What are marketplace business models and why do they matter? Business models define how your business operates and generates revenue from its products and services. A scalable model is important to help your business achieve sustainability in the long run. In fact, there are many types of marketplace business model, each of which has its own pros and cons. So it is essential to find out and apply the most suitable model for your site.
In the series:
An overview of online marketplace and its challenges
Commission model works by extracting a charge fee from each transaction. Specifically, when a consumer pays the provider for a product on your marketplace, a part of that payment will be taken as commission fee. This is the most common business model deployed by modern marketplaces. To achieve success with commission model, there are two key points to take into account:
- Transaction value: This is an advantage but also a challenge at the same time. First, users – both providers and consumers only get to pay when they receive value from your marketplace. Providers will pay commission fee only when they get orders from customers, which means they only pay when they earn. Similarly, consumers will pay only when they have found an appropriate provider for product/service they need. Meanwhile, you – the marketplace owner get the most profit by charging commission fee on every transaction made on your site. Apparently, commission model creates great benefits for all participants. Users won’t be charged until they get what they want, and you don’t miss out on any value passing through your site.
However, to provide your users with enough value in each transaction is not simple. The value the providers want is receiving many orders while consumers expect to find the most appropriate provider to get things done. To help providers get orders, a must-have requirement is having many buyers on site, which relates much to chicken-and-egg problem mentioned in the last post. For consumers, to help them find a reliable provider fast and effectively, a complete platform solution with excellent UX and UI is very important.
- Pricing structure: How do you design the commission fee? How big would it be? Who will pay the commission, the providers, the consumers or both? Would it be a same flat fee for every transaction or a percentage rate? To come up with a specific number requires a thorough research into the industry, customer behavior, and your growth strategy. Normally 10% commission fee is preferred but it still depends on many factors. More details about pricing structure will be discussed in the next post.
Commission is the most profitable business model since it takes a portion of every transaction, though it doesn’t mean that this model is ideal for all marketplaces. There are some cases when commission model will not work. For example, commission is only profitable when monetary transactions are the main activity on your marketplace. If your site is not about money exchange, but dating, bartering or hiring instead, then there’s no way for you to charge commission. Another example is when your marketplace includes different types of offerings, both monetary and non-monetary transactions, then it would be difficult to apply commission model as it won’t work for non-monetary transactions. In this case, a different business model or a combination of commission and other models is needed. Moreover, commission model is not for your marketplace if the size of transaction is huge. When high-value transaction is involved like real estate sales, it is complicated to validate the commission fee.
Listing fee is the fee users pay for their listing on your marketplace. For non-monetary transactions, listing fee is one of common marketplace business models. Typical examples include classified and directory websites where no money is transferred but the exchange of information between providers and the audience.
There are two main points to pay attention to in this business model:
- Site traffic: The key reason providers want to list their items on a marketplace is because of its large audience. Instead of creating a website for only their own listings, these providers found out that listing on a marketplace with high traffic will cost less and guarantee much more views for their listings. However, to reach a high level of traffic to your site is a real challenge, which somehow relates to chicken-and-egg problem. Since no one wants to list on a website that only has several views a day, there are a lot to do to attract a great number of visitors to increase visibility for the listings. Therefore, listing fee should not be the only business model on a marketplace but to be combined with other models.
- Cost level: An advantage of listing fee business model is that providers can control the costs. Users are not forced to pay a fixed amount from the beginning, instead, they just pay to list certain items, which is quite flexible. On the other hand, there’s a challenge for marketplace owner if they rely solely on listing fee business model. Unlike commission fee in which providers just pay when a real transaction has taken place, listing fee doesn’t guarantee the items will surely be sold. Because of this uncertainty, the fee can’t be too high, which in turn results in a low revenue stream from this model.
Subscription fee, also known as membership fee, is a recurring fee used to charge the users to have access to your marketplace. You can choose to charge all users or just some (charge providers and make it free for consumers or vice versa).
This model requires users to pay before having any access to your site, so the core value proposition lies in the content of your marketplace. Content mentioned here refers to listed items on your site, which has to be of special value to a group of users that make them willing to pay to join. Specifically, for consumers to pay subscription fee, your marketplace is expected to provide unique, valuable content which is not easy to be found on general sites, whereas providers will pay with a hope of earning more premium customers.
