NB: This is a guest article by Tao Tao, co-founder and vice president of product at GetYourGuide.
In part one I talked about the basic economics that make collaborative consumption and peer-to-peer marketplaces so powerful.
Now, I will look more deeply into supply and demand, and the key enablers for such business models.
Supply side: idle assets, distressed inventory, opportunity cost of leisure time, and professional vs non-professional suppliers
1. Idle assets
From microeconomics we know that companies produce additional goods or provide additional services as long as marginal revenue is higher than marginal cost, meaning any additional unit of production brings in more money than it costs to produce said unit hence yielding a marginal profit per additional unit produced.
Hence companies will keep increasing output until the marginal revenue is equal to marginal cost because then there’s no more money to be made from providing additional goods or services.
The same applies to individuals in a marketplace: in order to engage or continue to engage in an economic activity, my marginal benefit must be higher than the marginal cost to do so. In most cases, benefits are monetary benefits although there can be social and other benefits as well.
The underlying economics of peer-to-peer marketplaces rest on the concept of idle or unused assets. These are assets that could be activated at low marginal cost and reap significant marginal revenue.
Let’s take the example of Airbnb: the marginal cost of providing a sofa or empty bed is close to zero (cleaning the bed afterwards might cost a few bucks and creating an account on Airbnb takes a few minutes) whereas the marginal revenue of listing the bed on Airbnb for $50 a night would be $50 a night, which yields a marginal profit of close to $50 a night.
Hence market participants in peer-to-peer marketplaces have some sort of unused asset that is of interest to other market participants, and that could be monetized at low marginal cost and high marginal revenue.
On eBay people have unused items to sell, on Airbnb hosts have a free room or a couch that isn’t properly utilized or monetized, and BitTorrent users have unused upload bandwidth that can be provided for upload capacity in exchange for download capacity.
Therefore marketplace activity is more likely to emerge the larger the difference between marginal benefits and marginal cost is, and for peer-to-peer marketplace this difference emerges from idle assets that can provide high marginal benefits (monetary, social, etc.) from hosting someone for a night or renting someone your expensive tool.
However, peer-to-peer business plans need to make sure that the underlying assets are truly idle.
At GetYourGuide our initial goal was to provide guided tours via a peer-to-peer model but at some point we thought that the underlying factors for giving a great tour were primarily time, knowledge and sometimes friendship (after all, some of the best tours are given by friends).
Knowledge can be an idle asset (everybody knows a ton about their hometown without actually leveraging this knowledge), but time and friendship rarely are, so we didn’t think the economics would work out.
Admittedly, we were also very inexperienced first-time entrepreneurs, and many companies in the peer-to-peer tours and activities space that came after us have been more successful, so I’m not ruling out the model’s viability from the economics alone.
2. Distressed inventory and under-utilization
Related to above point but going beyond peer-to-peer marketplaces and into collaborative consumption in general, idle assets can also be seen as overcapacity or distressed inventory because underlying the rationale is that you have assets, inventory or simply potential just sitting there to be put to use.
Think about a platform for renting expensive tools, a car-sharing market or a co-working space. In all instances the initial cost of buying the tool, the car, or the office is high, but the (marginal) cost of extending their benefits to additional users is low.
It costs comparatively little to send the tool to someone else by mail, coordinate and pay a little more for fuel to pick-up an additional passenger, or coordinate different people to work out of the same office.
Participants don’t have to own said goods in order to reap their benefits and owners can reap additional revenue due to low marginal cost of extending the benefits of these goods to additional users.
Buyers pay less than buying said goods outright and sellers earn more than nothing, which would have been the alternative of not renting the tool, not sharing the car or not having other people work in the under-utilized office.
The end result is that both suppliers and consumers are better off due to a more optimal utilization of resources. The only losers are possibly tool manufacturers and real estate agents.
