What is marketplace liquidity?

Definition of marketplace liquidity

Marketplace liquidity is the likelihood that a transaction will happen on your marketplace.

When a buyer types something into your marketplace search, is that search likely to lead to a purchase? When a seller creates a listing on your marketplace, will the listing likely to get sold?

If an average user is likely to get the value they are looking for out of your marketplace, you have high liquidity.

Especially in the early stages, liquidity is a question of finding the right balance of customers and sellers to join your marketplace. If that balance is off, the likelihood of finding something to buy or customers to buy what you’re selling decreases.

Before reaching liquidity, early-stage founders face the chicken-and-egg problem. How to grow a user base when there’s no liquidity yet, and hence no value offered to either side? (Here’s a resource with 30+ examples answering this question.)

Liquidity is also a prerequisite for network effects – a powerful mechanism that is responsible for the value and defensibility of today’s marketplace unicorns.

As marketplaces are two-sided, there are also two sides to marketplace liquidity: seller liquidity and buyer liquidity.

Seller liquidity on a marketplace means the probability of a listing leading to a transaction within a certain time period.

Buyer liquidity on a marketplace means the probability of a visit leading to a transaction.

Why is marketplace liquidity important?

Liquidity is much more than one more marketplace metric to track. It's the difference between whether you have a marketplace product or not.

If you don't have liquidity, user's don't get a solution to their problem. Your marketplace isn't providing value. If you're not providing value, you don't really have a product.

Simon Rothman from Greylock Partners has said about marketplace liquidity:

"Liquidity isn't the most important thing. It's the only thing."

Josh Breinligner, investor and marketplace expert, said in our interview: the marketplace isn't your product, your product is liquidity.

Let's unpack this by looking at the concrete benefits of marketplace liquidity and the factors that affect reaching liquidity.

Benefits of marketplace liquidity

The core value proposition of any marketplace is that they match supply and demand. Here's why liquidity is essential for delivering this value.

• Efficient transactions. High liquidity means there are enough participants to match buyers and sellers complete transactions quickly and easily.
• Price discovery. Price discovery means the process where the participants in a market collectively determine the value of an asset through transacting. The more transactions your marketplace has, the more data points there are for determining the value what's being sold. The offering on liquid marketplaces is priced in a way that reflects their value, which makes the offering attractive for more users.
• Trust. The more users are in contact with each other, the likelier they are to trust one another. When users see transactions happening quickly, reliably, and at a good price level, they become increasingly confident in your marketplace.
• User satisfaction. The value of your marketplace is in matching supply with demand. Liquid marketplaces do this efficiently, which means they offer a lot of value. Liquidity, then, is the cornerstone of marketplace user satisfaction.
• Network effects. In network effects, an increase in users increases the value of a product. A liquid marketplace offers value, which attracts more users. These users increase the value of the marketplace, and the added value, again, brings in even more users. This positive feedback loop makes marketplaces more and more valuable over time, increasing its market share and defensibility.
• Stability and resilience. A liquid marketplace has fewer large price swings and is less vulnerable to external disrupts like economic downturns or regulation changes.

So, in a sense, liquidity doesn't bring a marketplace benefits -- liquidity the difference between wether you have a marketplace product or not.

That being said, liquidity isn't a purely binary phenomen that either exists or doesn't. There are many aspects than can impact the degree of liquidity on your marketplace.

Aspects that influence liquidity

Several key aspects influence marketplace liquidity:

• Number of users: When a marketplace grows, its liquidity improves (see also: network effects -- an increase in users increases the value of a marketplace). However, this only works if liquidity is already established and a balance of supply and demand is maintained. Striving for volume before reaching liquidity is recipe for marketplace failure.
• Trust. When participants trust the fairness and stability of a marketplace, they are more likely to engage actively and initiate transaction.
• Transparency: Clear information about products, prices, and transaction processes encourages participation.
• Pricing. Pricing discovery means the mechanism of establishing a price that works both for the supply and the demand. When the price is right, both parties are likelier to stay active on your marketplace because they get value from participating in transactions.
• Payment flow: The less friction in your payment flow, the easier it is to transact. The easier it is to transact, the higher the likelihood of successful transaction, and thus the higher the liquidity.
• Stability and security. Marketplaces that regulate and moderate their users' behavior are more stable and reliable to usres. Protection against fraud and compliance with market regulations is also an element of stability.
• Marketplace tech: Technological solutions can be used, for example, to improve the discovery and matching of buers and sellers and remove friction and increase trust in the payment process. Analytics tools help founders make data-driven product development decisions that boost activity on the marketplace.
• Focus. A narrow vertical and geographical focus helps establish liquidity in the early stages. As the marketplace begins to scale, strategic expansion into new geographies or verticals can boost the overall liquidity of a marketplace, provided that liquidity is first reached within the original and new geographies and verticals.
• Accessibility and inclusivity: Poor accessibility is an artificial blocker that prevents users that otherwise fit the target market from joining the marketplace. Removing such barriers of entry can increase participation. Furthermore, accessibility improvements tend to improve usability for the entire audience.

