Digital marketplaces like Amazon, Alibaba, Airbnb, Lyft, and Uber are becoming increasingly important in the economy. This has led many firms to consider the development of their own digital marketplaces, or the acquisition of marketplace startups. The interest is driven by two advantages that these online exchanges have over traditional retail firms. First, they generate revenue without owning the transacted assets and without employing the people providing the service. Second, they enable the discovery of untapped pockets of demand and supply in the market. For example, Uber has expanded the market for rides by matching drivers who work part-time with riders in areas that were previously underserved by taxi cabs.
Nevertheless, trying to develop a marketplace is risky. AngelList, a startup investment website, lists over 8,000 companies designated as marketplaces. Most of these have never delivered a sustainable value proposition. What, then, determines which marketplaces succeed or fail? My research shows that the design of the marketplace plays a critical role.
Consider the following observation: Cities have always had underutilized rooms or apartments, but it wasn’t until Airbnb appeared that these rooms were rented in substantial volumes. This wasn’t for a lack of trying. Craigslist offered a dedicated section of its online listings for short-term vacation rentals for many years before Airbnb. Yet, unlike its success in the market for used furniture purchases, Craigslist ultimately failed in the vacation rental vertical.
The Friction of the Rental Market
The reason that the short-term rental market was so difficult to crack was that it is inherently frictional. Each peer-provided room is unique, of uncertain quality, and only supports one trip on a given date. In contrast, hotels are standardized and can host multiple trips at once in nearly identical rooms. Without the right combination of marketplace design and technology implementation, guests would find it much more difficult to locate a private peer-provided room than a room in a hotel.
Airbnb was able to find and implement this combination of technology and design, while Craigslist was not. A casual browse through Airbnb and Craigslist today reveals many differences between the two platforms. Airbnb offers a standardized listing that includes detailed information, high-resolution photos, standardized prices, and a reputation system; Craigslist does not. The comparison is even starker if we compare Airbnb to Craigslist in the mid-2000’s, when it did not have photos, accurate filters, or a map on the search results page.
But these aren’t the only important differences. My research points to another unappreciated feature: the availability calendar. It turns out that listings– whether in the short-term rentals market, the job market, or the dating market– are often stale. The side of the market that receives offers often has little incentive to take down listings once they no longer seek offers. At the same time, searchers don’t know which listings are out-of-date. This gap creates much wasted search effort and often causes searchers to leave the marketplace altogether.
And that’s why it’s important to note Airbnb’s availability calendar and its absence on Craigslist. Because Airbnb knows which listings are booked and for what days, it can automatically hide previously booked or unavailable listings from the search results. Consequently, searching guests are much less likely to waste their time on stale listings. I found that using this calendaring feature reduced the rate of attempts to book at unavailable listings by over 60%. This is a drastic reduction in friction for searchers who are choosing between the marketplace and a traditional firm. And it demonstrates that an accurate availability calendar is a key reason why Airbnb has succeeded.
What does this imply for our understanding of marketplaces and for businesses that may want to test the waters? New marketplaces are risky experiments, even if many of the innovations seem obvious in hindsight. The upside is that entrepreneurs who find the right design can provide substantial value to the world by reducing transaction costs and enabling new markets.
Andrey Fradkin is a postdoctoral fellow at the Initiative on the Digital Economy at MIT Sloan. His research interests include the design of online platforms, the economic effects of digitization, and the economics of search markets. He’s provided expert input about the digital economy at the President’s Council on Science and Technology and the Federal Trade Commission. He previously worked as a data scientist at Airbnb while receiving a doctorate in economics from Stanford University in 2014.
The full working paper can be found here.