Therefore peer-to-peer marketplaces and collaborative consumption models are likely to emerge under two conditions: a market where assets impose high fixed costs but require comparatively low variable costs to extend its benefits to additional users, and markets where such assets tend to be under-utilized once the initial fixed cost investment has been made (eg. lonely couches, expensive tools lying in the basement, a parked car waiting to be driven, empty office space, etc.).
It is then up to the marketplace to provide good coordination so assets are allocated efficiently to achieve optimal utilization.
3. Opportunity cost of leisure time in C2C markets
So far we have simply assumed low marginal cost, but what does this actually mean for individuals in C2C markets where users don’t offer goods or services on a professional basis but do it their spare time?
When people list used items on eBay, they are mostly committing time, a slight risk investment (who knows if you really get paid), and small marketing fee for eBay. In fact, the main marginal cost for non-professionals is often the opportunity cost of leisure time (weekend and after-work time).
Whenever you ask people about the reason why they decide not to participate in a peer-to-peer marketplace, you are likely to hear the answer “Not worth the time”. After all, do you really want to spend your Saturday afternoon listing a $10 item on eBay, or, in the case of GetYourGuide’s early days, guide strangers through your city for $20?
Depends. If I could sell 20 items or guide 20 people at once, or sell something for $1000 or give a private tour for $500, then it might be well worth my time. The question is whether you can get the numbers to work.
Hence, if seeing time as a marginal cost ingredient, C2C peer-to-peer marketplaces are more likely to work if the perceived marginal benefits outweigh the time investment for each supplier. This relation, of course, varies depending on the type of suppliers in a marketplace.
A celebrity, for example, will not give a tour for $20 because his or her opportunity of cost of time is much higher. Similarly, since we are talking about the perceived value difference between time invested and benefit earned, this also means that C2C marketplaces work better if the target supplier group simply has a lot of time on their hands.
Additionally, to arrive at a high marginal benefit suppliers can not only choose to charge a high price per unit of goods or services offered, but they could also offer a lot of units at economies of scale. For example, if I cook something, it doesn’t take a lot of additional time to cook an extra portion and possibly sell it to multiple buyers.
Suppliers can reap economies of scale by treating time as a fixed investment and then recouping it through scale, e.g. by selling more than one item on eBay at once or guiding more than one guest through the city at the same time.
The likely equilibrium in marketplaces where suppliers can make use of economics of scale on an individual basis is a marketplace where most of the goods and services are provided by a small group of suppliers, thus resembling and possibly shifting towards a more professional marketplace over time.
4. Professional and non-professional sellers
Speaking of professional and non-professional suppliers, most marketplaces allow the co-existence of both, but under certain circumstances, e.g. due to desired market positioning on part of the professional sellers, it is possible that professional sellers do not wish to be associated with non-professional sellers.
In such cases, platform owners might be forced into a decision to commit into either direction, which would significantly reduce the supply side. Therefore peer-to-peer platforms where the co-existence of professional and non-professional sellers is possible tend to have a larger supply base.
eBay is a good example and so are vacation rental platforms. However, the challenge then lies in the customer product positioning because as eBay has experienced in the past, it is difficult to position yourself as both the marketplace for everyman auctions (peer-to-peer marketplace) and an authoritative platform for buying things online in general such as Amazon.
Such a wide positioning is already tough for large platforms, but it is even more so for startups that require laser-sharp focus on doing one thing well. In the same vein, as a platform it is difficult and costly to service and provide tools for both occasional and power sellers.
Demand Side: Product competitiveness
After having discussed the supply side in length, let’s take a look at the demand side, that is: will people actually consume the goods and services offered on a peer-to-peer or collaborative consumption platform?
As I pointed in part one, such marketplaces have great disruptive potential but platform owners must be very clear about which market they are trying to disrupt and explain why their product is cheaper, faster, smaller or better than what customers currently use.
If platform owners try to create a new market from scratch, e.g. make people do something they haven’t done before such as offering their room on a website (and thereby unleash the room’s hidden economic potential), this takes serious guts, some luck and sound economics.