To sum up, marketplace liquidity requires a balance between supply and demand. In addition, many things related to the business model, business strategy, and platform technology can impact liquidity.

How to measure marketplace liquidity

The most important metric for sustainable marketplace growth is liquidity. It can be tracked with a combination of three metrics:

• Sell-through rate
• Purchase rate
• Seller-to-buyer ratio.

Many marketplace founders, in the early stages, obsess over metrics like the number of users or the number of transactions.

The problem with these metrics is, first of all, that they're not actionable: they don't give any input on what should change for the business to grow.

Second of all, these numbers don't help with understanding your liquidity.

A high number of transaction or users doesn't necessarily mean that the supply and demand are well-matched. What you're interested is is the share of your sellers and customers that is actively reaching their goals on your marketplace -- not their crude numbers.

Because marketplaces are two-sided, liquidity needs to be measured separately for both sides: the sellers and the buyers. It's also important to look at the ratio of seller to buyers.

Seller liquidity metrics

Seller liquidity on a marketplace means the likelihood of selling what you list within a certain time period. This can be measured by:

• Sell-through rate = The percentage of listings that result in a sale within a certain time frame. The higher the rate, the higher the liquidity.
• Average time to sell = the average duration from listing an item to its sale. Shorter time suggests higher liquidity.
• Volume of repeat sellers = number of sellers who repeatedly list and sell items. A high volume indicates a healthy marketplace for the sellers.

Sell-through rate is the most important supply liquidity indicator. Note that your marketplace type plays a role in how you measure sell-through rate:

• On product marketplaces like Amazon, Ebay, or Etsy, you should measure the share of stock of a single seller, or the percentage of the overall stock, that's sold on a given time period (like monthly or quarterly).
• On rental marketplaces like Airbnb, Turo, or WeWork, measured how much usage the rental property or good is getting or how big a proportion of all assets are booked on a given day.
• On service marketplaces and on-demand platforms like Uber, Upwork, or Thumbtack, you might want to look at hourly availability. How many hours of the day can the supply successfully sell on your marketplace, or how big a percentage of suppliers are on duty on a given hour of the day.

Buyer liquidity metrics

Buyer liquidity on a marketplace is the probability of finding what you're looking for on the marketplace. You can measure this with:

• Purchase rate = the percentage of unique visits to your marketplace that lead to a sale. You can measure this by dividing the number of unique visits with the number of transactions within a certain time period. According to Simon Rothman, a good goal is between 30 and 60 percent.
• Search-to-fill rate = the share of searches (or requests) that lead to a sale. If search is a necessary component of your marketplace buyer journey, you can measure liquidity by dividing the number of searches with the number of transactions within a time period.
• Volume of repeat buyers = the number of buyers who make purchases frequently. Higher numbers suggest that buyers find it easy to purchase what they need, indicating good liquidity.

On the customer side, purchase rate (or search-to-fill rate) is the key liquidity indicator.

Here, the marketplace type isn't a big differentiating factor when it comes to liquidity. Be it a marketplace like Amazon, Airbnb, or Uber, customer liquidity can be understood as the share of unique visits (or searches) that lead to a transaction.
The only difference is a job site like Upwork or Hired, where the buyer side is the one posting listings. On these types of sites, buyer liquidity can be measured by the share of job listings that lead to someone getting hired.

Buyer-to-seller ratio

In addition to seller and buyer liquidity metrics, an important figure to discuss in relation to liquidity is buyer-to-seller ratio.

Buyer-to-seller ratio means the number of buyers one seller can serve. What your buyer-to-seller ratio is depends on your market.

In some cases, the seller-to-customer ratio might be as low as 1:1. This is the case in residential real estate, for example: one seller typically has only one asset to sell. On others, the ratio could be as high as 1:10,000, where one seller can serve thousands of customers. Stock photos or other digital assets is an example.

The higher your seller-to-buyer ratio is, the more you should focus on building supply in the beginning. This is because the seller brings more value to your marketplace if they can participate in multiple transactions.

A high provider-to-customer ratio also means you eventually need to grow your customer base at a faster rate than your seller base to reach seller liquidity.

So while the buyer-to-seller ratio isn't a metric that measures your current liquidity, understanding your ratio helps you understand the best tactics to improve your marketplace liquidity.

