Success factors in building marketplaces with FJ Labs
Last month we welcomed Jose Marin, partner and co-founder of FJ Labs, at our Marketplaces Journey (Trilha de Marketplaces), a presentation of the Astella Expert Network (AEN) for an exchange about the dynamics of marketplaces and how his experience is reflected in the fund’s investment strategy.
FJ Labs thesis is focused on investment in marketplaces and consumer-facing startups. The fund invests globally and since 2015 it has invested in more than 700 startups including Airbnb, NuBank and Habi.
Jose told us about his experience over all these years, and how he evaluates the opportunities and different business models within the marketplaces vertical, sharing his vision about strategies for building these early stage businesses.
Below are some of the most interesting insights from our conversation with him, and his views on the workings of the gears that move successful markets and marketplaces:
1 – A lot, but a lot, of fragmentation
What makes a market irresistible for building a marketplace business?
Segments with highly dispersed demand and supply are excellent opportunities for the emergence of new intermediation businesses. Fragmentation generates inefficiency: The ability of marketplaces to aggregate and simplify choice is the gateway to value creation.
The more complex the journey of discovering new customers or suppliers, the greater the value of the platform for both sides. Likewise, the more transparency and alternatives for the conclusion of the transaction, the greater its potential. By aggregating supply and demand, and facilitating the transaction with means of payment, logistics and communication services between the parties, platforms become essential.
2 – Liquidity is the lifeblood
We have talked about this at other times and, like the FJ Labs team, we strongly believe in the importance of creating an engagement strategy to generate liquidity and ensure the viability of the first transactions on a Marketplace (the old problem of “what comes first, the chicken or the egg?”).
Strategies to generate initial liquidity:
- On the supply side: financial incentives (discounts, shorter collection periods, reduction of commercial expenses, etc.) that help generate recurring demand, taking advantage of the supplier’s idle capacity, and very flexible delivery times, can be interesting tools for generation of initial liquidity.
- On the demand side, great liquidity boosters include: Incentivized selection (curatorships, and campaigns that help to improve buyer navigation and find new products/services); flexibility for orders with low recurrence (no minimum size or quantity required); finite consumption (no need for minimum orders); and just-in-time deliveries.
Meanwhile, remember that most marketplaces start by focusing on building a minimum network of providers (we talk about this here), but the constant balance between supply and demand is a daily challenge, and necessary to maintain liquidity.
3 – Monetization model: pick yours!
Understanding what is the best pricing model considering the ICP on both the supply and demand sides is essential. Depending on each of these profiles, one of the following models may be more strategic:
- Listing fee – Vendors pay a flat fee per ad, depending on location and product category. The platform adds intelligence that helps the seller in the communication strategy of his product to improve visualization according to the profile of the buyers.
- Visibility – Offeror pays proportionally to the number of ad views.
- SaaS – Model where supply or demand pays for a subscription. In monetization via SaaS, the users' priority is access to the platform or services offered by it.
- Take Rate – The transaction fee is one of the most common models for marketplaces, especially here in Brazil. By charging a percentage of the order on the supply, demand side or even on both sides of the transaction, this fee typically varies between 10% and 15%, depending on the type of model & vertical, and can go up to 1% (usually when you have very high tickets being transacted) or 75% in extreme situations.
4 - Unit Economics: careful with the ‘paid’ CAC
Jose Marin emphasizes that, although often, as an investor, you don’t need perfect Unit Economics to make an investment decision, “we like teams that have at least a vision on how to optimize the cost of customer acquisition”. Scale is essential to have better metrics, but care with this cost is important.
When the startup uses paid CAC for demand generation, it is interesting to compare this investment with the unitary return provided by the additional gross margin (which directly impacts the LTV) that the company is generating.
This means understanding how much additional LTV this paid media investment will add and whether or not that return is stable.
Putting these concepts into practice:
How do you know if a ‘paid’ acquisition strategy is being effective?
1) Calculate your Lifetime Value (LTV)
LTV (net) = Contribution Margin (in BRL or preferred currency) X Number of transactions per user (you can also add a dimension for retention)
2) Calculate your Paid-only CAC:
Paid Only CAC = Total Cost of Marketing and Sales / Number of new paying users originated by the paid media strategy
Unlike Paid-only CAC, Blended CAC mixes the acquisition cost of “incentivized” + organic strategies:
Blended CAC = Total Cost of Marketing and Sales / Number of total new paying users
What are good metrics?
In Jose's view, the following ratios would be the ideal:
12 months LTV: 2x Paid-only CAC, or more
18 months LTV: 3x Paid-only CAC, or more
He compares organic versus paid media as follows: When up to 25% of growth is being driven by organic conversion strategies (i.e., growth is very much Paid CAC), Jose calls this synthetic growth.
In cases where the company has 40% or less of growth coming from Paid CAC strategies, there is a perception that the company is undersizing its investment in paid media or underinvested in paid channels.
We at Astella think it’s possible to accelerate growth with greater or lesser efficiency. Acquisition via paid media has to be an accelerator and not the main channel. It is important that each business has independence in generating demand and not being in the hands of third parties.
And for all companies, having what we call “clear water”, and finding the best mix for this efficient growth is fundamental (and this changes according to the stage of the business).
5 – The importance of the Network Effect
One of the things that Jose looks for in marketplaces and sees as an important ingredient of success is that well-known phenomenon, the network effect.
As the network effect is built, it also builds greater and greater barriers for competitors, and this, clearly, translates into better margins and economics.
For those who want to know more about the work of FJ Labs and Jose Marin, it is worth taking a look at the fund’s website – where you will find a lot of interesting material and practical content to help entrepreneurs who are on the front line.
Thanks for the transparency and exchange of ideas, Jose!