A particular business pattern: multi-sided market.

What Is a Multi-Sided Market?

A multi-sided market (also called a two-sided marketplace or platform business) is a business model that creates value by connecting two or more distinct customer groups.

The key characteristics:

• Interdependent demand: Each group’s value depends on the other group. Riders need drivers. Drivers need riders.

• Cross-side network effect: More of Group A makes the platform more valuable to Group B, and vice versa.

• The platform is the bridge: You do not own the supply or demand. You own the connection.

Why multi-sided markets are powerful:

• Network effects create defensibility. The more users you have, the harder it is for competitors to catch up.

• You do not own inventory. Your costs scale differently than traditional businesses.

• You can take a percentage of every transaction (commission model).

Why multi-sided markets are hard:

• The chicken and egg problem (which side comes first?).

• You must serve two (or more) masters. What is good for one side might hurt the other.

• Network effects work in reverse. If you lose one side, the other side leaves.

Some great examples

In 1950, Frank McNamara: the credit card

A “member” of the Diners Club could charge meals at restaurants and pay the card company at the end of the month. Without enough cardholders, merchants wouldn’t participate, and without enough merchants on board, customers wouldn’t bother to obtain a card. Mr. McNamara loaded the charges on the merchants. American Express Company adopted this pricing model a few years later, and made a fortune.

Google: free premium or freemium

Google has created powerful and free tools to ease the communication amongst people (GMAIL, Google Hangout), share information (Google Prime, Google search, etc…), operating system (android) and much more… It even seems like Google tools are giving everything for free. However, there are some services useful for advertisers such as google AdWords and google AdSense. The more people Google reach, the more it creates value for advertisers and content creator.

Being at both side of the market

They are platforms that bring together two or more distinct but interdependent groups of customers. Credit cards, for example, link merchants with cardholders; computer operating systems link hardware manufacturers, application developers, and users; newspapers link readers and advertisers; video gaming consoles link game developers with players. They have existed for a long time, but proliferated with the rise of information technology. Microsoft Windows operating system, the Financial Times, Google, the Wii game console, and Facebook are just a few examples of successful multi-sided platforms.

Chicken or egg

The platform’s value for a particular user group depends substantially on the number of users on the platform’s “other sides.” A video game console will only attract buyers if enough games are available for the platform. On the other hand, game developers will develop games for a new video console only if a substantial number of gamers already use it. Hence multi-sided platforms often face a “chicken and egg” dilemma.

One-way multi-sided platforms solve this problem is by subsidizing a Customer Segment. Though a platform operator incurs costs by serving all customer groups, it often decides to lure one segment to the platform with an inexpensive or free Value Proposition in order to subsequently attract users of the platform’s “other side.”  One difficulty multi-sided platform operator face is understanding which side to subsidize and how to price correctly to attract customers.

The Chicken and Egg Problem (And How to Solve It)

The most common question for marketplace founders: “Which side do I build first?”

The answer: both. At the same time. But in one small, dense, balanced market.

Strategies to solve chicken and egg:

Strategy 1: Build One Side Artificially

Create supply yourself. Then attract demand. Then transition to real supply.

Example (Uber): When Uber launched, they hired their own drivers. They paid them hourly. They created supply. Then they attracted riders. Once riders were using the app, real drivers joined because there was demand. Uber phased out their own drivers.

How to do this: If you are connecting tutors and students, hire tutors yourself. Run the sessions. Validate demand. Then recruit tutors to replace you.

Strategy 2: Focus on a Tiny, Dense Market

Do not launch in an entire city. Launch in one neighborhood. One building. One college campus.

Example (Facebook): Facebook launched only at Harvard. Enough students to create activity. Not so many that the platform felt empty. Then expanded to other colleges.

How to do this: If you are connecting dog walkers and dog owners, launch in one apartment building. Get 5 dog walkers and 20 dog owners in that building. Make it work. Then expand to the next building.

Strategy 3: Subsidize One Side

Pay one side to join. Charge the other side. Once both sides are active, reduce the subsidy.

Example (PayPal): PayPal paid new users $10 to join. They subsidized both sides (senders and receivers). Once enough people were using PayPal, they reduced the subsidy.

How to do this: If you are connecting tutors and students, offer tutors $50 for their first session. Offer students $20 off their first session. You lose money upfront. You make it back on future transactions.

