How to solve the chicken and egg problem
Reading Time: 14 mins How to solve the marketplace chicken and egg problem By James Virgo Table of Contents A two-sided marketplace has a unique problem to solve. It
The top two sided marketplace business models [2023]
When building a two-sided marketplace, you need to generate revenue.
If you don’t generate revenue, you will eventually run out of money & your marketplace will die.
In our many years of experience building two-sided marketplaces, we have found that the majority of the time a commission based model is the best. This is when you charge a small fee to either the buyer, the seller or both buyers & sellers for transacting on your marketplace.
However, there are cases where the commission based model is unsuitable, so alternative models are needed.
In this article, we list out the top two-sided marketplace business models to generate revenue that actually work. We will look at how each revenue model works & what are the pros & challenges of each. These business models include:
Commission Revenue Model
The commission based revenue model is where the two-sided marketplace charges a fee for each transaction that takes place on their marketplace. It is by far the most popular two-sided marketplace business model.
Commission can be charged to either the buyer, the seller or both. The commission payment will also be either a fixed fee or a percentage of the total transaction.
The commission based model is so popular because it allows both parties (the buyer & the seller) to operate for free. The buyer only pays the seller only if a transaction takes place i.e. when the buyer & the seller both get some value out of the marketplace.
Pros of the Commission Model
Here are some advantages of the commission based model:
Attracts More Suppliers
This model is very attractive because it makes it easier to attract sellers to the marketplace. This is because sellers only pay when items are sold. Therefore, they risk only their time by bringing their business to the marketplace.
Monetize with every transaction
Marketplace owners find the revenue model very lucrative because they will earn a percentage or fixed fee out of every transaction that takes place. As the marketplace scales & the number of transactions increase, marketplace owners can earn more & more revenue.
Challenges of the Commission Model
Even with all of these benefits, there are also challenges to overcome with the commission model.
Marketplace leakage
If your marketplace is not providing enough value, your buyers & sellers will eventually find a way to go around your marketplace & transact outside of the marketplace.
Pricing
Figuring out how much commission you should charge the sellers, the buyers or both is difficult. If you charge too much, you will have high marketplace leakage. If you charge too little, your marketplace may not make enough revenue to survive.
There is no “one size fits all” approach to pricing. A few tricks to figuring out what rates you should charge are to
(1) Start low & find more profitable rates as you go, starting low can also help to keep competition out of the market.
(2) Analyse the competition. There is no way of knowing if your competitors’ commission rates are working for them. However, you can use your competitors commission structure as a starting point for your marketplace.
(3) Consider the transaction size. Physical product marketplaces generally charge a higher commission than service based marketplaces. Generally, low-cost and everyday items are purchased more during a short period. Thus, you can charge a commission at a higher rate on these products.
Low revenue in the early stages
Commission based models only make a lot of revenue when there are a large number of transactions. In the early days when you don’t have many users on your marketplace, there will not be many transactions taking place & therefore you will not have much revenue.
Marketplaces using the Commission Model
Well known companies that use the commission based model effectively include Airbnb, Uber & Upwork.
Airbnb commission model
Airbnb charges a percentage commission on both the host & the guest side of the transaction. The commission percentage will vary, however typically the host is charged 3% & the guest is charged 14.2%. The percentages vary based on predefined criteria. For example, hosts that have strict cancelling policies will be charged more.
Uber commission model
Uber charges 20% – 25% commission of the ride fee. They also charge for add ons such as safe ride fees, booking fees etc.
Upwork commission model
Upwork’s commission model changes regularly. As of September 2023, they were charging a tiered based commission structure of 20% on transactions less than $500, 10% on transactions between $500.01 – $10,000 & 5% on transactions greater than $10.001.
Subscription Revenue Model
The subscription model for marketplaces is when the marketplace charges a regular fee for access to the platform.
