Three reasons why marketplaces fail (and how not to)

Peer-to-peer marketplaces can be truly phenomenal businesses. They combine the convenience of online stores with a powerful advantage: on a P2P platform, every new customer can also become a provider.

This combination is so powerful that starting a new peer-to-peer marketplace might be one of the most popular online business concepts today. Many people are inspired by the recent successes of Airbnb, Etsy, Lyft, and the likes and want to apply these ideas to new markets. If you're one of them, I recommend you also take a look at our step-by-step guide on how to build an online marketplace.

Building a marketplace platform has never been easier. But building a successful peer-to-peer business is hard. In this article, I discuss some of the most common pitfalls I have encountered while working with peer-to-peer marketplaces since 2008. I look at three common reasons why early-stage marketplaces fail: they don't solve a real problem, their focus is too broad, or their business model doesn't scale.

People love peer-to-peer platforms, particularly those operating in the field of the collaborative economy. This enthusiasm is good news for an aspiring entrepreneur, but it also presents a challenge. Namely, the fact that people say they love your new marketplace idea doesn't necessarily mean they will use it.

Finding the right problem to solve is a common challenge for any startup, but it can be particularly tough for marketplaces. Adam Berk has written an insightful story about his experience with Neighborrow, one of the first "share with your neighbors" style startups, which he co-founded in 2006. Berk started with a familiar concept. Everybody owns lots of valuable stuff (power tools, sports equipment, cameras, and so on) that spends most of its lifecycle collecting dust in the closet. If neighbors could share these assets, there would be a lot less waste. What is more, people could make some extra money, and neighbors would interact with each other more. Everybody wins!

Not surprisingly, everyone loved the idea. Neighborrow was invited to all kinds of startup events, and the press was all over them.

But the company never reached liquidity (find a definition for this marketplace term and others in our marketplace glossary). People who said their concept was great never actually used the product.

Neigh*borrow hit the issue described by Jeremiah Owyang & Vision Critical in their report Sharing is the New Buying: How to Win in the Collaborative Economy. The report shows that while people like the concepts, the masses still use P2P marketplaces for the same reasons they consume products in general: to get a lower price, better quality, or convenience. While people find sustainability and a sense of community important, these values do not necessarily guide their actions.

Peer-to-peer marketplaces that enable sharing of relatively low-value items (like power tools, bikes, and kitchenware) are most likely to struggle with solving a problem. The challenge with such concepts is that they create a lot of friction. I have to sync my schedule with another person twice (to pick up and to return the item) and trust the person not to break anything. With low-value items, the money saved is often not enough to make up for the inconvenience.

Furthermore, while Airbnb can compete by offering "unique experiences" (like staying in a castle), the same does not apply to tool sharing. A power drill is a power drill.

This does not mean that a tool-sharing platform wouldn't be a great marketplace idea in general, though. It just means entrepreneurs should validate their idea carefully. A recent example that is currently seeing exponential growth in this space is the Dutch Peerby. They have innovated by creating a "reverse marketplace" based on borrowing requests instead of the traditional inventory-based model. With that model, they have managed to optimize convenience: their value proposition is that you will get the item you need within 30 minutes. That is usually a lot quicker than going to a store to buy it.

The lesson: Make sure you solve a real problem for your users. Find a way to launch a prototype as soon as possible and make sure people will actually use your product.

After finding a problem to solve, the next challenge is to start with a narrow-enough focus. Surprisingly often, I come across people who have a marketplace idea to "share everything". Intuitively, such an idea does make sense: people who are willing to share their tools with peers are probably also likely to share their cars. When you have built a network of trust for sharing one group of products, why shouldn't you use it for other assets as well?

An excellent summary of this lesson comes from investor Shervin Pishevar. He explains why he invests in companies that target only certain sharing economy verticals in a Pando interview. "That's what people want: a single-purpose company that provides a very powerful service people can trust."

Building a good product is so much easier if you target a specific segment. If you try to please everyone, you often end up pleasing no one. Furthermore, it's much easier to make a compelling marketing message and find the correct communication channels when you have a narrow niche in mind.

Building your initial supply is also significantly easier when you're focusing on a single vertical. For example, let's say I'm building a marketplace to share power drills. It's relatively easy to find 100 people in my city who are willing to offer their power drills for rent. With this initial supply, I can already offer a great experience for the person who comes to my site looking for a drill. They're pretty likely to find one that is available near them.

If my site were for "sharing everything" or even sharing tools for any purpose, I'd have a much harder time building that supply. Even 1,000 or 5,000 listings for different kinds of drills, sanding machines, and power saws would disappoint a customer who came looking for wire cutters.

