How I evaluate B2B Vertical Marketplaces
frameworks are cool, I guess.
Consumers in the developed world can buy any product or service online. However, many businesses purchase their products and services through offline methods. B2B Markets are many times larger than B2C markets (annual global spend is estimated at $100T) [1]. Overall, there is an incredibly exciting opportunity to back founders focused on building increasingly verticalized marketplaces for B2B products and services. I wanted to write down my thoughts about vertical B2B marketplaces and how to assess them.
What are B2B marketplaces
Markets have existed for as long as humans have engaged in trade. In the past, people used to physically gather regularly to buy and sell goods, livestock, and advertise other services. An example of this B2C market (that still exists today) is a flea market. Say that as a customer you visit this flea market and see a jeweler. The jeweler has rings, necklaces, and bracelets. However, where does the jeweler get his raw material from? There is a second layer on top of the B2C layer called the B2B layer. This is where businesses transact between themselves. In other words, the jeweler needs to procure gold, so he will go the gold marketplace and buy from companies that will sell him raw gold, from which he can then design his jewelry. This is called procurement and it exemplifies why the B2B workflow is very different than B2C. An interesting fact is that in Ancient Egypt, an educated class of people called “scribes” used to manage procurement for building the pyramids. They used to record the amounts of materials and workers needed, track the orders, and assess the quality of the materials.[2]
What value does a marketplace provide?
From a first principles lens, the fundamental value a marketplace provides is that it is a 1) mutually agreed upon place, 2) where people can come together, 3) to provide goods/services that are valuable to each other. In other words, it facilitates “economic flow” which could not have been possible otherwise
The fundamental dynamics behind B2B Vertical Marketplaces
Imagine you are a general store. You sell fruits, vegetables, and all sorts of other items like basic hygiene products. Every week you go to the market to buy these goods and then you resell them at your general store. As a buyer you go to the market because you know that all the suppliers will be there in one place. It’s easy to go to one place and buy all your supplies from there. On the other hand, the suppliers know many store owners come to the market. That gives us the major value proposition of a B2B marketplace: amalgamation. A marketplace brings buyers and sellers to one mutually agreed upon place.
Let’s dive deeper. When you go to this marketplace to buy your fruits and vegetables, you want to make sure that these suppliers are legitimate. In this case, this means that the marketplace should verify that these farmers, for example, have long history of supplying the specific products they are supplying so that they are reliable. This is also very core to the marketplace because it’s not my job as the buyer on this marketplace to figure out how “legit” the suppliers are. On the other hand, suppliers want to know they are transacting with people who will actually pay them. Therefore, the second core value proposition of a B2B marketplace is verification.
Say you buy a large batch of carrots from a reputed supplier at this marketplace. You decide to pay when you receive the carrots, but the farmer actually wants payment now. You negotiate and end up paying 50% now and agree to pay the rest when the carrots get delivered. Another customer buys from this same farmer, but the farmer tells him that he wants all the payment now. That customer is a competitor of my general store and this leads to a fight about why I get to only pay 50% now rather than the full amount, which he paid to this farmer. The man who owns the marketplace comes in and stops the fight, and determines that prices should be clear and set from the start. This leads to the third major value proposition for marketplaces: independence. In this case, a third party was able to step in and improve price discovery. This is extremely valuable because with this independence, the marketplace can help with other aspects of the transaction such as dispute resolution and transaction verification. In other words, allowing the supply and the demand to agree on things that would not have been possible without third-party verification. This needs to be inherent to the marketplace because the transaction takes place on the marketplace.
The fourth core value proposition of B2B marketplaces is ancillary services. These are services that can be defined as services that another company can provide, like payment, but “make sense” if the marketplace can provide it due to 1) lower friction, 2) lower costs, and 3) saving time. Here are some examples:
Logistics: there are probably third-parties who can help me get deliver all the fruits and vegetables to my general store, but they will charge a high price since I am a single customer and it is not a bulk order. What the food marketplace can do, rather, is bundle all the demand and get bulk pricing for the buyers at the marketplace, thus reducing logistics costs for me.
Payments: the buyer and seller will have to go to a different platform to finish the payment. They can go to the bank on the next day after the purchase, negotiate the payment terms, and sign the papers. Usually, the buyer will pay on credit due to the large transaction sizes. A marketplace can step in and allow all this paperwork to happen on the marketplace itself. Further, some marketplaces also provide credit to the buyers. All this saves time and reduces complexity for the buyer and seller on the platform.
So now due to this example of a general store, we have decomposed the value proposition of a B2B marketplace into four main variables.
When do B2B marketplaces provide little value?
Continuing from our example, say in my country there are only two main suppliers of fruits and vegetables. In this case, a marketplace is fairly useless because there are not that many suppliers. Using the terminology from the prior section, supplier concentration is high so amalgamation is not useful.
History of B2B Vertical Marketplaces
The last few sections of the article discussed the fundamentals of B2B marketplaces. However, it is valuable to highlight the existing B2B marketplaces that were created over the last 20 years in various industries and develop key lessons for the next generation of marketplaces.