However, the challenge of this model is that it works like an entrance fee which is likely to discourage people from joining your site, especially during the first phase when there are not many users on site. This situation can make chicken-and-egg problem even harder to solve. That said, it’s not impossible to implement this business model on your site. Some strategies can be executed such as making it free or offering discount to be a member to build up a certain user base at first. The fee will be applied later when your site has reached the critical mass.
Lead fee is the model in between listing and commission fee. In this model, customers will post a request, interested providers will pay to bid for that request. We usually call lead fee as bidding fee.
When is this model used? Normally, the purchase process is quite simple: Providers list their items, consumers will shop around, choose and pay for the items they need. However, in lead fee model, it is a bit more complex with one more step in between: Different providers make bid for customers’ requests, the customer will choose one provider to perform the task. In our daily life, you might have heard of auction events in which only luxury items are offered for sale. This is the same for online marketplace. Lead fee model only works its best for items whose value is high and requiring great effort to be completed.
So, how to know for which kind of items that lead fee is the perfect model? The answer is non-standardized products/services, which are the items tailored to a specific need of each customer. While standardized items are usually the products/services that are not so hard to execute and whose demand from each customer doesn’t vary greatly, it takes more time and effort to deal with non-standardized ones, hence, the cost is higher. A good example is Upwork vs Fiverr. Browsing Upwork website, you’ll see a lot of projects posted by different employers, and the requirements for each project are not the same. Freelancers will set bid for the employer and then the employer will decide to choose a freelancer to do the job. On the other hand, providers list their services on Fiverr for as little as $5. These mostly are small simple tasks that customers can quickly choose from for their needs without further adjustments. In short, for standardized tasks, commission model or listing model is potential, while lead fee is favored by marketplaces offering non-standardized items.
Freemium is the mix of free and paid services. The basic idea is providing core service for free for as many customers as possible and offering add-ons for paid customers. Dropbox, a communication platform, gives users 2GB free cloud data storage, but customers have to pay for extra space. Or LinkedIn, a social networking platform, makes it free for anyone who wants to create and maintain a professional profile online. It also offers Premium Subscription which helps users get even more out of LinkedIn. Free accounts can choose to upgrade to premium accounts right away or try it for free for 1 month. Another example is Etsy handmade and vintage marketplace. Freemium model is implemented by premium services catering towards power sellers: promoted listings, direct checkout, shipping labels; and the fact is this approach is working very well for the company and community.
However, not all companies can make big money from freemium like Etsy. For LinkedIn, only a relatively small revenue comes from Premium Subscription service. The challenge of freemium model is that it’s quite hard to scale because premium services need to prove good and valuable enough for a group of customers. This group needs to be big enough to generate high revenue stream for the marketplace. If only 1-2% of the total user base uses paid services, then freemium is not profitable enough to be the main revenue stream. Because of this, freemium is usually used as a supplement to main marketplace business models.
Providers pay to have their listings featured at top of page in order to have more visibility. Usually, newbies with new listings or providers who are offering special deals for their items would want to feature their listings to show them to more users.
Featured listings, however, should not be the main business model since the demand would not be so big and it fails to cover bigger value on site. Moreover, for this model to work profitably, a high traffic to site is of utmost importance as more people on site will increase the visibility of featured items. Because of these reasons, featured listings are often treated as an additional revenue stream besides the main ones.
Ads are a well-known monetizing method online. You would offer some spaces to allow ads to be displayed on your site.
Like featured listing, to generate high revenue from ads, you need to attract a significant number of users to your site. But unlike featured listings, ads do not belong to site contents, so they are not the reasons people visit your site. And customers in general don’t like ads, they are happier without ads.
There are still other better marketplace business models available, so consider to use this option. If ads are allowed on your site, they should be shown in just several positions and shouldn’t be so annoying to the point that makes people don’t want to come back.
Business models determine the revenue streams of your marketplace. Commission fee is the most common one used by marketplace platform since it obtains a portion of all the value passing through your site. For non-monetary transactions, listing fee model is often used. However, a marketplace normally does not operate with any single model but combine a main model with additional ones. Each model has its own advantages and challenges, so the key takeaway is to understand your business and determine the most suitable marketplace business models.
The next post will dig deep into commission business model.
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