The subscription business model is common where the marketplace value proposition is “helping suppliers find new clients”. For instance, consider a database of information that users of the marketplace choose to subscribe to in order to access. Popular examples of subscription based marketplaces include dating sites e.g. okcupid, music or movie streaming services e.g. Netflix or Spotify, couch surfing like sites.
Generally speaking, marketplaces that charge a subscription fee do not participate in transactions between users. In this case, the buyers & sellers will transact with each other off the platform. The subscription based model is therefore best suited for online marketplaces that do not carry out transactions between buyers & sellers.
Pros of the Subscription Model
Setting up a subscription model for a two-sided marketplace offers many different benefits; a few of these are listed below.
More predictable revenue
One of the best things about the subscription based model is that you can easily predict how much revenue is going to be generated over the next few months. This can make it easier to forecast & plan your company finances.
You can offer month-to-month, cancel anytime subscription, or a 12 month subscription or both. 12 month subscriptions make planning your finances even easier & generally, users signing up for a 12 month subscription will be offered a discount to help incentivise this higher level of commitment.
Helps attract more clients
Most subscriptions are relatively cheap compared to one off payments. For example, marketplaces focused on selling to small businesses might charge $500 per month, whereas marketplaces that focus on selling to individuals might charge $20 per month. By making the marketplace affordable, you can attract more clients.
High customer lifetime value
With a commission based marketplace, you are not sure if your customer will come back after the initial purchase. You therefore need to keep investing in customer acquisition strategies in order to get your customer to keep your business running.
In the case of a subscription based model, you can keep regularly earning from the same client. This means that you don’t need to invest as much in customer acquisition to keep your business running.
Potential for untapped markets
Some of the most successful subscription based two-sided marketplace disrupt their industries & tap into previously ignored potential.
For example, before Spotify, people had to pay much higher prices to purchase music on iTunes. The cost of buying music as one off transactions racked up very high if you were constantly listening to new music. The subscription model revolutionized this by giving listeners unlimited access to music all for an affordable monthly cost.
Just like Spotify did, you can find new markets by exploring the subscription based business model for your marketplace.
Challenges of the Subscription Model
In spite of the many benefits you get from exploring marketplace subscription models, there are also several challenges to be aware of. In this section we take a look at some of these.
Hard to maintain value
Subscribers keep paying as long as you provide enough value to them. For instance, Netflix provides value by constantly adding new movies & TV shows to their platform. Therefore, you have to find ways of providing enough ongoing value to your subscribers, so that they don’t cancel their subscriptions.
Solving the chicken & egg problem
Subscription based models can make it difficult to attract early adopters. These marketplaces can fall victim to the chicken & egg problem.
In the case of the commission model, we saw that neither the buyer or the seller risked anything by signing up to your platform, since they only pay when they find some value in the marketplace i.e. when a transaction happens.
Conversely, the subscription model forces buyers & sellers to pay in advance of finding any value. Paying in advance may discourage potential users from adopting the platform.
Some ways around this include offering a free trial or discount for early adopters of your product. You may also create different subscription plans such as free, basic & premium & offer different features or rights to each different user group.
Contract nerves
It is much harder to sell a yearly subscription than a monthly subscription & it is much harder to sell a monthly subscription than offering riskless free access (as in the case of the commission model). This is because people are generally more nervous about getting into contracts that require regular payments over an extended period of time.
Marketplaces using a Subscription Based Model
Here are some examples of marketplaces that use a subscription based business model include OkCupid, couch-surfing, Netflix & Spotify.
OkCupid subscription model
OkCupid is a dating app that connects people who want to date.
Like other popular dating sites, OkCupid is free to sign up for. OkCupid also offers two paid subscriptions, which are available in three durations. The basic plan comes in at $44.99 for one month, $23.33 for three months, and $14.99 for six months. The premium plan costs $54.99 for one month, $28.33 for three months, and $22.49 for six months.
Couch-surfing subscription model
Couch-surfing is a subscription based marketplace that connects travelers with local people all over the world. Locals can host travelers for short-term stays in their home or interact with other people interested in travel.
