Evaluating a (marketplace) business idea

**If you find this newsletter valuable, consider sharing it with friends, or subscribe if you haven’t already 👇**

# Q: I loved your series about [kickstarting and scaling a marketplace business](https://www.lennyrachitsky.com/p/how-to-kickstart-and-scale-a-marketplace). As an investor, I’m curious how you evaluate marketplace business ideas. What do you look for?

After looking at 100+ marketplace businesses over the past few years, I’ve learned one important lesson: First, forget about the *marketplace* part. Start by looking at the *business*.

**Most marketplaces fail not because of the marketplace, but because of more fundamental reasons** — not building something people want, too small a market, inability to acquire users, etc. So start by looking at the bigger picture before focusing on whether this works as a marketplace.

### Top 7 things to look for when evaluating a *business*

1. 🤤 **Product-Market Fit**: Do people *really* want this?
2. 🌎 **Market**: Do enough people really want this?
3. 💥 **Why now**: What has changed that now allows for this work?
4. 👋 **Distribution**: Can you acquire these people efficiently?
5. 🤝 **Team**: Is this the right team to build this?
6. 🛡️ **Moat**: Can you stay on top?
7. ⚙️ **Business model**: Can this become a fast growing, efficient business?

### Additional 7 things to look for when evaluating a *marketplace business*

1. 🤤 **Demand Product-Market Fit**: Do *customers* really want this?
2. 🤑 **Supply Product-Market Fit**: Do *suppliers* really want this?
3. ✨ **Scalability with quality**: Can you grow while maintaining the magic?
4. 📈 **High frequency and average order value**: What’s the potential revenue?
5. 🔒 **Reasons to stay on-platform**: Why won’t suppliers cheat?
6. 😏 **Non-monogamous**: Will customers need to come back?
7. 🧩 **Fragmentation**: How hard is it for both sides to find each other today?

Let’s look closer at each of these areas.

# Top 7 things to look for when evaluating a *business* idea

### **1.** 🤤 **Product-Market Fit** ー Do people really want this?

> “The only thing that matters is getting to product-market fit.” — Marc Andreessen

**What to look for**

- High cohort retention
- High MoM and YoY growth rate
- A product that’s 10x better than the alternative
- Passionate user feedback
- Willingness to pay

**Additional reading**

- [What is good retention](https://www.lennyrachitsky.com/p/what-is-good-retention-issue-29)
- [How to know if you've got product-market fit](https://www.lennyrachitsky.com/p/how-to-know-if-youve-got-productmarket)
- [Interviewing for product-market fit](https://www.lennyrachitsky.com/p/interviewing-users-for-product-market)

### **2.** 🌎 **Market —** Do enough people really want this?

> “When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.” ー Andy Rachleff

**What to look for:**

- A growing customer base being dramatically underserved
- High willingness to pay
- Customers who are desperate for this solution
- Is there a $1B/year revenue opportunity
- If the initial market is small, then large adjacent markets

**Additional reading:**

- [How Can You Tell If Your Market Is A Good One?](https://blog.eladgil.com/2011/03/how-can-you-tell-if-your-market-is-good.html) by Elad Gil
- [A rising tide lifts all boats; the importance of market selection](https://lsvp.wordpress.com/2007/08/17/a-rising-tide-lifts-all-boats-the-importance-of-market-selection/) by Jeremy Liew
- [7 Lessons from Andy Rachleff on Product-Market Fit](https://medium.com/parsa-vc/7-lessons-from-andy-rachleff-on-product-market-fit-9fc5eceb4432#:~:text=%E2%80%9CWhen%20a%20great%20team%20meets,market%2C%20something%20special%20happens.%E2%80%9D)

### **3.** 💥 **Why now ー What has changed in the world that now allows for this to work?**

> “The thing that I like to assume is every startup idea’s been tried … So, the question is not, has my idea been tried before? The question is, is it the right time for my idea to happen?” — Mike Maples, Jr.

