Leakage is what happens when a buyer and seller agree to circumvent the marketplace and continue transacting outside the platform. The transaction still happens, but the marketplace loses a revenue stream. For example, you’re looking on Airbnb for a place to stay next weekend. After discovering on the checkout page the 100€ fees that Airbnb will charge for your 10 day booking, you might be tempted to contact the host directly and save the money. Earlier we talked about retention in a marketplace in this post. The related phenomenon of marketplace leakage is something we think deserves special attention, as follows:
The structure of a marketplace can lead to marketplace leakage, even when the marketplace is well-managed at an operational level and the benefits are initially obvious for seller and buyer.
Marketplace leakage is a function of two fundamentals:
- value added by the platform.
Repetition of the same unique seller-buyer combination risks marketplace leakage. In the case of high repetition categories (although this is initially a positive characteristic) the risk is increased. Marketplaces such as food delivery platforms mostly avoid this problem intrinsically — usually a customer will not eat from the same restaurant every time. In repetitive ‘high-touch’ transactions between two parties, then there can be strong motivation to strike an agreement outside the platform. For example, in the case of marketplaces for gym classes or beauty appointments, the repetitive nature of the transaction — doing the same gym class once or twice a week with the same instructor — means that the customer is buying the same thing from the same seller over and over again. Equally, if you use BlaBlaCar to make the same journey every weekend with the same driver, then you may be tempted to just message him/her directly. The trust required for transactions such as service-based transactions to take place between the buyer and seller, for example a hairdressing service or pet care service, can mean that once a buyer has found a seller that they trust to provide this service, there can be a natural desire to take the relationship offline and away from the marketplace. Just like online dating, once the buyer has found the right match for their needs, there is no further requirement (and indeed sometimes a negative incentive) to keep the transaction within the walls of the marketplace..
Value creation or value added by the platform is a function of:
- value extracted from supply side
- value extracted from demand side
- value added by the platform
Value extracted from the supply side is essentially the take rate, or rake, of the marketplace. When marketplaces take a large cut of the transaction, usually from the supplier, this might not create enough value for the seller and their motivation to take a transaction offline is stronger. As Sam Madden wrote last year in this article about Homejoy, a cleaner had to hand over 25% of their wages to the company, a rake that was too large for any professional worth their salt. This resulted in Homejoy recruiting lower quality cleaners — ones who couldn’t find a job elsewhere, which in turn caused a reduction in their customer retention.
While marketplaces do not usually monetise the demand side, a marketplace must price so that the buyer is motivated to use the platform. If the marketplace is significantly more expensive for the buyer than the direct alternative, then they may instead use it as a lead-generation or product discovery platform, taking subsequent transactions offline. Sometimes this dynamic drives startups to giving up about retain customers and pivot from one monetising strategy based on take rate, to another based on cost per lead.
Finally, the value added by the platform is the key to keeping people in the marketplace. This can be through improved user experience compared to the direct alternative, through ensuring consistency of quality, through a seamless product discovery process, or other factors. For example, if you want to order food from a restaurant with no website, you may have to place an order, give payment details and co-ordinate delivery to the correct address over the telephone — a tedious task. A good marketplace finesses this process by expediting the transaction though a slick interface, usually in an app that already knows your address and billing details. What is more, a customer can use the same app for another restaurant, circumventing the repetitive task of handing over billing and delivery information, thus incentivising you to return to the platform instead of directly contacting the restaurant. In the case of a very simple order market — e.g. booking a haircut, where just time and name are needed — it is more challenging to add value by reducing friction than it is in a complex ordering process, but it remains possible through creating great user experience or scheduling tools for both sides of the marketplaces, etc.
The value creation for sellers also encompasses opportunity cost, or, a term we’re thinking of using at Samaipata, Fear Of being Kicked Off (FOKO). This is a mechanism that works well for platforms like Airbnb, where suppliers are banned from the platform if they are caught transacting outside of it. This is a strong disincentive because, especially in the case of Airbnb, it has the potential to deprive suppliers of large revenue streams. For marketplaces with lower liquidity or less frequent transactions, this may not constitute the same motivation.
In order to avoid marketplace leakage within high repetition markets and thereby maximise customer life time value (LTV), companies must maintain a laser focus on user experience. The good news is that there are all kinds of ways to generate a great user experience and keep customers coming back. Reducing the friction points within a transaction and saving the time of your customers are just a couple of the focus area to keep users in the marketplace.
At Samaipata, we are always looking for ways to improve. Do not hesitate to send us your thoughts. We strive to partner with early-stage founders and to support them in taking their business to the next level. Check out more ways in which we can help here or for all our other content here
And as always, if you’re a European digital business founder looking for Seed funding, please send us your deck here or subscribe to our Quarterly updates here.