How to improve marketplace liquidity

There are several things you can do to improve your marketplace liquidity.

In general, the way to improve marketplace liquidity is to build your user base thoughtfully with your optimal seller-to-buyer ratio in mind and improve the value your marketplace offers -- or how you communicate that value.

The key to reaching liquidity as early as possible is constraining your marketplace.

Start small 

It's much easier to reach liquidity with a small initial group of users.

This is why starting small is the ultimate strategy that most of today's biggest, most successful marketplaces have used.

In our interview with Casey Winters (Eventbrite Chief Product Officer, formerly at Apartments.com and Grubhub), he shared that GrubHub started food deliveries in a single neighborhood in Chicago. Kickstarter co-founder Charels Adler told us the co-founders focused exclusively on the art community as their first market.

Take the lean approach to building your platform

Optimizing your marketplace UX can significantly increase the likelihood of transactions.

But beyond the marketplace essentials, it's impossible to know what features and functionalities will deliver the highest ROI in your specific market.

The lean approach is the fastest and most cost-effective route to this information. Get your Minimum Viable Product (MVP) in front of real users as quickly as possible and start iterating based on user feedback and usage data.

I've heard countless examples of successful founders who've started with a no-code marketplace solution, a simple website with a form, or essentially just a spreadhseet.

Balance supply and demand.

Understand your optimal seller-to-buyer ratio and make upholding it a priority.

Sophie Aldeman from Hired put this well in our interview: "You need somebody who's always thinking about the supply/demand dynamic, and you're always constantly adjusting between the supply and the demand. It's a fine balancing act, which is what makes it fun."

Build trust 

Marketplace success is built on trust, and there are several tactics marketplaces can use to increase trust.

Start by developing a two-sided review feature and writing (and enforcing) a Code of Conduct. Many marketplaces in trust-intensive markets require user verification.

Community-building and other practices that enhance communication between users are great at establishing trust.

Help your sellers succeed

Educate your sellers on how they can succeed on your platform. Marketplaces like Airbnb and Etsy have extensive handbooks to teach suppliers about things like optimizing listing descriptions, market their offering, and offer customers a great experience.

Find a balanced pricing strategy 

The ideal take rate on your marketplace depends on several factors: marginal costs, competition, the level of network effects, seller differentiation, transaction volume and size, and more.

The golden rule of marketplace is to take as little as you need to remain sustainable. If you need to offer lower prices in the early days to get your marketplace going, offer time-based discounts.

Take liquidity into account in your growth strategy

When you design your marketplace marketing and growth strategies, take your optimal seller-to-buyer ratio into account. Identify which side of the audience needs work, and how quickly you need to see the results. 

For example, SEO is usually best for growing the demand side of a marketplace. According to a study by Lenny Rachitsky, most marketplaces have leveraged SEO for their demand-side acquisition and used different approaches to build supply.

Furthermore, SEO takes time to show ROI. So, you'll need different tactics to bring in supply, and possibly some shorter-span solutions to attract deman while the SEO impacts kick in.

Offer excellent customer support 

Offering a wonderful customer service experience can be the special sauce that differentiates you from a competitor, improves conversion rates, drives loyalty and repeat purchases, and generates word of mouth.

Furthermore, qualitative inputs from support interactions are phenomenal data points for product development and planning marketing efforts like content marketing.

Key takeaways

Liquidity isn't just a marketplace metric. It's the lifeblood of your marketplace

Liquidity indicates the likelihood of a transaction occurring in the marketplace. High liquidity means that buyers are likely to find what they're looking for and sellers are likely to sell what they list. 

Therefore, the lack of liquidity means your marketplace isn't providing value to users. 

Several factors influence marketplace liquidity:

• The number of active users.
• The level of trust and transparency in the marketplace.
• Effective pricing strategies.
• The ease and security of payment processes.
• The stability and security of the marketplace.

To measure liquidity, marketplace founders should focus on three key metrics:

• The sell-through rate, which shows the percentage of listings that result in a sale.
• The purchase rate, indicating the percentage of visits that lead to a purchase.
• The seller-to-buyer ratio, highlighting the balance between sellers and buyers.

Improving marketplace liquidity involves a strategic approach:

• Starting small
• Maintaining a balance between supply and demand.
• Adopting a lean approach to platform development.
• Building trust.
• Educating sellers.
• Finding a balanced pricing strategy.
• Taking liquidity into account in the growth strategy.
• Offering excellent customer support.

As Josh Breinligner, investor and marketplace expert, said in our interview: the marketplace isn't your product, your product is liquidity. 

So the best thing you can do for your marketplace from the get-go is, over anything else, to prioritize reaching liquidity as early as possible.