**What to look for:**

- Has there been an inflection in technology
- Has there been an inflection in adoption of a technology
- Has there been a change in regulation
- Has there been a change in a long-held belief
- A new distribution channel has opened up
- Costs have fallen or price points risen dramatically

**Additional reading:**

- [How to build a breakthrough](https://medium.com/@m2jr/how-to-build-a-breakthrough-3071b6415b06) by Mike Maples, Jr.
- [Andy Rachleff and Startup Lessons of Greatness: You need a breakthrough insight](https://medium.com/starting-greatness/andy-rachleff-and-startup-lessons-of-greatness-you-need-a-breakthrough-insight-ae846196ba7)
- [How Can You Tell If Your Market Is A Good One?](https://blog.eladgil.com/2011/03/how-can-you-tell-if-your-market-is-good.html)

### **4.** 👋 **Distribution ー Can you acquire these people efficiently?**

> “Most businesses actually get zero distribution channels to work. Poor distribution — not product — is the number one cause of failure.” — Peter Thiel

**What to look for:**

- A clear growth strategy
- A unique growth strategy
- Unique access to to the target audience
- A new untapped distribution channel
- High LTV/CAC ratio

**Additional reading:**

- [Peter Thiel’s CS183: Startup - Class 9 Notes Essay](https://blakemasters.com/post/22405055017/peter-thiels-cs183-startup-class-9-notes-essay)
- [Product To Distribution](https://blog.eladgil.com/2018/04/product-to-distribution.html) by Elad Gil
- [Startup = Growth](https://www.paulgraham.com/growth.html) by Paul Graham

### **5.** 🤝 **Team ー Is this the right team to build this?**

> “If you think about how do you get to the big idea, we call it an Earned Secret. You did something in your past, you tried to solve some hard problem, and you learned something about the world that not a lot of people in the world know.” — Ben Horowitz

**What to look for:**

- A+ founders
- Founders who deeply understand the customers problem
- Founders who have a unique insight or an “earned secret” about the opportunity
- Founders who have worked together before
- Founders who move fast

**Additional reading:**

- [Peter Thiel: successful businesses are based on secrets](https://www.wired.co.uk/article/peter-thiel)
- [Andy Rachleff and Startup Lessons of Greatness: You need a breakthrough insight](https://medium.com/starting-greatness/andy-rachleff-and-startup-lessons-of-greatness-you-need-a-breakthrough-insight-ae846196ba7)
- [a16z Podcast: Earned Secrets](https://a16z.com/2018/08/04/earned-secrets-ben-horowitz-interns-2018/)

### **6.** 🛡️ **Moat ー Can you stay on top?**

> “Don’t be the best. Be the only.” — Mike Maples, Jr.

**What to look for:**

- Are there network effects
- Are there economics of scale
- Are there high switching costs
- Is there a potential for a strong brand
- Is there exclusive supply
- Is there proprietary technology
- Is there proprietary access (data, accounts, regulatory protection)

**Additional reading:**

- [Don't be the best, be the only](https://vator.tv/news/2013-07-19-mike-maples-part-3-dont-be-the-best-be-the-only) by Mike Maples, Jr.
- [Competition is for Losers](https://www.youtube.com/watch?v=3Fx5Q8xGU8k) by Peter Theil
- [7 Powers: The Foundations of Business Strategy](https://www.amazon.com/7-Powers-Foundations-Business-Strategy/dp/0998116319) by Hamilton Helmer

### **7.** ⚙️ **Business model ー Can this become a fast growing, efficient business?**

> “It’s best to invest in pure tech companies; though there are always exceptions. As an investor you need to ask: How much of every dollar invested is going into technology development and how much is going to things like scaling, customer acquisition, subsidizing rides or deliveries, or some physical product.” — Naval Ravikant

**What to look for:**

- High margins
- Low CAC, high LTV
- Short sales cycle
- High cash flow
- Positive unit economics

**Additional reading:**

- [Why Software Is Eating the World](https://a16z.com/2011/08/20/why-software-is-eating-the-world/) by Marc Andreessen
- [Invest in Pure Tech Companies](https://spearhead.co/pure) by Naval Ravikant
- [Negative Unit Economics Create the Illusion of Success](https://spearhead.co/unit-economics) by David Sacks

No business will be perfect, but the more checkboxes you check, the better.