Lyft is an example of a company that does this really well. Their peer-to-peer marketplace only offers one type of service: rides. Meanwhile, horizontal players like TaskRabbit that try to cover all different kinds of services have struggled to scale their model. The clothes-swapping marketplace thredUP first targeted all types of clothes but saw big growth only after the decision to focus solely on kids' clothes. Only after they gained significant traction in this one niche were they finally able to broaden the focus again. The same pattern applies to rentals: many startups have noticed that focusing only on swimming pools or 3D printers, in the beginning, works better than going after multiple verticals at once.

A broad focus in the very early days does not necessarily lead to failure. In some cases, it might work to your advantage and help you find the right niche to focus on. At other times, though, doing lots of different things might prevent you from finding traction for any vertical. In general, my recommendation usually is to start with one niche and then change to another if it doesn't work. This approach requires much less capital.

The lesson: Launching a peer-to-peer marketplace is much easier when your focus is limited. Choose your niche, build a high-quality initial supply, and win over customers before broadening your scope.

So you've found the core problem to solve and picked the right niche. Now let's talk about how to make your marketplace business model sustainable.

First, you need to think about what it is that you want with your business. Are you planning to build a large VC-funded global marketplace business or a smaller local business? This decision can make a big difference. Let's look at a few examples to illustrate the point.

Zaarly was previously one of the best-known "reverse marketplace" businesses out there. At its peak, it processed more than $1 million in transactions per month. However, Zaarly had also raised a large amount of venture capital and was thus aiming for fast growth. While $1M may sound like a lot, it doesn't necessarily mean a huge business. As Sunil Rajaraman calculated in TechCrunch, the way Zaarly's commission model was structured meant that it only received $15k in revenue per month. A nice amount of money if you are a local business, but not enough for VCs. So Zaarly decided to pivot. And then pivot again.

There are many similar stories. ThredUP, having found its niche after the pivot discussed in Lesson 2 of this article, was also struggling with similar challenges in 2012. Eventually, this led the company to abandon the peer-to-peer model completely and instead become an online consignment store, angering its original community. TaskRabbit's pivot in 2014 caused similar angry reactions. TutorSpree shut down its marketplace after getting 7,000 tutors to sign up, and LooseCubes ceased its operations only a few months after its big funding round.

All these marketplaces were doing well by many measures. The only reason they shut down was that either their founders, investors, or both wanted more.

To sum up the lesson behind these examples, it currently seems like the once-popular reverse marketplace model has been difficult to scale. At the same time, service marketplaces with an on-demand booking model—like the ride-sharing apps Uber and Lyft—have been doing well.

All these examples also show that fast growth and VC money can be a double-edged sword for a P2P marketplace startup. As Raz Godelnik notes in his article about ThredUP's latest pivot, "it's impossible to be both Freecycle and eBay." If you want to build a big business, it can involve tough decisions that can sometimes conflict with the original values of your concept.

In the VC world, there are only a few winners. The examples of Freecycle, CouchSurfing, and StreetBank show that it's possible to scale a marketplace and have a big impact even with a non-profit model, but this is not without its challenges. Non-profits need money too, and it's really difficult to find a sustainable model solely through donations and similar sources of financing.

Luckily, there are more and more examples of successful marketplace businesses that have been built by bootstrapping.

What is more, everyone doesn't have to become big. The unique nature of the collaborative economy makes it possible for small, highly focused peer-to-peer platforms to thrive alongside their more prominent companions. A peer-to-peer marketplace for sharing low-value items can make a great lifestyle business, even though it might not be very interesting from a VC perspective. There are lots of similar niche marketplace concepts out just waiting to be discovered.

Another piece of good news: the cost of marketplace technology is a lot lower than before. You don't need VC money to build a profitable local marketplace business. With marketplace software like Sharetribe, you can set up your marketplace in a matter of minutes for a fraction of the cost of hiring a developer.

The lesson: If you're after VC funding, make sure your business model can scale fast enough. It's often a better idea to start by bootstrapping and build a sustainable local business.

In this article, I've looked at three common pitfalls for P2P marketplaces.

First, I discussed arguably the biggest challenge for any startup: finding the right problem to solve. The pitfall is particularly vicious for sharing-economy platforms because people tend to love the idea of such initiatives but never use them. The best way to battle this challenge is to validate your idea carefully, build a Minimum Viable Platform, and launch it as quickly as possible.

The next challenge comes with finding the right focus. All too often, marketplace founders aim at tackling multiple verticals with one solution and then fail to gain traction. A much better idea is to start small and focus on building supply and finding customers in a limited niche.

Third, peer-to-peer platforms struggle with finding the right marketplace business model for their business idea and plans. For VC-funded platforms with ambitious growth plans, in particular, the pace at which the business model scale might cause a challenge. Often, bootstrapping with a small local business and growing the marketplace from there is the key to long-term success here, too.