Instant Gratification and the Power of Right Now
In our introductory post, we laid out the 10 laws of successful marketplaces. We’ve since followed up with four other pieces on the importance of the expanding the Shadow Market, the benefits of boosting the rake, the advantages of vertically focused marketplaces, and the need to focus on suppliers. Fundamentally, we divide marketplaces along four clear lines, vertical versus horizontal, goods-focused versus labor-focused, local versus global, and on-demand versus scheduled. We’ve briefly explained why we generally favor vertical, labor-focused, and local marketplaces. In this post, we will explain why on-demand marketplaces have a distinct advantage in terms of avoiding disintermediation, maintaining pricing power, and boosting acquisition efficiency.
Much like any other business, the odds of a successful booking in a marketplace plummet dramatically the longer that a buyer has to wait. One of the hallways of Uber’s meteoric rise is the on-demand availability of totally homogenous supply. Uber users do not have to select between different options (UberX versus UberXL notwithstanding), and the platform is able to deliver the service with minimal wait times. Contrast this with a service like Thumbtack, where buyers submit their job criteria, and then wait several hours for leads to be returned that vary widely in price, experience, and delivery time. As a result of this wait, a significant portion of users that requested a quote fail to complete the transaction as they either decide to manually find a supplier, or reconsider their purchase decision. This universal trend is evidenced in the chart below, where the odds of qualifying a lead drop by over 6 times if the call is made more than an hour outside of lead creation. We believe that the importance of speed will only continue to grow as customers become more demanding, even three years ago, more than half of U.S. consumers cited slowness as the top reason for abandoning a purchase.
As a natural consequence of on-demand delivery, companies are able to attain greater pricing power. By consistently delivering a quality experience in a timely manner, consumers began to trust the marketplace rather than individual suppliers. As a result, the marketplace is able to dictate rates to both buyers and suppliers in a manner that isn’t possible when consumers have time to rigorously compare options, and suppliers the opportunity to compete on price. In essence, when the platform assumes the curation responsibilities instead of the buyer, it maintains tighter control over pricing, and may earn a long-term premium.
However, despite the long-term benefits of an on-demand structure, companies need to be careful with their gross margins and cash burn while delivering such a service. The nature of on-demand companies is such that marketplaces need to guarantee supply for a period of time in advance of demand, which may result in significant cash outlay. This is why companies like Uber, Lyft, and Didi have raised billions of dollars. For example, many of the on-demand food delivery companies need to pay to have drivers active in newly launched areas so that early customers will have a prompt delivery even before critical mass allows that locale to become profitable. At Menlo, we recommend that companies launch a limited amount of areas at once, and wait for a few to become profitable before launching additional zones. In this way, companies can avoid getting ahead of themselves in the event that scaling runs into issues, and use lessons learned from earlier launches to improve subsequent rollouts. In addition, companies should explore price discrimination within the customer base—by charging customers that want on-demand delivery a premium over those who are able to wait (while still binding the transaction immediately in both cases). This strategy was one of the reasons we were excited to back Munchery in the food space, as they were able to cover the incremental costs in their on-demand service through premium pricing.
Finally, it’s important to note the incredible leverage that a marketplace gets by optimizing the bottom of the funnel. Consider the example below which we believe roughly approximates a conversion funnel for a mobile marketplace.
The very top of the funnel scales relatively linearly with volume, as companies generally approximate a CPI (cost per install), and then allocate marketing budgets to hit growth targets. In fact, as companies continue to grow, this cost often increases as the market saturates, creating decreasing marginal returns for each incremental acquisition dollar spent. However, given the proliferation of mobile apps and the flattening of the number of active apps (which has held steady at ~27 over the past three years), companies will inevitably have some percentage of installs who never register or open the app. It’s very difficult for companies to tweak this number, as they have no way to interact with customers who have yet to provide contact information.
Next, companies can optimize the percentage of users who will actually request a job. While there is room to improve the UX of the app, as well as send well timed follow-ups, the impact of this is likely capped at ~2x. Consider the following chart on follow-ups, which shows that calling six times is 94% better than calling once (which we will use to approximate the impact of follow ups through email/push notifications).
Finally, once a user has submitted a request, the marketplace seeks to convert the maximum amount of these requests to accepted jobs. As we’ve shown earlier, the impact of delivering the service on-demand (within an hour or less) has a massive impact, increasing conversion up to 6x. As you can see from the following table, a marketplace that transitions from a scheduled to an on-demand model can increase their unit economics to a much larger extent than through other optimization strategies. As a result, we are constantly looking for on-demand marketplaces that take a sensible approach to growth now in order to capture massive opportunities in the long-run.