Couch-surfing charges a monthly subscription fee of $2.39. This works out to $28.68 each year. Alternatively, you can take an annual plan which costs only $14.29.
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Listing Fee Revenue Model
The listing fee marketplace model is when vendors pay for every listing they create on the platform. In other words, the vendor needs to pay each time they list a new item.
Since the commission based model is free to list, a marketplace that operates a commission based model will not earn any commission on unpopular listings as no one will pay for them. The listing fee model overcomes this challenge by charging a fee for every listing.
Pros of the Listing Fee Model
There are several benefits to the listing fee model for marketplaces. These include:
Low cost listing fees
Marketplaces that use the listing fees tend to attract more sellers compared to subscription based marketplaces. This is because marketplace listing fees tend to be cheaper than marketplace subscription fees.
Listing quality
Since it is not free to list, vendors spend more time making their listing high quality, rather than just posting lots of listings & hoping that one of their listings sells.
Challenges of the Listing Fee Model
The listing fee model has several challenges that you will need to overcome.
Riskier for sellers (chicken & egg problem)
The listing fee model is riskier for sellers because they need to pay a listing fee before making a sale. This can discourage sellers from using the marketplace.
One way around this is to offer new sellers a fixed number of free listing credits when they sign up, monthly or annually. Another way around this is to offer a free trial period with unlimited listings for the first 14 or 30 days.
Hard to monetize
Since listing fees are normally very low, it can be difficult for marketplaces to make enough revenue from the listing model to survive. For this reason marketplaces generally only use the listing model as a secondary revenue model.
Marketplaces using the Listing Fee Model
Two examples of famous marketplaces who use the listing fee revenue model are Craiglist & Etsy.
Craigslist listing fee model
Craigslist is a marketplace website where users can offer different products & services for sale.
While most of Craigslist’s service is free, it charges $25 to give increased visibility to your listing or ad on the platform. Craigslist charges $25 for job-related ads and several other listing categories. Most of Craigslist’s revenue comes from paid listings where the ads are optimized to appear in certain search results.
Etsy listing fee model
Etsy is a global online marketplace, where people come together to make, sell, buy and collect unique & creative items.
As a marketplace, Etsy makes money primarily by charging a 6.5% commission on items sold via its platform; however, it also has a secondary business model where it charges a $0.20 listing fee for all items that you want to list. This decreased the number of items listed per day but increased the quality of the existing ads. Paying the listing fees allows the user to post this ad for 4 months.
Lead Fee Revenue Model
The lead fee marketplace business model (also known as fees for leads) is a type of commission based business. The model works by allowing buyers to post a request for a product or service on the marketplace. The marketplace then charges the sellers in order to bid for this lead.
Marketplaces using this model can charge for leads in different ways. For example, the marketplace can charge vendors to view the leads or a one time flat fee for each sale that they refer.
Buyers & sellers can also be charged extra for additional services such as customer support, accessing analytics & so on.
In some cases, marketplaces may work with sellers to create discounted deals for their products & services, in order to help incentivize buyers to join their platform.
Pros of the Lead Fee Revenue Model
The lead fee model provides a better value proposition than the listing fee model.
Improved buyer engagement
As there is no fee for the buyer to list their request, there is no risk to the buyer to list their request for the product or service on the marketplace.
Improved seller interest
There is a lot of interest for sellers, since buyers come directly to them.
Challenges of the Lead Fee Revenue Model
There are two main challenges with the lead fee model: marketplace leakage & that the lead value must be high enough otherwise there is not enough money in the transaction.
Marketplace leakage
If the marketplace charges too much for a lead then this will motivate users to bypass the marketplace after the first transaction has taken place.
Lead must be worth enough
If the lead value is not high enough, the marketplace cannot charge enough for the lead to cover the cost of generating the lead.
