The Next Era of Spectacular Start-Ups

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The Next Era of Spectacular Start-Ups

Nine out of ten startups fail, according to Fortune magazine.1  But a handful of firms, like Uber and Airbnb, have not only beaten those odds, but have grown from zero to billion-dollar businesses in less than a decade.

What do those successful start-ups have in common?  They use an online marketplace business model that connects buyers and sellers.  And the model is becoming both increasingly popular and increasingly profitable.

In fact, according to the Harvard Business Review, a decade ago there were only two online marketplaces valued at $1 billion or more in the United States:  eBay and Craigslist.2  Today, more than a dozen businesses have soared past that milestone, including Airbnb, Etsy, Groupon, GrubHub, Seamless, Lending Club, Lyft, Prosper, Thumbtack, Uber, and Upwork.

That’s just the beginning.  By 2020, according to the venture capital firm Greylock Partners, the number of billion-dollar firms based on this business model will double.

What accounts for the growth of online marketplaces?  They are perfectly positioned at the intersection of at least three other trends that we’ve explored in previous issues:

  1. The escalating momentum of network effects
  2. The global cash glut
  3. The power of two-sided electronic markets

Let’s discuss how these three trends apply to online marketplaces, starting with network effects.  According to Metcalfe’s Law, “The value of a network increases in proportion to the square of the number of people using it.”

As more people join a network, it becomes more useful to everyone who uses it.  If only 1,000 people are buying and selling goods on an online auction site like eBay, the network has very little value, because buyers won’t find the variety they want, and sellers won’t get the competition among buyers that drives up prices.  When millions of people join a network, everyone derives more value from it.

The same is true of newer networks like Uber.  If there are only ten Uber drivers scattered across a major city, the quality of the service will be lower than if 10,000 drivers are available to pick up a passenger anywhere in the city within minutes.  Obviously, if there are ten passengers using the app in a city, there won’t be enough business to attract drivers; but if one million passengers use it, the drivers will have more opportunities to make money.

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