We are often asked what we look for when evaluating marketplaces. Typically, we list out five main factors:

1. High fragmentation: a lot of suppliers and buyers
2. A “playing the field” relationship between buyer and seller, as opposed to monogamy where the seller doesn’t have any need to visit the marketplace after the first time
3. High frequency: buyers need to use the service often
4. Total Available Market (TAM)
5. Transactional: if the marketplace can be part of the payment flow

We discuss all five in the first chapter of our Guide to Marketplaces, and many are based on Bill Gurley’s great post: “All Markets Are Not Created Equal: 10 Factors To Consider When Evaluating Digital Marketplaces.”

Recently, we have been thinking a lot about the new value that is created from marketplaces. And so, we’re adding a sixth factor to our list of criteria:  the ability to expand the overall market and create value.  We recognize that Bill addresses this point as well but we’d like to add more colour in this blog post.

Good marketplaces connect supply and demand in a more efficient manner, but great marketplaces create new transactions, and add new value to the entire market.

The value of marketplaces

The Internet created a more connected world and this had an enormous impact on the way goods and services are bought and sold. In the past, search costs for both supply and demand were high because we were limited by our geographical reach and only saw local offline ads for our region. Now, today’s online and mobile marketplaces are able to connect people with products and services from all around the world with a push of a button.

As geographical barriers come down and the cost of search and accessibility nears zero, more sellers are encouraged to join marketplaces since they see a clear, reachable demand for their supply. In this way, marketplaces aren’t just improving the efficiency of connections, they are also increasing the number of participants in the overall marketplace.

To break it down: more liquidity = more transactions = new value for the entire market.

Take Boris’ AbeBooks as an example. Before the Internet, the only way for a booklover to find a rare book was to stumble across it at a local bookstore. But with an online marketplace, local bookstores could go online – and then suddenly, individual book owners could also start putting their rare books online. This unlocked entirely new supply around the world. Without the online marketplace, these individuals never would have sold their books because there was no distribution channel.

Likewise, the sharing economy is a great example of creating value as these markets are effectively new altogether. For instance, people who never thought they’d be landlords or hotel proprietors are now hosts on Airbnb; people who never thought they’d transport people for money are now drivers on Uber. These platforms empower whole new groups of people to become sellers. More sellers = more participation on the platform = more liquidity = more transactions = more overall value.

But wait… don’t all marketplaces create new value?

Virtually all marketplaces create efficiency:  they make it easier for buyers and sellers to find each other and complete a transaction. But, not all marketplaces create value equally. For example, marketplaces may connect schools with substitute teachers, visiting doctors with hospitals, commercial landlords with retailers interested in setting up pop-up shops. These all certainly increase efficiency, but they might not necessarily expand the market.  The likely reason is because there’s finite supply and finite demand.  In other words, a new marketplace won’t create a new crop of teacher or doctors, or school and hospitals.  And in the absence of a new online marketplace, both sides would probably find each other eventually, albeit in an inefficient way (such as Craigslist).

When a marketplace doesn’t naturally create new supply and demand, it’s not likely that there will be more transactions in the overall market. In short, the marketplace’s ability to expand the total available market is limited. This means that the marketplace’s growth potential is limited as well.

As you’re building your marketplace or evaluating potential, think about efficiency and value. You want to create efficiency and bring search and distribution costs down and you also want to tap into new groups of participants, grow the overall number of transactions and increase value. The best marketplaces can do both!