadvantages, the business must weigh those in deciding which one best suits their platform.
A vertical growth strategy for two-sided markets is when the platform is introduced to a specific market through one specific channel. An example of this is Uber. Uber started with premium black cars in a few metropolitan areas. They then expanded to offering more general ride-hailing services to anyone. The advantages of starting a platform vertically include the following:
- It establishes credibility with the market
- Users are likely to adopt future advancements and variations
- Users/customers are not overloaded with information and features
- The company can focus on quality control systems
Some disadvantages include the inability to reach the entire market and allowing competitors to expand on the idea into other vertical markets.
In contrast, a horizontal growth strategy for two-sided markets is introducing the platform to a broad spectrum of markets through multiple channels. An example of this is Craigslist, where different categories of products and services allow anything and everything to be sold on the platform, not just one specific product. More recently, Uber has begun pursuing a more horizontal strategy with UberEats, leveraging their installed base of drivers to deliver food . Advantages of this growth strategy are reaching the entire market in one launch and allowing rapid expansion for the user base. Disadvantages of this strategy are high risk of external factors and unpredictability of the market response.
- Recruit quality users (both suppliers and customers). The third step is to recruit quality users on both sides of the platform. As stated in our overview of two-sided markets, it is important to maintain an appropriate proportion of buyers to sellers, though it can be challenging. In order to ensure this steady recruitment and growth of both sides, the platform must engage with reliable and trustworthy individuals. Businesses can find these individuals by hosting launch events, approaching influencers in the industry, and offering specific services to the potential users.
Host Launch Events. When recruiting quality sellers, businesses can follow in the steps of Airbnb sending a team of employees out to host events and generate excitement around the new industry platform. In the markets they physically visited, teams of two to three people would talk to the few early adopting users already using the platform to get an idea of what they thought of it. Airbnb would also throw parties
and information sessions, set up booths aroundtown, post flyers, and as Rosenfelt said, “do whatever it takes.” They also made a point to get contact information from everyone that showed interest in being a potential seller/host with Airbnb so they could follow up with more information .
Airbnb A/B tested its human launch strategy compared to a strictly social media strategy in reaching new users. Airbnb completed this by randomly selecting half of the market to physically visit and half to target using only Facebook ads. Airbnb kept meticulous track of what it cost to send people to advertise at these locations (including the cost of throwing parties, setting up booths, and other “on the ground” activities) and the listings that resulted, and compared that to the cost of the Facebook ads and resulting listings in the markets they did not physically visit. The conclusion was that the cost per acquisition was five times better for physically sending people into the markets than Facebook-only advertising. Not only did it prove to be more effective, but after kick-starting these markets with a human presence, they grew two times faster by themselves .
Attract Key Influencers. Another effective way to recruit potential sellers is to reach out to the top influencers in the market and have them use the platform first. For example, Etsy bought lunch for and gave “craft show kits” and promotional materials to influential “artists, crafters, and vintage collectors,” in return for using their platform. These were influential, well-established artisans with substantial followings that had the ability to draw buyers to the platform . Hand selecting the first sellers of the platform helps ensure that they are recruiting the best individuals to represent the business and creating an experience that get potential users excited.
Recruiting buyers goes hand-in-hand with selecting the right sellers. This can be achieved by hosting launch parties where individuals are able to see how the platform is used and who is using it. With these personal interactions, buyers get excited to use the platform. When Etsy gained its first sellers by reacing out to key market influencers, Etsy also gained those influencers’ followers as well. Many influencers have a large following of individuals who trust and rely on the influencer for information. By recruiting these influencers, businesses are able to also recruit their established following.
- Build credibility with those users. The fourth step that must be completed is building credibility with the users of the platform. Building credibility requires a trusted network where all users feel that they are benefiting from being a part of the network.
Businesses can learn the best practices of creating a trusted network by following Uber’s transparency tactics. Uber takes pride in the transparency of the company with its their rating system of both the sellers/drivers and the buyers/riders. This transparency also comes from its integration with Google maps, allowing users to see where exactly their driver is and how long it will take for them to reach their location. Uber’s mission was to change the end-to-end customer experience related to the ride-hailing/taxi services by providing easy access to service and transparency through its mobile app; through its mission, it has allowed credibility to be built with its user base .
Not only is transparency and a trusted network important when building credibility with users, but also the services provided for them. To further build credibility with users, platforms need to show a willingness to go above and beyond the basics and provide excellent services for its user base. People want to feel important and know that they are valued, whether as the service provider or customer. Implementing quality services specific to the user demonstrates that the company does care about them. For example, Airbnb launched their photography program in 2010. This program gives hosts the option to schedule a professional photographer to photograph their space to better advertise on the website. With better quality photos, the buyers held more trust in the property and the sellers experienced user care from Airbnb .
- Establish good word-of-mouth effects. The last step in creating a successful two-sided platform is establishing good word of mouth, crucial to the sustainable growth of any platform user base. Creating a community that attracts high quality sellers as the core of the selling-buying experience, in turn, creates goodwill with users who then take it upon themselves to inform other potential users of the platform.
Creating good word of mouth can be challenging for a new platform because of the following reasons: low number of users, lack of quality users, lack of credibility, lack of platform knowledge among users. Solutions for these challenges as previously mentioned are recruiting respected, established users, creating an easy-to-use user interface, and creating a trusted community.
Max Crowley from Uber Chicago explained, “We’ve found that our growth is driven substantially by word of mouth. When someone sees the ease of use, the fact that they press a button on their phone and in less than five minutes a car appears, they inevitably become a brand advocate.” In late 2011, word of mouth generated a new Uber user for every seven Uber rides . This example demonstrates how important positive word of mouth is for a two-sided platform. By creating a user-friendly experience for both sides of the market, the platform has the potential to grow and continue to do so self-sustainably.
Two-sided markets are becoming more prevelant in business. To reach self-sustainability, companies must select the correct business model, choose between a vertical or horizontal growth strategy, recruit quailty users, build credibility, and establish good word of mouth. By following these five steps, companies enhance the odds of launching a successful two-sided platform.
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