For instance, let’s assume the marketplace generates a lead for $5000 of labour. A vendor may only be willing to pay $125 for the lead (or 2.5% of the total contract value). This is because the vendor doesn’t necessarily know if they will win the bid & in fact, the vendor knows that they will only win a certain percentage of the leads that they bid on.
Working out how much to charge for a lead is a process of trial & error to work out what is the maximum amount that your vendors are willing to pay.
Marketplaces using the Lead Fee Model
The most famous company that uses the lead fee model is Thumbtack. Thumbtack is famous for iterating through several business models before landing on the lead fee model that worked for them.
Thumbtack lead fee model
Thumbtack is a marketplace for people to connect with professionals for services across a large range of services.
Vendors on Thumbtack buy credits. These credits allow them to send quotes to potential customers. So essentially you’re paying to contact customers. Each lead costs a certain number of credits & the number of credits is determined based on what service the vendor is offering. Credits can be purchased in bulk at discounted rates. All things considered, it will cost between $10 – $100 to get a lead on Thumbtack.
Interestingly, Thumbtack started out as a commission based business model however failed to make it work for them. This was because Thumbtack operates hundreds of categories of service. This made it very difficult to technically & operationally work out who does the job & for how long. As such they were unable to build payments into the platform & as such were unable to take commission.
Freemium Marketplace Revenue Model
The freemium marketplace business model works by offering the marketplace users free & premium paid for features. The model is challenging to implement since it requires the marketplace to offer features that are superior enough for the users of the marketplace to use.
Pros of the Freemium Model
The freemium model has several benefits &, as you will see, there are some who argue that the freemium model will eventually eclipse the commission based model for marketplaces.
Fast lead generation
A freemium model will allow users to experience the value of your marketplace without paying anything. This is very attractive to both buyers & sellers on your marketplace.
Using a freemium approach marketplaces are often able to build a large user base & gain the trust of these users. The marketplace can then layer in premium features over time that they use to generate revenue.
Generate customer feedback
Another major benefit of using the freemium approach is that the marketplace can collect valuable customer feedback & data. By watching how free users interact with the marketplace, the platform owners can learn about needs, preferences, pain points & behaviours. The marketplace can also solicit feedback through surveys, reviews or ratings.
These types of activities will enable the marketplace to tailor the marketing message, segment the audience & identify the most engaged customers.
Challenges of the Freemium Model
In addition to the benefits of the freemium model, there are also challenges & drawbacks that should not be overlooked.
Conversion & retention
One of the biggest challenges with the freemium model is converting & retaining free users. Not all free users will see the value or the need of upgrading to a premium version &, with less buy in, free users are more likely to churn & switch to a competitor.
To combat this, marketplaces need to carefully design their product so that it creates a clear differentiation between free & premium offerings. Premium features will need to be attractive enough for users to pay for & they must solve enough of your customers’ pain points that you cover the costs of running the free accounts.
If you follow a freemium approach, it is best to monitor key metrics such as customer acquisition costs, customer lifetime value, churn rate & conversion rate.
Revenue & profitability
Another challenge marketplaces face with the freemium approach is profitability scaling & maintaining the quality of the product or service.
The marketplace will have many free tier customers & there is a cost to running these free users. As the number of free users increases, so does the complexity of managing the free tier users. Marketplaces using the freemium model will therefore need to invest in infrastructure, security, support & building innovative premium features.
Marketplace using the Freemium Model
A great example of the freemium model is the marketplace unsplash.
Unsplash is a marketplace for photographs to sell their photos. Photographers upload their work onto Unsplash & then buyers are able to access a subset of the photos for free. If buyers want access to all available stock images, they must pay either a monthly subscription fee or compensate the photographers directly.
Ads & Featured Listings Model
The ads & featured listings model occurs when the marketplace allows vendors to pay in order to enhance the visibility of their listing, either as an ad or a featured listing.
With this model, sellers will pay the marketplace to have a featured listing higher than others or to be at the top of a certain category of listings.
Pros of the Ads & Featured Listings Model
The benefits of using the ads & featured listings model include.