The end product must be truly compelling to consumers and as a first-time entrepreneur the most common mistake is to forget that solving a problem isn’t enough – you must provide a much better solution than what’s out there already to justify the switching cost.
1. Price
Are the products that your platform offers price-competitive? Is a vacation rental room cheaper than a hotel room? Is an amateur guide cheaper than a professional guide? Is the meal cooked and delivered by an amateur cheaper than from a restaurant?
Most importantly, can you find a price for your products that is above your suppliers’ marginal cost (so that they will actually do it), and at or below the consumers’ willingness to pay, which may take into account the price of existing solutions, meaning the price must be lower than existing alternatives so customers will actually switch to this product instead (assuming your product is comparable or a so-called “substitute” product to existing solutions)?
As an example: are travelers willing to stay at stranger’s place for a price that is both attractive to the host and relatively more attractive to the traveler than paying an alternative price for staying at a hotel room or simply not travelling altogether? Finding a price where both the supply and demand sides are satisfied might not work with all types of products or services.
As a final note, any profit margin for the platform itself derives from the difference between the price that suppliers are willing to take and the price that customers are willing to pay.
If a supplier is willing to offer something for $20 and the customer is willing to pay $25, the platform could keep $5 (assuming no other cost and zero competition from competing marketplaces).
2. Product experience
Peer-to-peer platforms often involve goods and services offered by amateurs but do consumers really want to purchase them? Collaborative consumption implies that consumers are not the sole users of a certain service or good.
- Do I really want to stay in a stranger’s room compared to a hotel room?
- Do I want to work with other people out of the same office?
- Do I trust a network of “peers” when it comes to finance or insurance?
- Can amateurs provide the same degree of quality of service than professionals who have been doing it for years?
- How much worse is a used TV compared to a new one?
All of these considerations must be reflected in the price, either as a premium or a discount on the price compared to more traditional products. In most cases only experimentation can reveal consumer preferences for such product attributes.
However, one common observation is that users consider the social component of collaborative consumption to be a major plus, meaning – everything else being equal – many consumers will prefer a social product over a non-social one.
Working with like-minded people in the same office is nicer than sitting in a café by yourself even if you may have to clean the kitchen together. And having a host who not only provides accommodation but also kinship, cultural exchange and local tips plays to the very fundamentals of traveling.
3. Product choice
Interestingly peer-to-peer marketplaces can have both too much and not enough product choice at the same time. Speaking from our own experience of trying to create a peer-to-peer marketplace for experiences, we quickly ran into the problem of having both a limited spectrum of products (everything seemed to be a walking tour of some sort) and an overabundance of product entities.
Basically, we had more or less the product offered by different suppliers in slight variations. Choice can be good to a certain degree but it should be among relevant choices where differentiating product factors actually matter to customers.
Product diversity is not required for peer-to-peer platforms with homogenous products (BitTorrent only requires that you have upload and download bandwidth but does not care what type of bandwidth), but if a varied product spectrum is required for consumer appeal, platform owners must ask themselves if their suppliers can provide that, and how to steer suppliers into creating varied but relevant product choices.
A second danger and one thing I hear a lot from first-time entrepreneurs wanting to create a peer-to-peer marketplace is the claim that you can “offer anything”. But anything is nothing. A nightclub that plays every kind of music will attract a few rockers, a few hip hop fans but only a nightclub focused on a certain niche will be successful.
Customers and suppliers alike need hints on what to expect and why they should invest time and effort into a new platform. Seasoned entrepreneurs understand that you need to apply a “beachhead” or “wedge” strategy, ie. to begin with a selected vertical that is constrained by something like geography or product line, and then expand into adjacent fields from there.
Finally, many service platforms offer services instead of fixed products. Finding the proper way to parameterize and match service offerings to buyers can be a particularly difficult challenge here.