Many of these successful marketplaces were started by a consortium of leading industry participants (either on the demand or on the supply side), which meant early adoption was virtually guaranteed. The chicken-and-egg problem of bringing on supply and demand at the same time is the main reason many B2B marketplaces fail to get traction.
The main takeaway here is that many offline B2B marketplaces already exist across industries, and therefore any new marketplace must be significantly better than the existing alternative. Further, many of these offline B2B marketplaces are now modernizing and building online solutions, and these companies have a clear advantage over any new entrant because they already have the supply and demand relationships.
What are the different types of B2B vertical marketplaces?
B2B marketplaces differ significantly depending on the industry. A marketplace for trucking will be different than one for apparel, and that will be different than one for freight. How can you differentiate between these marketplaces? There are a few variables to consider:
End-market GMV (smaller markets: dental supplies, larger markets: trucking)
Supplier Product Standardization: this is an operations concept, but is very important. In markets like dental supplies, there are a known quantity of SKUs. In other markets like customer custom manufacturing, each order will be different.
Supplier Fragmentation: Airplanes, for example, have only two OEMs, so a marketplace is not useful in this regard. However, airplane parts have thousands of players, so a marketplace makes sense in this context.
Monetization Methods: some marketplaces have a standard take-rate of each transaction, but others have a flat fee structure
Implied Monetization Level (% of GMV): this is a proxy for how much value the marketplace is creating for its constituents
Differentiating the different types of marketplaces is valuable because some are more attractive to invest in than others, which will be discussed next.
Assessing B2B Vertical Marketplaces
Team
In many of these verticals like manufacturing and laboratory equipment, deep industry expertise is required to understand why a marketplace is even needed in the first place. Further, as mentioned in a previous section marketplaces bring market participants together, so having deep industry connections helps onboard supply and demand to the platform faster. Another benefit of having founders with industry experience is that they understand the specific pain points of the supply or demand side, and can therefore solve that “chicken-and-egg” problem more thoughtfully.
Market Opportunity and Dynamics
Existing Offline Marketplace
If there is an existing offline marketplace, the new experience must be significantly better (10x) to make it justifiable for market participants to get off the existing marketplace and join the new one. It is much more valuable to create a marketplace where one did not exist before (the opportunity in emerging markets like India) or where the existing marketplace is highly dysfunctional.
Existing Competition
As mentioned in the earlier section, many online marketplaces already exist across major industries. If the new entrant is verticalizing a part of the industry, the question to ask is “can the existing marketplace add that capability in its platform?”. Some of the incumbents mentioned earlier are horizontal marketplaces and are mainly focused on larger companies. Therefore, focused on a simple digital solution for a highly specific vertical and geography can possibly meet the needs of customers significantly better than the existing alternative.
Large End Market
Some marketplaces will simply focus on one function and on a niche part of the market (e.g., orthodontic supplies) while others will focus on larger GMV markets (e.g., trucking). At the end of the day, a company focused on larger GMV is attractive for marketplaces from an investment perspective because 1) it creates more value for both sides of the market, and 2) can result in higher revenues and therefore investment outcomes.
Level of Product Standardization
When each order is different (i.e., custom manufacturing), that can mean a highly complex order flow. That means the marketplace can build a competitive advantage overtime which will be difficult for any new entrant to overcome. On the other hand, some marketplaces will have supply that is relatively standard (i.e., restaurant supplies), and these marketplaces must reach scale because the barrier to entry to start a marketplace in these segments will be generally lower.
Supply and Demand Fragmentation
An investor would want to see supply (and preferably demand as well) being fragmented because that is the best scenario for a marketplace for provide significant value. This is because, as mentioned previously, the core value proposition for marketplaces is connecting buyers and sellers.
Product
Many B2B marketplaces begin by offering ancillary services to one side of the market. For example, some marketplaces may offer a free SAAS tool to suppliers, and then later encourage them to come onto the platform. At the end of the day, in a mature marketplace you want to see many ancillary offerings such as lending, payments, transaction admin, and so on. All these services provide more value to both sides and build on the competitive edge of the marketplace.
Unit Economics
Generally, unit economics will be a function of the value provided by a marketplace. Usually the take-rates by marketplaces are lower than those of B2C because businesses are more price sensitive. Some marketplaces don’t even charge on a transaction basis, but rather on a subscription basis. Overall, what matters here as an investor is what is the hurdle LTV-to-CAC ratio and can that marketplace generate those unit economics.
In summary, when assessing B2B vertical marketplaces the two key things to look for are:
1) Founders with deep industry relationships and knowledge
2) The marketplace should provide 10x more value than the existing alternative through a combination of value propositions such as digitization of existing offline marketplace and verticalization of an existing horizontal marketplace
[1] https://www.bvp.com/atlas/b2b-marketplaces/
[2] https://www.sourcesuite.com/procurement-learning/purchasing-articles/history-of-procurement-past-present-future.jsp