To build a pricing strategy for your marketplace is not easy. What works for this marketplace might not work for the others. Many people may prefer high rate while others think a very low rate would be effective in attracting a lot of users to site. There’s no right or wrong answer since each marketplace has its own business strategy including pricing structure to remain competitive in the market while still being able to make profit out of it.
Commission fee is the most popular business model whose pricing structure is also complicated to determine. How much should you charge? Should it be a same flat rate for every transaction or the percentage of the total sum? Who will pay the bill? The buyers, the sellers, or both? There’s no correct formula for this but we will discuss important aspects to help you decide the pricing for your marketplace.
In the series:
- An overview of online marketplace and its challenges
- Determine marketplace business models for your business
- How to make commission model work for your online marketplace
The market and competition
The market your business is operating in has certain impact on your marketplace pricing strategy. There are 2 main factors to consider: the competition within the market and how your competitors are doing.
Are you choosing the horizontal or vertical market? While the former offers products and services in a wider range of industries, the latter focuses on a single niche. Going either way, chances are you’ll face with a lot of competition. However, choosing the vertical market would reduce much competition if you could discover a niche that not many people step onto. With great power of negotiation due to small to no competitors, high commission fee is more likely to get accepted.
But, the truth is there’s hardly any potential niche that you could remain the only provider for a long time. Sooner or later, the others will jump in and you’ll have to share a piece of the market. Therefore, competition is avoidable and a competitive pricing structure is more preferred. Once other marketplaces like yours exist, users have more choices. The buyers would go to different marketplaces and compare their products and services before making purchase decision. Similarly, the providers wouldn’t only sell on your site but on others as well. For these providers, competitive pricing is one of the most important factors to keep them selling on your site.
What others are doing
No single strategy can work for all marketplaces but observing what others are doing with their pricing is a good idea to have a big picture of your niche. Doing some quick research, you’ll notice 20% commission fee is often recommended. Is it the optimal rate? Let’s analyze some modern marketplaces.
Below is the table comparing commission rate of some big modern marketplaces.
On the other hand, the general rate of product marketplaces is a bit lower than service marketplace, partly due to additional shipping fee involved which makes total marketplace fee increase significantly. Particularly, Etsy is the most generous player when taking only 3.5% cut, while both Amazon and eBay applies different charges for different product categories. The rental marketplace – Airbnb charges both hosts and guests, with 3-5% and 6-12% respectively.
Apparently, each marketplace has its own commission structure from simple to very complicated, and there’s no certain rate that ensures your success. In service marketplace, 20% seems to be preferred. However, for a new platform, the most important goal is to get as many users to your site as possible, so 20% might sound a bit high and not attractive comparing to other competitors.
To bring providers from other channels to yours, commission rate should be lower to a point that you’re still able to make a profit out of it. Having helped thousands of customers build up their freelance service marketplaces, our advice would be 10%. It’s a reasonable number, not too high for providers, and not too low for you. Don’t rely all profit on commission fee, you can always develop pricing strategy for your marketplace with other fees to earn more.
Amazon and eBay have designed a complex commission structure due to their diversity in product range. Transactions with higher value enjoy lower commission and vice versa. On Amazon, 15% is the rate applied for most categories, the lowest rate 6% is for personal computers – luxury goods, whereas 45% is cut from each Amazon device accessories sale. The difference lies in transaction total size.
Why does Amazon need to create distinct charge rates? This can be explained in 2 main points:
- User’s expectation:
- People usually think the work amount to process an $1000 order is not much different from the $100. So, instead of taking away 15% (for example) of $1000, your users expect a lower percentage which equals the amount cut from $100 transaction.
- It’s easier to charge a high rate on low-valued items. Let’s compare 20% of $500 and of $5, which is $100 and $1 respectively. $100 deducted from $500 is really painful, not to mention other fees the providers have to bear. On the other hand, 20% of $5 doesn’t feel that big so this commission rate is easier to get accepted. That’s why Fiverr, whose concept is to offer services starting from $5, has been successful with the rate of 20%.
- The demand for each product/service is not the same. For instance, fast-moving consumer goods (FMCG), such as soft drinks, toiletries, snacks, cosmetics, and other low cost items are sold quite quickly and purchased again and again in a short time. On the flip side, expensive goods and services require thorough research before users make purchase decision, which makes its sales are not as high as those of low cost products/services. When comparing these two types of products and services, providers with low priced items can generate revenue on a more frequent basis, so the more they earn, the more likely they are to accept high commission rate.
The key takeaway is: low commission for high-valued items, and higher commission for low cost products/services. If your marketplace offers products/services ranging from low to high cost, applies a diverse pricing strategy. On the other hand, if you focus on a narrow niche catering to a specific product/service, consider a single rate structure.
Total marketplace size
Most marketplaces operate with more than 1 business model. A successful marketplace is the one that can effectively combine different models together which also means the revenue would come from multiple sources, not just depending on 1 method. In a platform where commission is utilized as the main model, listing fee, freemium or lead fee models are often used as well. What does this have to do with the pricing? The business model mixture will substantially add up the total marketplace fee per transaction to a higher level than the commission fee itself. Therefore, it’s advisable to consider the total payment as a whole when designing commission structure. Let’s compare fees paid by users in several marketplaces. SaleCalc.com is pretty a useful tool to help us have a rough estimation of marketplace fees, as well as profit desired when selling on Amazon, eBay, Etsy, etc.