Enablers and blockers: coordination, transaction cost, trust, and regulation
1. Coordination
The main job of peer-to-peer and collaborative consumption platforms is coordination and playing the matchmaker. A good matchmaker reduces suppliers’ access cost to reach customers by providing and matching sufficient and relevant marketplace participants with each other.
eBay allows someone in Berlin to sell something to someone in London by providing the market reach (e.g. the seller might not have sufficient buyer interest in Berlin alone) and providing the necessary tools to allow users to find each other’s goods and services efficiently (a good search with relevant filters in eBay’s case).
This is essential for allocating under-utilized or distressed inventory and the more efficient a platform can perform its matchmaking functions, the easier it will be for suppliers to find buyers, for distressed inventory to be properly allocated, and for consumers to find what they need.
Therefore marketplaces must provide both relevant reach that is big enough (but not too big as to create an empty disco) to allow for sufficient matchmaking potential, and tools to facilitate coordination.
Such tools can include strong communication and messaging features, booking and payment systems for transaction platforms, inventory system to indicate availability, methods to efficiently allocate resources (e.g. various forms of price auctions from eBay’s sort-of-Vickrey auctions to MyHammer’s reverse auctions), and good search (pull) or recommendation (push) features.
Good coordination can create entirely new markets and the Internet as a coordinator is probably the biggest reason for the strong emergence of collaborative consumption and many kinds of marketplaces in general.
2. Transaction cost
In our analysis we have so far ignored transaction cost, which ranges from credit card fees to shipping cost. As these fall, we will also see more collaborative consumption models emerge, especially for lower-priced products and services where an absolute reduction in transaction cost has a relatively higher impact than for higher-priced items.
Communication cost also falls in here.
3. Trust
Platform owners must increase the perceived trust in order to facilitate and smoothen transactions, especially if non-professional suppliers are involved. There is a lot of business literature on this topic and some of the measures include upfront reference checking (e.g. real address checking on commerce platforms), review systems, community features, identity validation using a third-party service (Facebook, et al.), and smart tit-for-tat mechanisms.
In fact, there are few reasons for any modern C2C platform not to leverage Facebook unless identity concealment is important. Thanks to Facebook, Twitter and other communities we now have a web of people that transactional platforms can instantaneously tap into.
Whereas you could formerly only trust brands, it is now much easier to trust individual actors on platforms (to a degree). I’m sure we will see many more C2C platforms build on top of Facebook’s generated trust (a sort of trust outsourcing if you will).
4. Regulation
Entrepreneurs need to understand the regulations of their sector. This is especially important for service products such as travel, food, finance and so on. Regulation usually exists in order to protect vested interests by barring new players from entering the market, to protect consumers, or often both.
You may argue that certain regulations make little sense but trying to enter a heavily-regulated industry can be a tough nut to crack. For companies with global aspirations, this becomes even more difficult if regulations differ from country to country.
Nonetheless, sometimes startups have been able to change regulation in their favor by arguing from the consumer standpoint against the incumbents’ vested interests, or capitalized on good timing with changing regulations.
Conclusion
Hopefully this two-part analysis was able to show that peer-to-peer marketplaces and collaborative consumption are powerful forces if the economics and accompanying factors work out.
There is a spectrum between peer-to-peer and regular marketplaces, between individual and collaborative consumption, and properly positioning a platform is a crucial business decision. Done correctly, the rewards can be sky-high.
Ultimately, these are not new concepts: the Internet and other enablers have simply taken some of the implementations to global winner-takes-it all scale.
NB: This is a guest article by Tao Tao, co-founder and vice president of product at GetYourGuide.
NB2: Globe money, Boat trip Asia and doors images via Shutterstock.
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Tao, great two part series. I enjoyed reading. I like how you broke down the economics of the new peer-to-peer marketplaces.
This is really a very good analysis of two-sided markets. Thanks for sharing!
Chuck