Back to stories

The Only Metric That Truly Matters for a Marketplace Is the Shadow Market

October 23, 2015

In case you missed it, we laid out our “10 Laws of Successful Marketplaces” in a prior blog post where we described the 10 key factors that characterize many of today’s big marketplace winners. We wanted to expand on some of our thinking in a series of follow-on posts that will allow us to share in more detail the learnings we’ve picked up from our investments in Uber, Getaround, Poshmark, Rover, UpCounsel and several others. We’ll start with what we believe to be the single most important factor for successful marketplaces: shadow market expansion.

Traditionally, marketplaces have been thought of as clearinghouses where buyers can come to more easily find and transact with a variety of sellers. However, at a fundamental level, a marketplace needs to successfully create a “tax” (the fee or take-rate of the marketplace) that sellers are willing to consistently pay. At a minimum, for a marketplace to function properly, suppliers need to consider the platform’s take rate as an important part of the marketing budget. For example, rather than spending money to advertise in the local press, realtors may decide to shift part of their marketing budget to Zillow, where they will hopefully acquire a number of leads that turn into clients.

However, if a marketplace is only acquiring buyers that would already be accessible to a supplier, then the value that flows to the marketplace is capped. Consider that many of the suppliers in today’s marketplaces (Uber drivers, Instacart pickers, etc.) are effectively SMBs, and that the SBA lays out as a “general rule” that these sort of businesses should spend 7-8% of revenues on marketing. As a result, if you are looking at a marketplace that doesn’t expand the size of its core market, you would consider the total market to only be a fraction of total spend, perhaps in the 4% range (as a replacement for part of a marketing budget). Many of us have heard that the market for black cars in the U.S. is $11 billion, and so without the market expanding UberX, Uber certainly wouldn’t be on the meteoric growth path of today.

On the flip side, if a marketplace expands into the “shadow market” (or a class of buyers that was previously unavailable to a supplier), then it has the potential to accrue far more value. Now, rather than looking at a marketplace fee as a tax on existing business, suppliers realize that the overall pie has expanded. We’ve found that suppliers often don’t think about fees, but rather the raw amount of money that they are bringing home. As long as the marketplace increases that net amount (larger overall market outweighs larger fee), the platform is able to extract far more value from the ecosystem. An easy way to think qualitatively about whether a business has the potential for shadow market expansion is to consider whether a buyer might choose the marketplace over an “unpaid” alternative. As we mentioned in our earlier piece, we believed that dog owners were happy to pay for an affordable, quality dog boarding option through Rover rather than burdening their parents with the misbehaving puppy for a third weekend during the summer.

The “shadow market” question is what we’ve been asking ourselves as we examine some of the other emerging marketplace companies. Ultimately, we believe that the success of companies such as Shyp and Instacart come down not to unit economics or city expansion, but whether or not the introduction of the service gets people to ship more packages and shop for groceries more often. If Instacart does not create incremental new business for its retailers (Costco/Whole Foods), its value proposition and take rate is threatened. Similarly, Shyp needs to expand the number of packages people will start shipping through its ease of use. If it does not do that, its ability to maintain its rake is capped. Massive funding rounds, city by city expansion, and unit economics are important metrics, but without shadow market expansion these businesses won’t be breakout winners.