Inefficiencies in a marketplace

When evaluating a marketplace, the first places to look are its supply and demand flows, and how well it matches the two. Growth and retention of the two sides (or more, as there can be three-sided marketplaces too), along with a match rate usually form form the primary health metrics of a marketplace. Match rate (or fill rate or utilization factor or a dozen other names) refers to the portion of demand (or supply, depending on your denominator) that is able to transact on the marketplace.

By and large, these are the primary ways to evaluate the operations of a running marketplace business. However, marketplaces are complex systems and there are a few other factors one must look at to assess quality and sustainability of its network effects. These are also important factors to consider when designing a new marketplace.

First: Information Flow. Information about sellers and their goods (or services) and information about buyers (when appropriate for the functioning of the marketplace) needs to be available fast, cheaply, easily and universally in the marketplace. An unequal information flow creates arbitrage opportunities and hurts some participants.

Second: Trust. Can market participants expect the marketplace provider to live up to their promises? Can buyers and sellers trust each other to enter into a mutual transaction? A lack of trust may not prevent a transaction, but becomes a transaction cost that may become prohibitively high.

Third: Competition. On both sides of the marketplace, and should be encouraged by the marketplace. An example of demand-side competition is when you find a vacation rental available in Lake Tahoe for the holidays, you know it will be taken by someone else if you don’t book soon. The marketplace can help a traveler understand how fast these homes are getting booked.

Fourth: Property rights. Is there clean definition of individual property, and is common property minimized? This is often key in physical marketplaces.

Fifth: Transaction costs. These can spring from inefficiencies caused by any of the above characteristics, or just inherent costs.

Some examples from the world around us:

The online display advertising marketplace used to be very poor in terms of information flow. It was hard to know how much to pay for a slot or worse, where your ad will display or which brands will be advertised on your website. With recent ad exchanges and real-time bidding tech, that gap has been closed. I think Facebook and Twitter ads have an information gap but since they own one side of the marketplace, advertisers don’t have much of a choice.

Craigslist has a distinct lack of trust.

Click fraud on text ads (like Google’s Ad Words) is a transaction cost arising from an inefficiency.

The job market (at least tech jobs in Silicon Valley) has an information problem as well as high transaction costs. People aren’t comfortable talking about compensation, so it is hard for a job-seeker to figure out current market rates. For employers, it is hard to figure who might be passively looking for a change. Costs are obviously high with the many steps required to even get into the interview stage.

Payment processing fees are inherent transaction costs, although no one thinks twice about them these days. However, handling physical cash also isn’t free.