Sustainable ways to grow cash-burning marketplaces
Consumer-to-consumer platforms can overcome significant cash burns and achieve long-term growth by leveraging scarcity, a new study finds
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Amazon’s three-decade journey from a Seattle garage to a US$1.8 trillion market cap demonstrates the almost limitless potential of two-sided marketplaces in the internet age. It’s a simple concept; match buyers and sellers using their smartphones and then take a cut from the resulting trades.
Two-sided marketplaces, also known as consumer-to-consumer (C2C) platforms, lack inventory and have low staff costs, which powered the concept into sectors as diverse as freelancing, holiday rentals and second-hand clothes. They also permanently changed global shopping habits with China alone recording US$3.3 trillion worth of sales in 2023.
The success of Amazon and its Chinese peer Taobao demonstrates the other major advantage of this business model – scalability. But achieving scale costs money, lots of it. Amazon’s first profit in 2001 came off the back of losses close to US$150 million in the previous year, and other big names have plunged even further into the red as they pursued growth.
Uber burned through US$25 billion of cash over 13 years before recording its first quarterly profit in 2022, vacation home platform Airbnb lost US$1.2 billion in the year ahead of its 2020 IPO, and Walmart-backed Indian e-commerce outfit Flipkart burnt US$3.7 billion of investor’s cash in 2022.
“We have probably all seen many business cases where companies burn cash to grow their marketplaces in the early stage,” says Kevin Chen Hongfan, Assistant Professor of the Department of Decisions, Operations and Technology at the Chinese University of Hong Kong (CUHK) Business School.
While matching buyers and sellers and taking a cut is a simple idea, the interplay between the diverse groups active on these platforms is complex. With the established business model of C2C platforms typically being to subsidise the early stages of growth and then make profits over the long term, discovering the most efficient way to incentivise participation has major cost implications.
“What should the growth strategy be for a two-sided market that has many supply and consumer types? How is the growth strategy related to the most basic economic intuition that scarcity creates value?” Professor Chen asks.
In a paper titled The optimal growth of a two-sided platform with heterogeneous agents, Professor Chen uses an analytical model without a true dataset to answer the above questions. Co-authored by his colleagues from the same department, Professor Sean Zhou and Associate Professor Philip Zhang Renyu, as well as doctoral student Zhu Yixin, the paper delves into how growth potential and network structure influence the optimal commission approach for platforms during the growth and maturity phases.
Finding the scarcest agents in the marketplace
The number of variables involved in C2C platforms is vast, but Professor Chen says three key components exist for designing commissions in the platform’s growth strategy. “Firstly, scarcity creates value,” he says. “Targeting the scarcest type of market participants is a good growth strategy.”
The scarcest agents refer to either buyers or sellers that are currently underrepresented or have the lowest population ratio compared to a benchmark in the long run. For example, if the platform finds the benchmark to be optimal to serve 20 sellers and 100 customers on the platform, while currently there are two sellers and only five buyers, the buyers are the scarcest agents because they are in lower numbers relative to the platform’s targeted state.
Secondly, while the above example illustrates how to identify the scarcest resources in the marketplace, the platform needs to identify the state of the size of market participants, under which it can maintain and maximise long-term profit. Here, the scarcest agent refers to the user segment that has the lowest population ratio compared with this state.
“Such a benchmark can provide good guidance for the platform’s commissions,” he says. By focusing on the scarcest agents, the platform can implement strategies to attract more of them, such as offering incentives, lowering fees, or enhancing marketing efforts to bring in more buyers or sellers, depending on which group is lacking.
“Thirdly, the platform could target the quality of service from both sides as the metric in the design of its commissions, and these should be structured to achieve the fraction of market participants to participate in trades out of the potential market size,” Professor Chen adds.
Different strokes for different folks
C2C marketplaces vary widely. The needs and spending power of a corporate client looking to hire a web developer for a long-term project over Upwork are markedly different from those of a teenage Taylor Swift fan scouring Etsy for a new friendship bracelet.
Take Amazon, the most visited e-commerce platform globally. Its network effects can power supersized growth in C2C marketplaces, which can result in a winner-takes-all competitive landscape. However, this is not true for all businesses and every location.
Consumers are willing to use multiple food delivery services, and ride-hailing apps such as Uber and Lyft have been unable to repeat their US success in numerous Asian markets when faced with competition from local players like Grab and Gojek.
“Every platform is different and the competitive landscape of the platform determines how urgent the platform needs to take the market. However, growing the scarcest agent type relative to the long-run benchmark could create value in the long term,” he says.
About the researchers
Professor Sean Zhou
Professor Sean Zhou is currently a Professor and the Chairperson in the Department of Decisions, Operations and Technology at CUHK Business School. He is also the Director of the Supply Chain Research Centre under the Asian Institute of Supply Chain and Logistics at CUHK. He received his bachelor of science in electrical engineering from Zhejiang University in 2001 and a master of science and PhD in operations research from North Carolina State University in 2002 and 2006, respectively.
Professor Philip Zhang Renyu
Professor Philip Renyu Zhang joined CUHK Business School as a visiting scholar in the Department of Decisions, Operations and Technology in 2021 and has been an Associate Professor since 2022. He holds a PhD degree in business administration (operations management) from Olin Business School at Washington University in Saint Louis and a bachelor’s degree in mathematics from Peking University. His research interests are applying artificial intelligence and data science to address fundamental business operations issues under the emerging trends in technology, marketplaces, and society.
Professor Kevin Chen Hongfan
Professor Kevin Chen Hongfan is an Assistant Professor of the Department of Decisions, Operations and Technology at CUHK Business School. He received his PhD and master of business administration degrees in operations management from the University of Chicago Booth School of Business. Prior to that, he studied industrial engineering and applied mathematics at the Georgia Institute of Technology. Professor Chen’s research primarily focuses on revenue management, platform marketplaces, and optimisation under uncertainty.