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Powered by Battery  |  May 10, 2018
Searching for the Next Billion-Dollar Marketplace? Look in the Shadows

Most online-marketplace entrepreneurs, investors, and executives all agree that a big market size and total addressable market (TAM for the business geeks) is crucial to the success and long-term viability of marketplace companies.

But how exactly do you define a big market? Is it $1 billion? $10 billion? $50 billion? Then there are more-difficult, related questions, like, is a given company serving a new or existing market? Is the market still growing, or is it mature? The answers to these questions create a much more nuanced picture of a company’s probability of success.

Established marketplace incumbents like Amazon, eBay and others were on a more straightforward trajectory: They had the opportunity to ride the Web 1.0 wave in the 1990s. Effectively, they were competing in massive markets, like retail, against brick-and-mortar competitors. So to win, they simply had to ride the wave of the first Internet boom to greenfield opportunity, and massive growth.

That playbook obviously doesn’t work today. Online and mobile transactions are extremely advanced and commonplace. So how do new Internet marketplaces—sometimes called “peer to peer”, or operating in the “sharing economy”–stand out and grow? One key factor that is common to many next-generation marketplaces like Didi, Uber, Airbnb, Turo, Wag*, Instacart, Poshmark and others is that they have what we call a “shadow” market of potential suppliers of a service.

What is a shadow supply market?

A shadow market is one that unlocks a latent supply base of people or assets that were previously not part of a given marketplace. The concept is pretty simple: Before the advent of ride-sharing services like Didi and Uber, random people weren’t your taxi drivers. Before Airbnb, people didn’t rent their apartments or homes out for short periods to people they’d never met. Before Wag*, unknown people wouldn’t enter your home and walk your dog.

In all of these cases, a shadow supply base (drivers, apartments, dog walkers) did not exist before, and a new, innovative marketplace got them online and part of a new type of two-sided transaction. By making it easier to list new assets and services, the marketplace creates value for both sides.

How companies can leverage a shadow market

Take rates and suppliers: The hardest part of building a marketplace is often solving the chicken and egg problem: Actually getting your company off the ground by acquiring enough supply (car drivers, apartments) or demand (people needing rides or places to stay). In this construct, convincing suppliers that your platform is legitimate and important is often one of the hardest parts of first building your business.

One of the best attributes of a good marketplace is a high “take rate”. This is the cut a marketplace takes from each transaction. Elevated take rates enable great unit economics for a company, allowing them to spend more to acquire more customers and grow more efficiently. When speaking with existing, professional suppliers, like hotels or car-rental companies, we find they’re often not eager to pay large transaction fees to outside providers. Often, they already have existing channels, websites and other ways to acquire customers. Most times are already discoverable on the internet, which makes it difficult to take a cut of the transaction.

Leveraging a shadow supply base, though, gives a company more ability to charge a high take rate—since your marketplace might be the only place for people to access a certain service, like dog-walking or ride-sharing. You can see this in the high take rates of Uber, Airbnb, and Wag*, which run about 15-20% or more, with the lower take rates of eBay (about 8%), Opentable (about2%), or Angie’s List (5%). None of those incumbent companies were leveraging shadow markets, and customers have other avenues by which to access those companies products or services.

Cheaper and better: Because shadow suppliers aren’t part of an existing business with an established cost structure, they can afford to offer lower pricing than professional suppliers. This is why Airbnb can charge less than hotels ad Uber less than taxis. These companies don’t have overhead like office space or employee benefits.

Contingent/flexible supply base: Another aspect of shadow supply markets is that they tend to have a contingent, or flexible supply base. This means that unlike a hotel, which always has to be full to make money, an apartment owner has more options: He/she could put the unit on Airbnb, sublet it in some situations, or continue living in it. The supply is more flexible. Similarly, taxi companies try to keep their cars on the road as much as possible. But with Uber, it’s easier for drivers to work when it’s busy—say there’s a big event in town—and do something else when there is less demand for rides. In addition, having a flexible supply base is important for onboarding supply quickly when demand ramps up, as well as having the ability to ramp it down during off-peak times or seasons.

Supply becomes demand: Another great thing about shadow suppliers is that they can also often become your customers. An Airbnb host is likely to be an Airbnb customer when they travel, and a Wag* walker can become a Wag* customer when he/she gets a dog. When you have a professional supplier (think a plumber on Angie’s List, or a restaurant on Grubhub), they are probably not going to buy other suppliers’ goods.

What other Shadow Markets are out there?

I am always on the hunt for new shadow markets in which novel sources of supply can kickstart large new marketplaces. Emerging categories for shadow markets include some of the following, across both business and consumer markets:

  • Nursing: The market for nurses is massive and in many ways broken, as traditional staffing firms take large cuts to place nurses in hospitals and other facilities and have onerous pricing models. Meanwhile, the market itself is defined by a shortage of nurses. A shadow supply of certified nurses working on demand could deliver better care and provide advantages for both sides of the market—caregivers and patients.
  • Trusty and safety: Latent supplies of human experts in areas such as cybersecurity, investigation and traditional security offer untapped markets. These can be highly valuable, differentiated services unlocked by a trusted marketplace in the middle.
  • Alternative travel: More and more people are using new modes of transportation and experimenting with new types of travel experiences, driven by millennials’ need for new experiences. Companies that are innovating by using private land, vehicles, and other latent assets to create new forms of lodging for travelers are likely to unlock shadow supply.
  • Medical: Services like Uber and Lyft have rolled out transportation for healthcare services, which is a small step in the re-invention of the medical industry. Shadow supplies of ambulances, urgent medical care, or even less-regulated veterinary care could create disruptive models in the healthcare system.

But in truth, shadow markets can crop up in any industry, in any geography. As internet and digital marketplaces continue to connect more offline services, shadow markets will play a big role in re-defining categories and creating the next billion-dollar companies.

*Denotes a current or former Battery investment. For a full list of all Battery investments and exits, please click here.

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