Next, once you feel like this is a good business as a *business*, it’s time to shift your focus to thinking about the marketplace elements.

# Additional 7 things to look for when evaluating a *marketplace* business idea

### **1.** 🤤 **Demand Product-Market Fit — Do** ***customers*** **really want this?**

> “A lesson I have learned many times in my 20 years as a marketplace investor is that aggregating demand is the one and only key.” — Bill Gurley

**What to look for:**

- Is this much cheaper or easier than the (non-marketplace) alternative? How badly do customers need this?
- Can they maintain good unit economics while delivering a cheaper/better alternative?
- Will they be able to aggregate all of the demand eventually?

**Cautionary tales:**

- [Cherry](https://techcrunch.com/2013/01/13/iterations-lessons-we-can-draw-from-cherry/)
- [Homejoy](https://www.forbes.com/sites/ellenhuet/2015/07/23/what-really-killed-homejoy-it-couldnt-hold-onto-its-customers/#2a2288111874)
- [Zimride](https://techcrunch.com/2015/01/28/zimride/)

**Additional reading:**

- [The Hierarchy of Marketplaces — Level 1](https://medium.com/@sarahtavel/the-hierarchy-of-marketplaces-introduction-and-level-1-983995aa218e) by Sarah Tavel
- [Cracking the Chicken-and-Egg Problem 🐣 - Growing Initial Demand](https://www.lennyrachitsky.com/p/how-to-kickstart-and-scale-a-marketplace-2e5)
- [Why hasn't 'Airbnb for food' taken off?](https://www.quora.com/Why-hasnt-Airbnb-for-food-taken-off/answer/Casey-Winters) by Casey Winters

### **2. Supply Product-Market Fit — Do** ***suppliers*** **really want this?** 🤑

> “The supply side — homes/hosts for Airbnb and drivers for Uber — are the most important aspect of most consumer marketplace startups…supply side is 👑” — Andrew Chen

**What to look for:**

- Does the supplier *meaningfully* benefit, e.g. significant income, high-quality demand? How badly do they need you?
- How exclusive is the supply to this marketplace?
- Are you leveraging an underutilized fixed asset?

**Cautionary tales:**

- [Exec](https://startupgraveyard.io/company/exec/)
- [Prim](https://fortune.com/2014/01/22/prim-anatomy-of-a-folded-startup/)
- [Zaarly](https://techcrunch.com/2013/03/16/marketplaces-businesses-are-tough-to-build/)

**Additional reading:**

- [Underutilized Fixed Assets](https://kwokchain.com/2020/01/23/underutilized-fixed-assets/) by Kevin Kwok
- [28 Ways to Grow Supply in a Marketplace](https://www.lennyrachitsky.com/p/28-ways-to-grow-supply-in-a-marketplace)
- [Cracking the Chicken-and-Egg Problem 🐣 - Growing Initial Supply](https://www.lennyrachitsky.com/p/how-to-kickstart-and-scale-a-marketplace-911)

### **3.** ✨ **Scalability with quality —** Can you grow while maintaining the magic?

> “The ultimate success of your marketplace will depend on your ability to create meaningfully more happiness in the average transaction than any substitute, not how many transactions you accumulate.” — Sarah Tavel

**What to look for:**

- Fill rate (e.g. % of times a customer finds what they want)
- Positive experience rate (e.g. % of 5-star reviews)
- How much “supply” even exists that can provide this service globally?
- As it scales, will this supply be able to provide the same level of service?
- How important is consistency and quality to the customer experience?

