In this new series we explore market design and the holy grail of all online marketplaces – thickness.
Let’s walk through a hypothetical scenario: whenever you open your Uber app to book a ride, you only find a cab available around you about half the time. Would you use Uber as your preferred mode of transit?
How about this: the only way to find a ride on Uber was to text the ten closest drivers and hope one of them would reply to your text to confirm your ride. Does that sound more convenient than going to the curb and sticking your hand out to stop a passing taxi?
Each of the above scenarios is a perfect recipe for what economists call market failure. For a marketplace to thrive, it needs to prevent the above nightmare scenarios on its platform. In our last series, we spoke about the role of risk-reward tradeoffs in online marketplaces such as Uber. Today we’re answering a far more fundamental question – how are marketplaces designed?
An art and a craft
Market design is a relatively recent field of economics that seeks to address the kinds of market failures mentioned above. One of the founders of this school of economics, Paul Milgrom, described the field as “a kind of economic engineering, utilizing laboratory research, game theory, algorithms, simulations, and more.” While game theory offers structure for players to understand the rules and ideal strategies of a game, market design gives the market-maker tools to influence the behavior of participants to produce a desired outcome.
Three things markets need to do to function properly
In order for a marketplace to function smoothly, it needs three critical attributes – thickness, the lack of congestion, and safety.
A thick market is one where there are a sufficient number of buyers and sellers to ensure that most of the players can transact satisfactorily. However, as markets become thicker they risk becoming congested if the right buyers and sellers can’t find each other. Finally, even if the marketplace is thick and not congested, it still needs to create a safe environment where buyers and sellers can transact based on trust. Let’s look at each of these factors at play in online marketplaces.
A thick market – Uber ETAs and idle times
Nascent marketplaces need to ask themselves the question – how thick is thick enough? As always, the answer is ‘it depends’.
In 2017, The New York Times created a fascinating simulation that allowed people to vary the number of drivers in a city while holding the number of customers constant. The simulation allows readers of the times to understand the impact on customer ETAs and idle times, i.e., the amount of time a driver spends not carrying a fare. In this case, as the supply in the market gets thicker, customer wait times fall. However, driver idle times increase. For riders, a satisfactory outcome is achieved. For drivers, the outcome could be considered desirable if the fare they charge for a ride adequately compensates them for their increased idle time. Of course, Uber rightly pointed out in a press release, that falling ETAs attract more customers to the platform leading to a decrease in idle times as well.
Congestion – Airbnb’s rejection problem
The early successful online marketplaces were able to address thickness in a way that traditional platforms could not. The next question is ‘how thick is too thick?’ It all depends on how the marketplace deals with congestion.
In 2015, a study found that 49% of inquiries on Airbnb were rejected or ignored by the host leading to half of customers abandoning their purchase. The fact that a user’s search for a host is impeded by faulty listings and that the search process is too burdensome for some users are signs of congestion.
To deal with congestion, marketplaces can improve the quality of “inventory” or make it easier for users to find what they are looking for. In 2017, Airbnb pushed more hosts towards ‘Instant booking’. This opt-in feature ensures that a host is available and reduces congestion on the platform. Ultimately, a marketplace is too thick/congested if users are frustrated enough to leave the platform.
Safety – eBay faked it, but StockX made it
Safety and trust remains the moving goal post for online marketplaces. The internet allowed people to invite strangers into their homes and into their vehicles but it brought with it a new challenge – trust. Trust comes from reputation and repeated transactions. New marketplaces entries have used trust as a differentiating factor successfully. For example, StockX, a marketplace for rare and collectible sneakers, verifies each purchase made on its platform and provides a physical “Verified Authentic” tag. For a market that suffers from counterfeit products, this physical tag became a symbol of trust that buyers were willing to pay a premium for.
The challenge of marketplace design
We think these concepts are well documented in both tech and econ literature.
Obviously platforms need users, users need to be able to find matches, and matches need to be safe and trustworthy. The most urgent of those requirements, and the top of our marketplace design funnel, is users; both buyers and sellers.
The most studied and yet most misunderstood aspect remains thickness. Everyone is familiar with the term network-effects, but in today’s tech parlance, it’s become synonymous with scale. A thick market can be an engine for virtuous growth. Increasingly though, it’s clear that marketplace adoption resembles punctuated equilibrium and market leadership can be ephemeral. A key question for engineers, designers and economists at these companies would be to understand how to retain their users to maintain marketplace thickness.
I’m a product and strategy professional with 6+ years of experience in consumer technology and strategy consulting. I write about product management, business strategy and my experiences as a young professional in consumer and B2B software.
I am a finance and strategy analyst with an entrepreneurial background and research experience at the Federal Reserve. I am interested in tech products, network economics, and corporate finance.