Strategy 4: Start with a Single-Player Tool

Build something useful for one side even without the other side. Then add the multi-sided element.

Example (OpenTable): OpenTable started as a reservation management system for restaurants. Restaurants used it even without diners. Once OpenTable had restaurants, they added the diner side. Diners joined because they could book at thousands of restaurants.

How to do this: If you are connecting freelancers and clients, build a time-tracking or invoicing tool for freelancers. Freelancers use it even without clients. Then add a “find clients” feature.

PSP/Xbox versus Nintendo Wii

Innovation: Powerful console for hardcore gamers

Traditionally, video console manufacturers targeted avid gamers and competed on console price and performance. For this audience of “hardcore gamers” graphics and game quality and processor speed were the main selection criteria. As a consequence, manufacturers developed extremely sophisticated and expensive consoles and sold them at a loss for years, subsidizing the hardware with two other revenue sources.

First, they developed and sold their own games for their own consoles. Second, they earned royalties from third party developers who paid for the right to create games for specific consoles. This is the typical pattern of a double-sided platform business model: one side, the consumer, is heavily subsidized to deliver as many consoles as possible to the market. Money is then earned from the other side of the platform: game developers.

Innovation: Fun factor for casual gamers

Nintendo, on the other hand, focused on a market segment that was far less sensitive to technological performance. Instead it lured customers with its motion-controlled “fun factor.” This was a much cheaper technological innovation compared to new, more powerful chipsets. Thus, the Nintendo Wii was less costly to produce, allowing the company to forego commercialization subsidies.

This is the main difference between Nintendo and rivals Sony and Microsoft: Nintendo earns money from both sides of its double-sided Wii platform. It generates profits on each console sold to consumers and pockets royalties from game developers. To summarize, three interlinked business model factors explain the commercial success of the Wii:

• Low-cost differentiation of the product (motion control)

• Focus on a new, untapped market that cares less about technology (casual gamers)

• Double-sided platform pattern that generates revenues from both “sides” of the Wii.

The Two Most Important Metrics for Multi-Sided Markets

Metric 1: Liquidity

Liquidity is the probability that a user finds what they are looking for quickly.

• For Uber: What percentage of ride requests get matched within 2 minutes?

• For Airbnb: What percentage of guest searches show available listings?

• For eBay: What percentage of buyer searches show relevant products?

Why it matters: Low liquidity drives users away. If a rider cannot find a driver, they delete the app. If a driver gets no ride requests, they stop logging in.

How to measure liquidity: Match rate (successful matches / total attempts). Speed of match (time from request to confirmation).

Metric 2: Balance

Balance is the ratio of supply to demand.

• Too many drivers, not enough riders → Drivers get no rides → Drivers leave.

• Too many riders, not enough drivers → Riders wait too long → Riders leave.

The ideal balance: Varies by marketplace. Uber aims for slightly more drivers than riders (so rides are always available). eBay aims for slightly more buyers than sellers (so sellers compete for buyers).

How to measure balance: Supply/demand ratio. Active suppliers / active demand users.

Pro tip: Monitor balance in real time. Use dynamic pricing (Uber surge) or waitlists to keep balance healthy.

How to build your own multi-sided platform

Who should you serve?

You won’t be able to serve everybody all around the world, so you should be specific and focus on at least 2 clear customer segments. Keep in mind that for a multi-sided platform to work, one customer segment won’t show up without the other.

Start by creating a community of users

Creating value and creating a strong sense of community between users is key to develop a multi-sided platform. A multi-sided platform grows in value to the extent that it attracts more users, that’s why you should focus on:

1. Attracting user groups

2. Matchmaking between customer segments

3. Reducing cost by channeling transactions

Turn your customers value into recurring revenue

Each Customer Segment produces a different revenue stream. One or more segments may enjoy free offers or reduced prices subsidized by revenues from other Customer Segments.  Choosing which segment to subsidize can be a crucial pricing decision that determines the success of a multi-sided platform.

How to recognize potential customers ?

As an entrepreneur, you want to make sure there are people who are going to pay for your products. As of now this seems useless until you face a “bad client”; the type of clients who almost make you hate your business. Then, how do you differentiate them from your true customers?

There’s no given radar, but you can make sure with the following stages:

1. They have have a need

2. They understand that they have a problem

3. They are searching for a solution

4. The problem is so important that they started using an interim solution

5. The customer has committed or can quickly acquire a budget to purchase a solution