Horizontal markets make a lot of sense in the physical world. Retailers like Walmart and Target cater to every need, are affordable, and can be found just about everywhere. The online world has its own horizontal giants. Amazon, Alibaba, eBay and Craigslist command significant market share, scale, and power.
Marketplaces are one of the few business models with true network effects
From an investment standpoint, marketplaces are particularly interesting opportunities since a leading company can easily assume a winner-take-all or winner-take-most position. Marketplaces are also one of the few business models that exhibit true network effects; supply and demand follow each other. Look, for example, at the ongoing battle between Uber and Lyft.
There is no incentive – for drivers or passengers – to align with the second most popular transportation marketplace service, and solving this through crazy financial incentives isn’t sustainable. It’s simple: drivers maximize their income by tapping the largest pool of potential passengers (demand). Passengers, meanwhile, have no incentive to choose the second largest transportation provider. Accessing the largest pool of drivers (supply) increases the odds that they’ll find an available driver nearby and minimize wait.
It’s a high stakes battle: when one company controls a market with strong network effects, they can generate huge profits, retain customers and keep competitors at bay – which usually means the leader takes all.
Marketplaces reward the first mover advantage
If you can identify the winner early, an investment has less risk. First mover advantage often provides an “unfair advantage” — the first company to reach meaningful scale stands a much better chance of owning the category. Being the biggest in a winner-take-all world means a bigger exit (or bigger company), since the ecosystem doesn’t get fragmented. The reduced competition lets companies grow faster. Even a winner in a smaller market can sometimes be more lucrative than a second or third – or even first – in a much bigger category, simply because there’s less competition.
The flaws of horizontal marketplaces
The problem with horizontal marketplaces is the winners have already been declared – and they’re very difficult to disrupt head on. Because there’s not room for many (if any) more horizontal Goliaths, vertical marketplaces (businesses that cherry-pick elements from broader horizontal incumbents) become more compelling. By exploiting the inherent weaknesses of horizontal leaders and intently focusing on a single product or good, these companies can deliver a vastly improved customer experience, presenting an opportunity for vertical competitors to gain traction.
As an example let’s use the classic horizontal marketplace: the flea market. While there are a huge variety of goods at these gatherings, it’s often hard to find what you want, due to the overwhelming number of choices. Assuming you do find what you’re looking for, you then have to haggle with individual sellers. And, there are no guarantees as to the quality or reliability of your purchase.
In many ways, the flea market is an offline analogy for what we see on horizontal Internet markets like Craigslist, right down to the flaws. Horizontal marketplaces may enjoy massive scale and liquidity, but shortfalls in consumer experience leave them vulnerable to disruption by focused “vertical” players.
The importance of customer experience for vertical marketplaces
An effective, intuitive and painless customer experience is critical for vertical marketplace companies. It’s the Achilles’ heel of horizontal marketplaces – and it’s the best way to make your business capture the coveted market leadership position.
The early rollout of verticals was fairly slow. Over the past few years, though, they have emerged at a more rapid pace.
For example, hust in secondhand apparel and accessories, we saw how companies like Poshmark, Twice, ThredUP, Tradesy, and The Real Real grew very quickly.
The proliferation of vertical marketplaces
In other verticals, we saw how companies like Raise (gift cards and store credits, a Bessemer portfolio company), MIND BODY (a fitness and wellness marketplace, a Bessemer portfolio company), and Chairish (furniture) emerged. This proliferation took place for a few reasons:
- First and foremost, the number of people willing to buy online and from a marketplace has grown dramatically in the last five to 10 years. Verticals that used to be too small to sustain standalone marketplaces now have a potential customer base that’s meaningful.
- The advent and adoption of many online trust and safety mechanisms (like review scores, credit card fraud protection, etc.) have transformed Internet marketplaces, making them safer and more reliable.
- The trend toward urbanization has also made it easier for verticalized marketplaces like Uber and Airbnb (which thrive on density in a geographical area to get started) to develop liquidity.
- At the same time, there have been dramatic improvements in the ability of marketplaces to target and advertise to specific consumer subsets, such as highly targeted Facebook advertising, which can narrow an audience based on specific zip codes or interests.
- Meanwhile, the proliferation of mobile devices has reduced the friction involved in supply and demand generation. The limited screen real estate on mobile devices has also encouraged focus and simplicity within a shopping experience, making vertical marketplaces a better fit for this form factor than broader horizontal destinations.
- A number of new technologies like elastic search have also gained popularity, allowing much deeper querying and algorithmic matching of buyers and sellers.
We’re only at the beginning of the road for vertical marketplaces – and that’s an exhilarating place to be for both venture capitalists and entrepreneurs. With so many verticals that are still untapped, there’s plenty of room for startups to make an impact – and for those that already have, the growth potential is massive.