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Supply-Side Economics

December 15, 2015

In our introductory post, we laid out the 10 laws of successful marketplaces. We’ve since followed up with three other pieces on the importance of the expanding the Shadow Market, the benefits of boosting the rake, and the advantages of vertically focused marketplaces. We’ve noticed that many marketplace prospects are highly focused on the economics and retention of buyers on their platform, and treat supplier retention as a secondary concern. At Menlo, we encourage our companies not to neglect the supply side, as supplier retention is directly correlated to overall platform quality and NPS.

Best-in-class supplier retention looks significantly different from buyer retention. It’s expected that buyers of a service follow a natural decay curve; after all, few people need to order a handyman or pay for legal services every single month. As we’ve mentioned, consumer businesses with 20% of more of their initial customers returning on a monthly basis are well-positioned for long-term success.

However, for suppliers, it’s reasonable to expect that many are providing services on a consistent basis as a source of income (especially in labor marketplaces). As a result, retention metrics offer us significant insight into the quality of the supplier experience. For example, an independent lawyer who tries UpCounsel had previously used other marketing channels to acquire customers. If UpCounsel is providing lawyers with a superior alternative to their traditional practice, it’s natural to expect that lawyers will shift hours over time to the platform. As a result, best in class marketplaces often see suppliers ramp their hours on the platform after their initial month of activity. When we evaluate labor marketplaces, we are looking for supplier retention curves exceeding 100% and resembling the example chart below.

Strong supplier retention is absolutely essential for any successful marketplace, as it increases the overall quality of the platform by helping to ensure a more consistent experience. Maintaining a stable set of suppliers enhances transparency, as buyers can transact with the experienced operators likely to deliver a high quality service, and avoid those that have been flagged by negative feedback. When marketplaces are forced to continually onboard new suppliers to replace existing ones, inexperienced suppliers are more likely to provide lower quality services. This, in turn, erodes buyer trust, NPS, and retention, and may set off a severe downward spiral. We believe that Homejoy experienced this negative feedback loop, as platform disintermediation caused continual supplier churn that resulted in declining cleaning quality and the eventual collapse of the service.

In addition, it’s important for founders to consider the unit economics of suppliers in addition to buyers. Nearly every marketplace company we meet with has a good understanding of the payback period and LTV of their buyer acquisition efforts. However, few manage to approach their supply acquisition effort with similar rigor, and as a result may be ill-prepared to allocate resources properly as the company enters different phases of growth. Many successful marketplaces describe a variety of “tipping points”, in which management’s focus oscillates between growing the buyer or supplier base in order to maintain a healthy marketplace equilibrium. By understanding the economics of supplier acquisition in advance, companies will be well prepared to achieve balanced growth over the long haul.

When we first met with UpCounsel, we were incredibly impressed by the way in which lawyers flocked to the platform with essentially zero marketing. As a result, the UpCounsel team found themselves in the enviable position of being able to monitor supplier quality without pressure to ramp volume. At Menlo, we believe that long-term, successful marketplaces are driven by supplier retention and growth, and encourage founders to get on board with “supply-side” economics.