**Cautionary tales:**

- [Handy](https://www.inc.com/magazine/201611/jeff-bercovici/from-pivot-to-profit.html)
- [Wimdu](https://www.eu-startups.com/2019/07/imitation-simply-wasnt-enough-a-wimdu-post-mortem/#:~:text=The%20merger%20came%20with%20speculation,and%20failed%20to%20secure%20more.&text=Wimdu's%20official%20statement%20said%20it,employees%20in%20Berlin%20and%20Lisbon.)
- [Etsy](https://www.businessinsider.com/this-is-why-etsy-is-failing-2015-6)
- [TaskRabbit](https://www.reforge.com/blog/taskrabbit-marketplace-growth)
- [Laurel & Wolf](https://www.failory.com/cemetery/laurel-wolf)
- [Fab](https://www.inc.com/christine-lagorio/jason-goldberg-fab-lessons.html)
- [Beepi](https://www.forbes.com/sites/maryjuetten/2019/01/15/failed-startups-beepi/#51ea99742e57)

**Additional reading:**

- [Hierarchy of Marketplaces — Level 2](https://medium.com/@sarahtavel/hierarchy-of-marketplaces-level-2-f1c44ed4a39) by Sarah Tavel
- [How Billion Dollar Marketplaces Are Built with Marco Zappacosta, Co-Founder & CEO of Thumbtack](https://www.nfx.com/post/billion-dollar-marketplace-thumbtack/)
- [13 Metrics for Marketplace Companies](https://a16z.com/2020/02/21/marketplace-metrics/) by a16z

### **4.** 📈 **High frequency and average order value —** What’s the potential revenue?

> “When building a marketplace, most companies strive to excel on all fronts: high frequency, high retention, and (relatively) high transaction values. Luckily, it turns out there’s more than one way to build a successful marketplace.” — D'Arcy Coolican

**What to look for:**

- The more frequent and the higher AOV, the better
- If neither frequent nor high AOV, needs to be a huge market size, cheap user acquisition, and high retention
- Is the business able to extract enough value (e.g. take rate) from each transaction?

**Cautionary tales:**

- [Zocdoc](https://www.cnbc.com/2018/08/07/zocdocs-price-surge-has-doctors-fretting-over-excessive-costs-and-an.html)
- [Thumbtack](https://www.nfx.com/post/billion-dollar-marketplace-thumbtack/)
- [Omni](https://techcrunch.com/2019/11/25/omni-shuts-down/)
- [NeighborGoods](https://www.fastcompany.com/2682702/what-happens-now-that-sharing-economy-pioneer-neighborgoods-has-been-acquired)
- [Sharingear](https://www.failory.com/cemetery/sharingear)
- [Neighborrow](https://pando.com/2013/03/16/what-can-be-learned-when-sharing-leads-to-failing/)

**Additional reading:**

- [Four Paths to Marketplace Success](https://a16z.com/2020/02/20/marketplace-engagement/) by D'Arcy Coolican
- [WTF is Marketplace Liquidity?](https://medium.com/point-nine-news/wtf-is-marketplace-liquidity-f2caca3802c0) by Julia Morrongiello
- [Four Strategies to Win Big with Low Frequency Marketplaces](https://caseyaccidental.com/low-frequency-marketplaces/) by Casey Winters

### **5.** 🔒 **Reasons to stay on-platform —** Why won’t suppliers cheat?

> “The real risk to most marketplaces is that they provide all of these valuable services and, at the moment of the transaction, the transaction ‘leaks’ and the buyer and seller settle the transaction off-platform.” — Charles Hudson

**What to look for:**

- What keeps supply or demand from taking this off-platform, and avoiding your fees. The answer is usually convenience, obfuscation, or protection.
- How much more convenient is to stay on platform?
- What protections or reputation do I build for staying on platform?

