Opinion: How the network effect can be a problem for online marketplaces

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Ethan Stock lived the Silicon Valley dream. He had recently sold his company to eBay, and emanated the tanned skin and relaxed composure you’d expect of someone who just cashed a big corporate check. But as we sat across from one another in a Palo Alto coffee shop, I was surprised by what he said next: “Mediocrity is worse than failure, you know?”

For seven years before the acquisition, Stock served as the founding CEO of Zvents, an online guide for local events. Though he was successful by anyone’s standards, I could tell he was a guy who—like me—had learned some hard lessons about marketplace businesses.

“Zvents grew incredibly well,” Stock told me. “We were the largest events site of its kind, providing local listings in hundreds of markets and attracting over 14 million monthly unique visitors.”

The company had done what so many tech companies dream of doing: they cracked the network effect and built a marketplace business that increased in value with each new user. The more event organizers posted to the site, the more useful the site became to people looking for things to do. Both parties loved the site, and Stock’s marketplace business was in the middle, connecting visitors to events they otherwise wouldn’t find.

“But I learned the network effect isn’t everything. In fact, it became a liability.” Stock’s words confused me. How could being in such an enviable position of creating a valuable marketplace business be a bad thing? “Getting paid was a bitch,” Stock said, and he began to unravel how certain marketplace businesses like Zvents can succeed themselves to death.

The expectation of completeness

Marketplace businesses exist to connect two or more parties—typically, the buyers and the sellers. Investors love these marketplace businesses because they tend to grow quickly and spawn winner-takes-all companies. A long line of successful Silicon Valley startups have found success providing a place for people to connect and transact. Examples include industry titans like eBay and LinkedIn and some of today’s web darlings like Uber and Airbnb.

“Marketplace businesses are great,” Stock told me. “But there is a fatal flaw in some marketplace businesses that can hogtie their ability to make money — the expectation of completeness.”

We certainly created value […]. We just couldn’t capture very much of that value.

Stock explained how Zvents had planned to charge event organizers to list on their site. “Once we reached critical mass and it was clear we were becoming the market leader, we expected event organizers would start paying.” Unfortunately, reality fell short of expectations.

Like many marketplace businesses, the company was catering to users who expected to find a comprehensive listing of all local happenings. To keep users coming back, it had to ensure it was displaying everyone’s events , as an incomplete list would send visitors looking elsewhere.

“When we asked event organizers to pay up, they said, ‘what for?’” Stock said. But threatening to remove a listing was not possible because the platform needed them all to keep site visitors happy.

So, Stock’s team offered event organizers better ways to reach users like sponsored placements, which displayed the listing more prominently on the site. But the attempt to finally get paid largely fell flat. “We certainly created value for them,” Stock said. “We were sending people to their events. We just couldn’t capture very much of that value. I guess it’s the old saying: ‘Why buy the cow when you can get the milk for free?’”

Just like Google

“Google is similar if you think about it,” Stock said. The comment surprised me given the tremendous success of the search giant juxtaposed with the Zvents story. “They also create much more value than they capture.”

Implications

TL;DR