Strategy

Online marketplace: How to build a case for your business

George Chang
George Chang July 9, 2021
Online marketplace: How to build a case for your business

Online marketplaces are not a new concept. They have been around for nearly as long as ecommerce has, but why has this business model erupted so quickly and garnered so much attention? The emergence of “Mega Marketplaces” such as Amazon, Alibaba, Uber and Airbnb, coupled with recently developed technologies from major SaaS providers, have together given rise to a new way of disrupting and accelerating the digital landscape. 

According to Forrester, online marketplaces have powered 80% of the growth in the ecommerce realm, which means the scale and customer adoption of marketplaces have displaced traditional first-party (1P) ecommerce as the preferred model, not only for B2C but also for various B2B industries.

COVID-19 added fuel to the acceleration of marketplace strategies as many companies turned to online marketplaces to sell their products in order to survive. Marketplace strategies not only help companies survive and thrive, but they also unlock latent potential, capturing key competitive advantages. 

So, why isn’t everybody launching new digital marketplaces and taking over the world? 

Key challenges in launching new marketplaces 

1. Online marketplaces are a black box

For many potential marketplace operators, this model represents an unknown variable from technological, operational, financial and strategic perspectives. Digital marketplace operators tend to be larger organizations or meteoric technology startups – making access to knowledge of the marketplace harder to find and more concentrated.  

2. Change management

Introducing or launching a new online marketplace is typically a transformative approach, impacting numerous departments. The organization may possess a certain structure or inertia which could create resistance to this change. According to renowned Harvard researcher, John Kotter, 70% of strategic projects don’t reach completion and/or fail. Marketplaces are one of those key projects which have a danger of sputtering to failure.

3. Technology

A vast majority of online marketplaces are built on custom platforms, each containing features and functions that are painstakingly scoped, prioritized, coded and then tested. Today, there are a handful of commerce development platforms that can help you build an online marketplace to sell your goods without an army of product managers and developers.

I’ve spent the majority of my career in ecommerce, especially around online marketplaces. I’ve been a top-five seller on eBay at two different companies, built the Newegg Marketplace, managed the Sears Marketplace, ran Rakuten’s ecommerce business which included 1P vendors and third-party marketplace sellers, sold enterprise marketplace software and was the CEO of one of the largest bedding sellers on Amazon. I’ve learned a lot of lessons, many of them the hard way, and now I would like to share those with fellow practitioners who are considering embarking on this same journey.  

Throughout the year, we will release a series of articles. Each post will focus on a specific lesson on how to successfully build an online marketplace to sell your products. You’ll read concrete examples from my own experience in online marketplaces and I will come with a specific asset to help you on your journey. My goal is to empower you by simplifying how you navigate the potentially treacherous marketplace journey and offer you key, tangible takeaways.

Building a business plan for your marketplace: Key actions

Build your business case

Building a case for a brand new ecommerce business model is one of the most challenging parts of the process since it requires the green light from your executive team. Companies often have processes where they evaluate multiple competing initiatives and have to prioritize projects that will have the highest positive impact on their business. 

For example, during my time at Newegg, we were already a fast-growing $2.5B USD retailer, but we were reaching the ceiling of growth with our current business. The company naturally had a number of initiatives on the table, such as an international expansion, building a new B2B team, enhancements to our core gaming enthusiast experience and launching an online marketplace to sell our products. I was tapped to run the online marketplace business unit, but I had to build the appropriate business case to justify capturing the precious resources needed to launch this strategic initiative.

In addition, once your marketplace strategy has been approved, it’s imperative to have a strong grasp of the budget and resources required to run the business. Some of these will be hard resources such as dedicated headcount and distinct marketing budget, whereas others are soft costs – either shared or borrowed resources from other departments like Finance, Customer Service, Logistics and Marketing.

In terms of building a business case for an online marketplace, I recommend splitting it into three different sections: financial forecast, strategic impact and customer satisfaction

  1. Financial Forecast – This is the direct and indirect revenue streams generated from the marketplace minus the operating expenses, which are a combination of hard and soft costs.
  2. Strategic Impact – What the value of a third-party marketplace is in terms of agility, brand perception and overall competitive landscape.
  3. Customer Satisfaction – Ultimately every organization’s mission is to satisfy the “customer”.

The parts of a business plan cover three main elements: financial forecast, strategic impact and qualitative customer benefits. Let’s explore these areas further.

Online marketplace Financial Forecast

Financial forecast

Direct/Operating Revenue Financial forecast based on the product/service transactions of the marketplace

Gross Merchandise Value (Marketplace) – This is the transaction value of the merchandise or service through the online marketplace.  

Gross Merchandise Value (Non-Marketplace) – If you are adding an online marketplace to sell products in your current ecommerce business plan, there could be an incremental benefit to your first-party (1P) nonmarketplace business.

Commission Revenues These are the proceeds from each sale (if there is a transaction) paid to the marketplace operator, normally calculated as a percentage of the sale.  

Indirect Revenue – These are revenue streams that are NOT derived from sales of the product or service

Seller Advertising These are funds that sellers contribute to either boost their brand recognition or increase the visibility of their products/service on your online marketplace. These are typically in the form of sponsored product ads or banner placements, as well as other marketing vehicles such as email blasts, higher search ranking and brand stores. These can be administered manually, built internally, built through a third-party provider or a combination of all three. Typically, this is something marketplace operators explore once the marketplace is mature and is generating substantial traffic. At Rakuten, 10% of our profit was derived from advertising funds from sellers.