**Cautionary tales:**

- [Tutorspree](https://www.failory.com/cemetery/tutorspree)
- [Homejoy](https://www.nfx.com/post/the-nfx-marketplace-scorecard/)
- [Handy](https://www.inc.com/magazine/201611/jeff-bercovici/from-pivot-to-profit.html)

**Additional reading:**

- [Marketplaces, ratings systems, and leakage](https://www.charleshudson.net/marketplaces-rating-systems-and-leakage) by Charles Hudson
- [How Modern Marketplaces Like Uber and Airbnb Build Trust to Achieve Liquidity](https://firstround.com/review/How-Modern-Marketplaces-Like-Uber-Airbnb-Build-Trust-to-Hit-Liquidity/) by Anand Iyer
- [Four Questions Every Marketplace Startup Should Be Able to Answer](https://medium.com/@jgolden/four-questions-every-marketplace-startup-should-be-able-to-answer-defb0590e049) by Jonathan Golden

### **6.** 😏 **Non-monogamous — Will customers need to come back?**

> “A repeated mistake is attacking verticals where a satisfactory supplier ‘match’ ends the customer’s need to re-enter the market in search of an alternative. This negatively impacts many vertical service provider markets (such as pediatricians) where customers are actually prefer a monogamous relationship.” — Bill Gurley

**What to look for:**

- Will customers need to come back for more?
- Is one match/relationship enough? e.g. doctor vs. restaurant.
- Does the platform get paid just once, or for the tenure of that relationship

**Cautionary tales:**

- [Zocdoc](https://www.cnbc.com/2018/08/07/zocdocs-price-surge-has-doctors-fretting-over-excessive-costs-and-an.html)
- Many therapy/coaching marketplaces

**Additional reading:**

- [Hierarchy of Marketplaces — Level 2](https://medium.com/@sarahtavel/hierarchy-of-marketplaces-level-2-f1c44ed4a39) by Sarah Tavel
- [10 Factors To Consider When Evaluating Digital Marketplaces](https://abovethecrowd.com/2012/11/13/all-markets-are-not-created-equal-10-factors-to-consider-when-evaluating-digital-marketplaces/) by Bill Gurley
- [The Guide to Marketplaces](https://versionone.vc/marketplaces-guide-ed2/) by Version One

### **7.** 🧩 **Fragmentation —** How hard is it for both sides to find each other today?

> “We typically look for high fragmentation of both supply and demand, meaning with many hundreds or more of suppliers, and many thousands or more buyers, there are not a few dominant players on either side. The high fragmentation indicates high competition, so the players will be encouraged to use the marketplace to compete with each other.” — James Currier

**What to look for:**

- How fragmented is the supply and the demand currently? Could they easily find each other without your marketplace?
- Are suppliers “leaning into” your platform? Are up and coming suppliers hungry to gain market share and compete?
- What is the distribution of spend across suppliers? Do only a few matter?

**Cautionary tales:**

- [Shipitwise](https://medium.com/shipitwise/goodbye-for-now-shipitwise-is-shutting-down-ae5a4bdf1550)
- Many B2B marketplaces

**Additional reading:**

- [10 Factors To Consider When Evaluating Digital Marketplaces](https://abovethecrowd.com/2012/11/13/all-markets-are-not-created-equal-10-factors-to-consider-when-evaluating-digital-marketplaces/) by Bill Gurley
- [10 Marketplace KPIs That Matter](https://medium.com/@algovc/10-marketplace-kpis-that-matter-22e0fd2d2779) by Andrei Brasoveanu
- [The NFX Marketplace Scorecard](https://www.nfx.com/post/the-nfx-marketplace-scorecard/)

Beyond these seven, there are certainly other attributes that increase the chances of success, such as being in the payment flow, and building trust early on, but I find these seven elements the *most* essential.

Finally, as I learn more about marketplaces and investing, I’ll use this post as a living document. So consider bookmarking it. And, if you have any feedback, additional examples, or insights, PLEASE [hit me up](https://twitter.com/lennysan).

*Thank you [Sarah Tavel](https://twitter.com/sarahtavel), [Dan Hockenmaier](https://twitter.com/danhockenmaier?lang=en), and [Mike Duboe](https://twitter.com/mduboe) for reviewing early drafts of this post.*

**If you’re finding this newsletter valuable, consider subscribing if you aren’t already**

Sincerely,

Lenny 👋