Marketplace Businesses and the Network Effect
Source: https://www.nirandfar.com/the-curse-of-the-network-effect/
Marketplace businesses are platforms that connect two or more parties, often buyers and sellers, in purchase activities. For instance, a restaurant booking platform and connects consumers to restaurants. For this kind of businesses, the more users using the platform, the more valuable the platform becomes—in the example above, consumers will be able to find more good restaurants and restaurants will be able to reach more consumers. Thus, we can say that these businesses benefit from network effects. As soon as they pass a threshold, these businesses would grow quickly and become “winner-take-all” companies. Some well-known examples are eBay and LinkedIn.
The blog article is about one of those successful marketplace companies called Zvents, a platform connecting events and local people. Riding on the benefits of the network effect, Zvents grew incredibly fast, becoming one the largest event sites of its kind, attracting more than 14 million visitors every month. However, the network effect did not promise the long-term success of the business.
In the words of Ethan Stock, Zvent’s CEO, “the network effect became a liability”. When marketplace businesses like Zvent grow to a certain extent, buyers will have the expectation that the information on these sites is complete. For Zvent, it meant that all events should be up on the website for local residents to view. This expectation hinders the company’s ability to make money. When Zvent became the market leader and thus wanted to charge event organizers a fee to put their events on the website, surprisingly, many organizers refused to do so. Zvent could not threaten the organizers who did not pay to remove their events from the site, as the platform was expected by the users to be displaying everyone’s events. This resulted in a case where Zvent created value for the organizers, yet was unable to monetize the value—if the value of the business could not translate into actual profit, then what for? In the end, it is the money that keeps the business going.
In fact, many other marketplace businesses face the same difficulty as Zvent did—one example is Google. As Ethan Stock stated, the value that Google created is far more than the value it captured. When we type something and click search on Google, we expect Google to give us a complete list of results from our keywords. If Google only displays to us the information from companies who pay Google, we would probably switch to other websites for more comprehensive information. The fact is that most of the information on Google is not paid by someone to be accessible by Google users—the fact is that Google could have made so much more money by charging all companies a fee to be on Google, but could not do so due to users’ expectation of completeness.
In class, we learned about how the network effect allows social media platforms to grow. From that point of view, it seems that the network effect was only doing good to these businesses. However, when considering the long-term growth of a company and the profitability of such platforms, we have to re-evaluate whether the network effect is a curse or a blessing. On one hand, it is definitely unfair to say that the network effect is bad, since it can indeed contribute greatly to the grow of a marketplace platform. On the other hand, the benefit of the network effect is partially offset but the liability—the expectation from customers, sometimes—it brings along.
Is there a way to go around this issue? The blog suggests that this may not a problem for two-sided platforms that facilitate the monetary transaction themselves between buyers and sellers. When the flow of money goes through the platform, it is more reasonable and acceptable to collect a share of the transactions. Indeed, this could be solution for marketplace businesses that struggle to make profit.