#3: eBay UK
Though this isn’t 100% accurate calculation, it does give us a great insight into the total fee amount deducted per sale. Not only commission but also other fees are to be taken into consideration when designing marketplace pricing strategy. 3 marketplaces from above examples keep their total fee under 20% (including payment processing fee), especially Etsy under 10%.
What if the total fee per transaction is too high? When looking at how much is earned from each sale, the seller would notice the revenue they actually get and the final amount of fee subtracted, not just the commission. And of course, no one is happy with a too high cost, especially when the majority of products and services traded on your site are low-valued items. Remember your competitors are always ready to steal providers from your site by offering attractive low selling rate. As long as the fee seems reasonable compared to income level, sellers will continue to stay on your marketplace.
The level of marginal cost is another important factor to consider when making pricing strategy. By definition, marginal cost is the change in total cost that comes from making or producing one additional item. When there’s a new order for a product/service, how much is the additional cost? How does it affect the net profit a provider can earn?
You can’t take high commission from products/services having high marginal cost since the net profit left for providers is not much. On Etsy – a marketplace trading handmade and vintage items, the general marginal cost is quite high since most items are not mass produced but handmade which requires greater effort and time to create. For example, a provider on Etsy receives a new order for 1 Custom Toddler T Shirt. To complete this order, the provider needs to buy necessary materials like a T Shirt, paint brushes, watercolors, then design the T Shirt, pack the item and ship it to the buyer. You may wonder why providers don’t increase the sale price to enjoy higher profit. Remember that the competition is fierce, while one offers high price, the others are always there giving much lower price. Hence, although the marginal cost is high, sale price can’t always go big.
Marketplaces for stock photos, however, show a total contrast. The providers just make the initial effort to produce the original photo, which is worth the money. However, from the second purchase onwards, the marginal cost is almost zero. Just copy and paste the file and send it to customers. In this case, it’s reasonable for you to take a large portion from each sale. Shutterstock, for example, charges 70-80% fee per transaction.
In any marketplaces, there are always top sellers and those who only make several sales a year. We shouldn’t treat these 2 types of providers the same as their income differs from each other. In terms of commission fee, it doesn’t necessarily mean low charge for underperforming sellers since there are other approaches available.
Before that, I’d like to explain how provider differentiation benefits your marketplace. Having a distinct, special treatment for top sellers is a useful way to retain them on your site. Competition is severe, if you don’t find way to keep these sellers, sooner or later they will leave you to settle down with your competitors. On the flip side, you can’t just care for top sellers. Everyone once starts as a newcomer making very few sales. Creating offers for these people helps attract new users to your site, which is utterly needed for a new marketplace.
The first approach to retain successful sellers is to reduce commission fee as sales go up. Doing this way, you will encourage providers to sell more, which in turn increases your commission revenue. Or, instead of cutting down on commission rate, you can award special benefits to people who make impressive sales, such as multiple promotional offers, instant withdrawal, cheaper shipping, featured listings, prioritized support.
The second approach is for people who don’t make many sales: Give them access to all basic features and only charge the basic fee. This platform doesn’t stress the goal of monetizing on new sellers. It just takes necessary fees to facilitate a transaction (commission, listing fee, payment processing fee) and offers everything else as paid services for big sellers. Attracting new small sellers to site with affordable fee while emphasizing the monetization on big sellers, Etsy has successfully brought a lot of people to its craft platform.
Who pays the commission fee
Who’s going to pay the bill? Providers or customers? In fact, whichever side you charge, it doesn’t make any difference. You still get the commission fee and the rest goes to provider’s pocket. If things are kept that simple and transparent, there’d be no headache about who pays the fee. However, optics do matter and influence people’s behavior.
The simple rule to make decision: Charge the side that gets the most value out of your platform.
As you can see, most product/service marketplaces takes commission from sellers. Why? The competition in this field is severe, buyers will usually make comparison between different marketplaces offering the same items before buying. If they see a line in their invoice stating something like “Service fee”, it’s very likely that they will leave your platform, no matter how little the fee might be. The general feeling would be like: “I spend money, bring revenue to your site, why am I charged other fees besides the item price?”. Not shopping in your marketplace, they still have many other alternatives.
On the other hand, sellers can be multi-homing on many marketplaces but they are the ones that get the most value out of it. Marketplaces are where providers display their products/services, sell to customers and earn money. So it’s fair to charge them an amount for providing a secure selling platform.
If both are getting great value from the platform, charge both. Airbnb – an accommodation sharing marketplace uses this strategy. Both customers and hosts are charged commission fee, at 6-12% and 3-5% respectively. Both sides get good value from each transaction: while hosts earn more revenue for sharing their living space, guests have great experience tasting the local life with local people. With this type of sharing, guests seem to benefit more as other alternatives like hotels don’t give them much sense of local experience, thus, they are the side that is more willing to pay commission to hire an accommodation from the hosts. On the flip side, it’s a bit more difficult to persuade hosts to join the platform since not everyone is open to the idea of sharing their house with total strangers, so the fee taken from this side shouldn’t be high.
Commission is the most popular business model in modern marketplace, but to be successful with it, you need to provide enough value for your users and design an effective pricing strategy. In a service marketplace, sellers are often the side paying commission fee. While 20% is said to be a good rate, there’s no optimal commission rate that can work for all platforms. Consider the market, your competitors, the transaction size, total marketplace fee, marginal cost and provider differentiation to come up with the final rate.