Seller Subscription Some operators insist their vendors/ suppliers/ service providers pay some type of subscription fee in order to sell on the online marketplace. This ensures a higher overall quality of sellers on the online marketplace and also increases the operator’s profitability. An example of this is Amazon’s monthly Professional seller fee of $40 or Houzz’s Pro’s monthly fee of $59 USD for construction and interior design professionals. During my time at Rakuten, this helped to bring in a 6-figure profit number to my bottom line.

Third-Party Advertising – Expanding your catalog allows operators to expose different categories which in turn can be appealing for third-party advertisers or syndicated third-party ads.

Operating Costs and Expenses

Organization Head Count – The marketplace core team will require distinct, dedicated roles which need to successfully build and run an online marketplace. These can be supplemented by support departments in Finance, Customer Service and even Marketing.

Technology – In the old days of ecommerce, this meant hiring a small army of developers and setting up a bunch of servers. Today, however, there are many different online marketplaces to sell products on that you can choose from with various cost structures. I remember one instance when I was at Newegg, and we were uploading 10 million used books from a strategic marketplace seller into our catalog. My Director of Engineering told me we need to add $97,000 USD worth of infrastructure to host all the product content.

Marketing – Like every good digital strategy, you will need a marketing budget to support the expansion of your online marketplace to maximize the eyeballs on your expanded assortment. Oftentimes, third-party marketplace products can drive incremental sales to your 1P products. During my time at Rakuten, we heavily relied on Product Listing Ads (PLA) via Google since our third-party marketplace catalog was 20x our 1P assortment. Fifty percent of the traffic which originated from a marketplace item also clicked on a 1P item. In other words, the long-tail traffic of our online marketplace generated traffic to our core 1P products.

Credit Card and Returns – Credit card merchant fees usually add up to 3% and returns can range from 1% to 20% depending on the type of product so make sure you account for those costs upfront.

Online marketplace strategic impact

Strategic impact

Agility – Including an online marketplace to sell goods in your business strategy means the organization is adding products or services in a manner that is highly scalable and offers a quick response to the market. For example, Etsy recently reported its 2020 Q3 earnings of $2.4B USD, of which 11% of its total GMV came from masks, meaning it was able to add an incremental 11% to the business in 90 – 180 days, additionally taking seller interest away from other retailers.

Brand Perception – Many online marketplace operators will leverage third-party inventory to offer brands that have a higher position than their current inventory, therefore helping to improve their overall brand perception. For example, one of my former clients was a major fast-fashion retailer who wanted to onboard brands such as Nike and Adidas to augment their current assortment and elevate brand awareness.

Competitive Landscape – Similar to increasing agility, having access to third-party assortment arms the operator with a competitive advantage by offering a deeper or broader catalog. A competitor without access to third-party inventory would have a difficult time competing with the speed, scalability and agility of a company that has an online marketplace to sell third-party products in addition to their own.

Channel-Friendly Ecosystem (for Brands and Manufacturers) – A majority of your sales is (or has historically been) driven through your distribution and dealer network. However, recent customer shopping trends, plus COVID-19, have dramatically changed the customer shopping landscape. 

How do you migrate smoothly to a direct-to-customer strategy without upsetting the channel? How do you capture precious customer data to help you drive product development to help you survive and thrive? 

A Channel Management Marketplace helps remove friction from going directly to the customer by onboarding your distributors/dealers into your online marketplace. This creates a win-win-win scenario wherein the manufacturer captures all the data, the distributor/retailer enjoys the sale and the customer finds what they are looking for.

Customer satisfaction

Customer Lifetime Value – It’s no secret that happy customers are good for business. As a matter of fact, a study by Bain and Company found that an increase of 5% in customer retention could translate into increased profits of 25-95%! 

Another recent study from Forrester asserts companies enjoy a 1.5 base point increase in their CX index score when they utilize an online marketplace to sell a broader selection of products. Other elements include loss of revenues from out-of-stock items or limited brand assortments.

What about cannibalization?

Many companies inherently fear cannibalizing their current business and this often stems from incumbents within the organization. Unfortunately, this is a narrow-minded thought process and doesn’t represent a strategic mindset needed to succeed in today’s competitive environment.  

When I was running the business at Rakuten.com, we had both a 1P business and a third-party marketplace business. The online marketplace business was growing much faster than the 1P business, but there were also questions of cannibalizing sales. We actually did a study and discovered that 50% of our original traffic on third-party marketplace items resulted in customers browsing a 1P product instead. In other words, the marketplace was not only growing and adding value to the business, but it was also adding value to the 1P portfolio!  

The support you need

The online marketplace model can unlock the inherent value of your business and help propel your organization into a competitive advantage for years to come. It can be difficult; it can be challenging. However, there is help. 

VTEX has the technology, tribal knowledge, and customer-focused approach to help you succeed in building an online marketplace to sell diverse products. I hope these assets will be of value to you and if you have any other questions please feel free to reach out to me personally at george.chang@vtex.com.

In part two of this series, I will drill deeper into how to define your online marketplace approach and how to define your MVP (minimum viable product) scope.

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