Many of today’s top internet companies are marketplaces. The reason is because the internet drastically reduces the ‘transaction cost’ of marketplaces by making it easy for participants to exchange information. Marketplaces have been around as long as agriculture (when people could specialize and trade). Initially, however, people needed to physically travel to a town square to see the goods, negotiate price, and settle the transaction. As the telephony system evolved, people no longer had to travel and could “call-in” an order, as demonstrated by the chaotic trading pits of traditional stock exchanges. Brokers functioned as aggregators of supply and demand, and helped organize the flow of information and goods between sellers and buyers. However, they were still a cost of inefficient markets (the most extreme representation of this is the existence of gangs in the market for illegal drugs).
Internet enabled trading was the first and most advanced online marketplace. Today, the internet is making markets more efficient in just about every industry. Some marketplaces are bringing greater transparency and trust into the market. Zillow is bringing better information into the real estate market. ZocDoc is bringing transparency into the market for doctors in the same way AirBnB is changing the market for short-term housing rentals. Other marketplaces are displacing middlemen entirely. Beyonce just released her latest album directly on iTunes without the traditional music promotion cycle and sold a record 1 million copies in 6 days. Uber is displacing dispatcher companies and Silk Road is displacing street gangs.
Online marketplaces make markets more efficient in several ways. First, it removes the physical cost of gathering buyers and sellers in the same location. For example, eBay and etsy allow limited edition items to be sold from around the world, when previously you had to hunt for them in antique shops and flea markets. Second, it makes it easier to display relevant information (prices, reviews, product/service characteristics, etc.) and also update that information in real time. For example, Uber helps bring transparency to the location and pricing of cabs while ZocDoc brings transparency to the quality and availability of healthcare professionals. Third, by amassing large scale (due to the first effect), these marketplaces are massive in scale, thus providing greater liquidity, more accurate pricing, and less idle resources (e.g. inventory, unused capacity). For example, oDesk helps to better utilize the resources of programmers and designers, while Uber reduces the amount of time cabs wait and search for customers. Lastly, with the advent of social networks, online marketplaces help to establish trust among market participants that did not exist before. For example, AirBnB establishes buyers’ connection to sellers’ through Facebook mutual friends, which established trust and opened up many previously idle apartment spaces for rent.
Stay tuned for my next post regarding the structure of successful online marketplaces…