Let’s Get Vertical

In our introductory post, we laid out the 10 laws of successful marketplaces. We’ve since followed up with two other pieces on the importance of the expanding the Shadow Market, and the benefits of boosting the rake. In our initial post, we also noted that marketplaces focused in a particular vertical tend to grow faster and achieve critical mass more quickly. Within a broad horizontal marketplace, it becomes more difficult to achieve sufficient liquidity, whereas a vertical marketplace immediately brings together buyers and sellers seeking to complete the same category of transaction.

To make this point, it’s helpful to examine the paths taken by two vertical marketplace businesses (Uber and AirBnB) versus two horizontal companies (eBay and Etsy). As you can see from the graph below, vertical marketplaces were able to experience explosive growth in years 4-5, while horizontal marketplaces continued to grow steadily, before reaching a milder inflection point after 6-7 years in business1,2,3,4. Please note that numbers for AirBnB and Uber are estimated from the public sources cited below, Menlo is an investor in Uber but has not used any proprietary information in this analysis.

We want to make sure that we are comparing apples to apples, as eBay was founded in a different time period (consider that in 1999 there were 280m users online and no smartphone penetration versus today’s nearly 3 billion internet users and 75% smartphone penetration in the US5,6). Examining Etsy is likely a more appropriate comparable, and as you can see their GMV growth has yet to accelerate to the same degree as Uber or AirBnB despite being in business for a much longer period of time.

It is also interesting to compare marketplaces that could be considered subsets of each other. For example, Upwork (formerly oDesk and eLance) is the leading platform for hiring remote workers. Rev is a marketplace for transcription and translation services that has grown to become the largest provider of Certified Translation in the US, despite these services also being available on UpWork. Likewise, Thumbtack purports to cover all local professionals, yet UpCounsel is building a thriving business by focusing exclusively on legal services. We believe that marketplaces like Rev and UpCounsel will be long-term winners as a result of the specialized tools that they can build to enhance supplier productivity and create platform “lock-in.” Rev developed proprietary transcription software that dramatically increases productivity, and UpCounsel has powerful practice management tools for independent lawyers. Broad horizontal platforms simple don’t have the resources to create specialized platform tools, which prove to be a distinct benefit for vertically focused marketplaces.

In addition, it’s worth noting that the fundraising dynamics of vertical and horizontal marketplaces are very different. Etsy only raised approximately $100m before going public, and while eBay went public much earlier in its lifecycle, it raised only $60m in its IPO8. Of course, Uber and AirBnB have raised orders of magnitude more money than this in the private market, at last check right around $10.5 billion combined7.

We believe that the nature of a vertical marketplace lends itself more easily to fundraising, as early liquidity provides a variety of “proof-points” earlier in the company lifecycle that allows for founders to raise money to accelerate the business. Even recent successful horizontal marketplaces like Thumbtack haven’t been able to raise capital at the same rate that Uber and AirBnB have, with $275 million raised in the seven years that it has been in business7. For example, Uber was able to raise a large Series B round as a result of its early success exclusively in San Francisco. By verifying unit economics in a single market with sufficient liquidity, investors are comfortably investing money into a vertical marketplace with the plan to “rinse and repeat” in other markets.

Such a fundraising strategy is inherently more difficult for horizontal marketplaces, which take longer to hit a critical mass, and may have increased uncertainty as they build various amounts of liquidity within different categories. One way for founders of horizontal marketplaces to counteract this is to focus on gaining liquidity within specific verticals before expanding their focus. We’ve seen companies do this by either focusing on highly specific geographic areas (which becomes increasingly possible with the advent of next-gen Facebook targeting), or single categories within a broader market. Companies like OfferUp may target specific neighborhoods to achieve critical mass faster, while Handybook might have thought about only offering a specific service like housecleaning to prove the model.

In this way, horizontal marketplaces can bring a variety of proof-points to investors which will allow them to de-risk the business while raising additional capital to expand into additional geographies and verticals. Whether it’s a horizontal marketplace growing vertical by vertical or a pure vertical marketplace, we believe these business will have an advantage over their broader counterparts over the next few years.

  1. Etsy Revenue: http://techcrunch.com/2015/03/29/unpacking-etsys-s1/
  2. AirBnB Revenue Estimated from: http://www.wsj.com/articles/the-secret-math-of-airbnbs-24-billion-valuation-1434568517 by assuming 11% take-rate on revenue for quoted 2013 and 2015 revenue numbers and taking midpoint for 2014 revenue
  3. Uber Revenue Estimated from: http://venturebeat.com/2013/12/04/uber-on-track-to-make-210m-on-over-1b-of-rides-in-2013-as-revenue-jumps-68/ for 2013 GMV number, and http://www.reuters.com/article/2015/08/21/us-uber-tech-fundraising-idUSKCN0QQ0G320150821 for 2015 number. 2014 is estimated at the midpoint.
  4. eBay Revenue: CapitalIQ
  5. Internet Users: http://www.internetlivestats.com/internet-users/#trend
  6. Smartphone Penetration: http://www.comscore.com/Insights/Market-Rankings/comScore-Reports-December-2014-US-Smartphone-Subscriber-Market-Share
  7. Crunchbase
  8. http://www.cnet.com/news/ebay-roars-into-public-trading/