4 strategies for setting marketplace take rates
I’ve written in the past about take rates and growing take rates and often got questions on how to think about setting them. So, I summarized all my thoughts in this piece for TechCrunch a few weeks ago, which is paywalled, so I’m republishing here.
Every entrepreneur of a marketplace or platform startup needs to grapple with the question of what prices they should charge for transactions on their platform, known as the “take rate”.
While there is no formula set in stone, I’ve analyzed the take rates of over 25 private and public marketplaces below which I’ll use to help shed light on some considerations for founders to guide their decision, including:
The goal isn’t to maximize take rate
Understand the market structure you operate in
Distribution is king & can be charged for
Value-added services can help grow take rates
Note that the definition of take rate used in this piece will be a percentage which is calculated by dividing the revenue made on the transaction by the platform by the total value of the transaction.
1/ Maximizing take rate isn’t the goal
One of the most important considerations for founders to remember is that maximizing the take rate of the platform is not the goal.
A higher take rate typically leads to lower transaction volume, and depending on the stage a company is in, it may be advantageous to charge a lower take rate than what a platform can sustain to gain a strategic advantage.
One specific case of this is when startups are going after relatively nascent markets which they are trying to grow. A great example of this is OpenSea, which charges a 2.5% fee on transactions, quite low compared to other marketplaces that offer buying and selling goods. However, given that NFTs were relatively nascent, their low fees in part helped reduce friction to trading and helped grow the market and they were the primary beneficiary capturing over 90% share.
Another case of this is when markets are extremely competitive and may have some winner-take-all dynamics of economies of scale. In this case, a marketplace could start with lower take rates to try to grab share or achieve scale, before raising it over time.
A general rule of thumb to remember is that the goal is to maximize the long-term profit dollars, which is (the take rate times average transaction value - variable cost) * (number of transactions), noting that:
Take Rate and number of transactions will often trade-off with each other
A lower take rate in the short term can lead to better outcomes in the long-term
Charging lower take rates than what you can “get away with” may lead to higher retention and value creation in the long run.
2/ Understand the nature of the market you operate in
Referring back to the chart above, it’s clear that take rates are extremely variable, even within industries. However, certain market-driven factors play a role in determining the ranges in which you can operate. This is evident by noting that certain companies such as Uber have to charge very different take rates in delivery (~10%) vs ridesharing (~20%).
Some key considerations for founders when it comes to understanding the nature of the market are:
Is the product being sold digital or physical and how much margin is available? Given digital products are infinitely reproducible, marketplaces that deal with them can charge higher take rates because the venture has 0 production cost. On the other hand, marketplaces involved in physical products with lower gross margins can charge less given that their suppliers make lower margins on the products. Many digital marketplaces tend to cluster in the 30% range while physical products tend to be in the 15-20% range.
Competition: Founders should also think about what the next best alternative to not using their marketplace is (i.e., what is the competition and what it looks like) when understanding the market. Sometimes, competition can come in the form of direct startup competitors or sometimes it can come in the form of pen and paper or the use of broker intermediaries (i.e., an offline process today). Understanding the take rate charged by competition relative to the experience provided by competition is a good exercise for founders to go through.
The concentration of suppliers on the platform: The more fragmented suppliers on the platform are, the higher marketplaces can typically reasonably charge since the bargaining power of any individual supplier is lower. For example, typically travel marketplaces can only charge 3-5% on the airlines’ side given there are only ~5 key suppliers. However, on the hotel side, where there is more fragmentation, they can charge 15-20%.
The concentration of buyers on the platform: In general, consumer marketplaces cater to individual consumers, which by definition makes the buyer side very fragmented. However, in cases where there are a concentrated set of buyers, that reduces the take rate the marketplace can charge, at least to those buyers. One example of this is Affirm for whom Peloton represents >20% of volume as a customer. While Affirm doesn’t break out the take rate by the customer, it’s very likely they have negotiated better rates for themselves, which also reduces the overall take rate Affirm has.
3/ Distribution is King (and can be charged for)
One of the most critical factors which influences what take rate your platform can charge is whether you are driving distribution for the suppliers on your platform. Said differently, do your suppliers believe they are making incremental sales simply because of being on your platform? Or do they end up having to do all the marketing work themselves to attract eyeballs?
The willingness to pay from suppliers for platforms that are not involved in distribution much and are more around transaction processing or infrastructure set up (hosting a store, etc) is typically only 2-5%. This is evident in the take rates of a company such as Shopify which is in the ~2% range since they only provide infrastructure to operate a store (compared to Amazon’s marketplace which is 15% since it has aggregated customer demand and can therefore drive incremental distribution).
For transactions that are truly incremental to them, the willingness to pay from suppliers can be as high as 50-60% of their gross margin on that sale.
While most marketplaces charge a blended take rate which takes into account their ability to drive incremental demand, there are some which have even gone further and set different take rates based on different distribution methods such as Udemy: It charges a 3% take rate if the instructor using Udemy sells the course themselves, but charges a 50% take rate if the Udemy sells the course on behalf of the instructor.
4/ Growing take rates through value-added services
The more value a marketplace provides which is deepened by value-added services, the higher the take rate it can charge. Additionally, take rates aren’t set in stone and can be grown over time by introducing more value-added services.
Below are some key value-added services and some rough estimates on how much incremental value they provide:
Payments: Most marketplaces provide inbuilt payment and transaction processing on their platform, which allows them to usually charge an incremental 3-5% take rate (however, the bulk of this typically goes in processing fees).
Quality Control and Authentication: Marketplaces that can help create trust by verifying the items on it and managing quality can typically charge 2-5% extra because of the better experience for buyers. One example of this is GOAT, which charges 14% on sneaker sales partly because it verifies the authenticity of them itself vs eBay which charges 9% and is more unmanaged.
Advertising: Advertising is often one of the best ways for marketplaces that have aggregated customers to grow take rates. Marketplaces can sell ad inventory to allow suppliers who want more sales to pay for those sales, without raising take rates for suppliers who don’t want or need more sales. While the benefit from advertising varies depending on its effectiveness, companies such as Alibaba and Amazon have been able to grow their advertising businesses to drive an incremental 2-5% of take rates.
Thanks for reading! If you liked this post, give it a heart up above to help others find it or share it with your friends.
If you have any comments or thoughts, feel free to tweet at me.
If you’re not a subscriber, you can subscribe below. I write about things related to technology and business once a week on Mondays.