Additional revenue stream
The ads & featured listings model works as a great additional revenue stream for a marketplace. It should not however be your sole revenue stream & you should be very careful not to overload your marketplace with ads.
Challenges of the Ads & Featured Listings Model
Even though the ads & featured listings model can be a good revenue generator. There are some challenges to this business model that make it appropriate only as a secondary revenue stream.
Only works for high traffic marketplaces
The main challenge is driving enough users to the marketplace so that users are willing to pay for the ads. There are many marketplace strategies to drive traffic, most of these either cost money or require a high time investment to set up.
Small number of paying users
With this business model, the number of paying users will always be massively outnumbered by the number of non paying users. For this reason it is normally only used as a secondary business model in the marketplace.
User retention
In addition to the above challenges, you will find that if you have too many ads on your marketplace, this will lead to low user retention. This is because no one likes to be inundated with ads.
Marketplaces using the Ads & Featured Listings Model
Two great examples of marketplaces using the ads & featured listing models effectively are Zillow & Ebay Classified Division.
Zillow ad & featured listings model
Zillow is a real estate marketplace that connects realtors, brokers & property managers with their customers. Zillow charges management companies & agents for advertising on their platform.
Ebay (classifieds division) ad & featured listing model
Ebay is an online auction marketplace for people to buy & sell a wide variety of goods & services.
Ebay has a classifieds division where users can list & sell on their platform for free, but users pay a flat fee if they want their offering to be displayed first.
Data Licensing Model
All marketplaces generate data. Depending on the nature of the marketplace and the data it generates, marketplace owners may be able to licence & sell anonymized & aggregated data to third parties or research organisations.
Pros of the Data Licensing Model
There are several benefits to licensing the data that your marketplace generates for a fee.
Minimal direct costs
Unlike physical products or services, data can often be licensed with minimal direct costs. Once collected and processed, data can be licensed multiple times without incurring significant additional expenses.
Long term revenue potential
High-quality, relevant data can have long-term value, allowing you to generate revenue even after initial collection and processing efforts.
Challenges of the Data Licensing Model
It should come as no surprise that there are high technical challenges when it comes to storing your marketplace’s data securely. However, in addition to the technical security challenges, there are also other challenges to this business model.
Data quality & accuracy
Maintaining the quality and accuracy of the data you license is essential. Inaccurate or low-quality data can lead to disputes and damage your reputation.
To do this, you will need to use data normalization & quality assurance techniques. You will also need to make sure that you are storing data in a high quality database.
Data ownership
Clarifying ownership rights and intellectual property rights of the data can be complex, especially if it involves user-generated content or contributions. Before selling any of your users data, it is best to consult with an attorney who specializes in data privacy, intellectual property, and commercial law.
Ethical considerations
Selling or licensing user data can raise ethical concerns, and transparency about data usage is crucial to maintaining trust with your users.
Marketplaces using the Data Licensing Model
Many marketplaces who licence data to third parties. For example, Yelp, Twitter, CB Insights, Zillow etc. There are some notable exceptions to this, for example Airbnb who do not allow third parties to access their data unless the third party is guaranteed to substantiate the end-user, or the Airbnb ecosystem.
Let’s take a quick look at how the company Yelp licence their data.
Yelp data licensing model
Yelp is a platform for user-generated reviews and business information.
Yelp offers data licensing services through the Yelp Fusion API. Businesses can access Yelp’s local business data to enhance their applications and services.
Mixed Revenue Model
When choosing a revenue model for your marketplace it is a good idea to start with just one model. However, over time you can add additional business models to your marketplace.
Note: you should only look to add additional business models after you’ve found at least one business model that works well for your business.
Pros of the Mixed Model
All major marketplaces evolve their business models over time to create a better functioning & more profitable marketplace. Although there are many benefits of the mixed model, the main one is that you can add additional revenue streams.
Add additional revenue streams
Of course, the biggest benefit to the mixed model is that you can boost your revenue by finding ways to upsell & cross sell to existing marketplace users.
Build a strategic advantage
Imagine that you are operating a commission based model very effectively, however you start to layer in premium features for your power users. You can now charge more for your premium features & maybe even lower your commission to keep your competitors at bay whilst still making more total revenue.
Challenges of the Mixed Model
There is one major challenge of the mixed model that you should be aware of.
It takes time & resources!
Although mixed models are great, it takes a lot of time & resources to find even one revenue model that works. Finding multiple revenue models therefore takes a lot of time & resources.
You should not use a mixed model for your business until you’ve first found a marketplace business model that works for you.
Marketplaces using the mixed model
Most major marketplaces such as Amazon, Uber, Airbnb, Etsy etc. use a mixed model. Let’s break down how one of these established marketplaces uses the mixed model to both generate more revenue, but also to develop a strong competitive advantage.
Etsy mixed model
We spoke about Etsy above in the section on listing fees. Etsy actually combines three business models together. They use:
- Listing fees to keep the quality of the listings for all sellers high
- Transaction fees for all users
- Premium services for sellers
Unpacking Etsy’s S1 (and there is a great analysis in Tech Crunch), we see a mixed marketplace business model which is being used to maximize their revenues whilst not losing their users to competitors.
To see why this is the case, let’s use the graph below to break down Etsy’s different revenue streams.
The graph below shows the rapid growth of the premium seller fees which has almost double in the last 2 years, compared to their transaction fees which are growing more steadily.
Etsy’s premium seller services are the fastest growing revenue stream for Etsy. However, these premium features cater toward a small section of the marketplace’s users. The “power sellers”.
The average Etsy seller isn’t interested in the seller’s premium services, as they’re too small to be concerned with fulfilment efficiency and/or they’re not thinking about investing in marketing yet.
This strategy is so interesting because Etsy has been able to lower the transaction fees for the average seller, whilst simultaneously increasing their revenue with the use of premium seller services for larger marketplace users.
Essentially, Etsy has found a way to make more revenue without raising their transaction fees, meaning that they are able to retain smaller users & keep out potential marketplace competitors, whilst simultaneously maximizing their revenue.
Having difficulty finding the right business model for your marketplace?
Some final thoughts
There are several core marketplace models. The most popular marketplace model & often the correct one to use is the commission based model.
However, there are times when the commission based model does not work. We saw why this was the case for the professional services marketplace Thumbtack.
Moreover, all major marketplaces use the mixed model. This is when they offer multiple business models targeted at different types of user e.g. power users versus average users in order to maximise revenue & build a strategic advantage.
Mixed models are the holy grail of marketplace business models however, remember that business models evolve over time as the company matures & you learn more about your customers. Therefore start simple & find a business model that can work sustainably before adding in new & more complex models.
Dittofi has some major experience building marketplaces & helping to design business models that work.
To speak to us about your marketplace, schedule a free 30 minute app consultation with one of our marketplace specialists today.
FAQ
Still have questions?
A marketplace business model is a type of business model where a company acts as an intermediary or platform that connects buyers and sellers in a particular market or industry. In a marketplace, the company does not typically own the products or services being offered; instead, it provides a platform or ecosystem where independent sellers and buyers can interact, transact, and exchange goods or services.
One of the most well-known examples of a marketplace business model is Amazon. Amazon operates as a massive online marketplace that connects millions of buyers and sellers worldwide.
Creating a marketplace business model involves careful planning, strategy, and execution. Some steps involved are: market research, craft a value proposition, choose a business model, choose a tech stack & build your platform, launch your MVP, find users & iterate.
For more information check out our blog on how to build a website like Airbnb.
The average commission rate for a marketplace can vary widely depending on several factors, including the industry, the types of products or services being offered, the level of competition, and the value provided by the marketplace to both buyers and sellers. Commission rates are typically negotiated between the marketplace operator and the sellers.
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