Village Fundamentals | Why Marketplace Platforms Need Incentives
In this series we explore the fundamentals of marketplace platform incentives programs. In this article we describe how modern platform businesses are different from predecessors and why incentives are critical to platform business success. Onward!
- The core concept of a marketplace is to get supply and demand to a place they can easily meet each other.
- Platform businesses make trade easier/better/ cheaper in their niche and take a cut for their troubles.
- What distinguishes today’s platforms from their forebears is their huge scale. This is thanks to two things: (1) software and (2) the Internet.
- The relationships between buyer-seller-worker-platform often don’t fall into any of the old categories of work and employment. There’s a lot of uncertainty in how they should pay people.
- Even the best and biggest platform businesses have issues with profitability and reputation, which shows up in stock price, regulatory run-ins, or media scandals. The root cause is almost always misaligned incentives.
What’s a marketplace?
Here’s the basic idea of a marketplace. Someone has, say, $10 and wants to buy a pair of socks. At the same time, someone else makes a pair of socks at a cost of $8, and is willing to sell them for $10 for a $2 profit. Both people, therefore, are probably happy to make a trade. But first they need to find each other–like, physically.
The place you go to make the trade? A marketplace.
Of course, you don’t strictly need a marketplace to sell socks. You could go house to house trying to find someone with $10 looking to buy socks. But that’s super inefficient. You’re going to end up spending a lot less time making socks and a lot more time looking for people with chilly feet.
Sure, there are tons of nuances to how marketplaces work–information efficiency, regulation, trust, raw goods availability, pricing elasticity, etc. But the core concept is: get supply and demand to a place they can easily meet each other.
The Birth of the Platform Business
Marketplaces have evolved a lot (over the last 600 years in particular), but they've provided pretty much the same function. You go to the mall or to the internet; either way you’re using a marketplace.
What’s new in today’s world is the platform business.
Platform businesses are companies like DoorDash, Etsy, or Uber. They make trade easier/better/cheaper in their niche, and then they take a cut for their troubles.
This isn’t a brand new concept (remember shopping malls–or if you’re old like me, mail catalogs?). What distinguishes today’s platforms from their forebears is their huge scale. This is thanks to two things: (1) software and (2) the Internet.
If you’re a retailer you can find something like 15,000 active shoppers at a shopping mall. If you sell on Amazon you can find 300 million (almost the size of the entire US population!). That’s a big deal.
I said before: marketplaces do the same thing now as they did 600 years ago. But… something strange happened when platform businesses evolved from malls into 300 million-user Internet behemoths.
Platform businesses started to look a little bit like nation states.
The Problem (and the Opportunity) with Platforms
To encourage a lot of people to buy and sell stuff through them, platform businesses do a lot of work.
In some cases they do this–literally–at the scale of a whole country. They build infrastructure and new technology, like apps, algorithms, and AI; they invest lots of money in things like jump-starting new markets or R&D; they educate people on how to buy and sell more effectively; and much more.
What’s most important for this article, however, is what they don’t do.
Platform businesses do not tell people what to do. Airbnb doesn’t tell its hosts when to make their homes available. Uber doesn’t tell its drivers when or where to drive. Amazon doesn’t tell its suppliers what to manufacture. These businesses can strongly suggest stuff… but for reasons (legal, moral, competitive) they can’t and don’t order their users around as if they were, say, employees.
But platform users–like buyers, sellers, and workers–aren’t employed by the platform. So the platform has to let them just sort of do whatever they want.
In general, this is a good thing. It ensures (1) the flexibility of platform work that makes it appealing and (2) the laissez faire efficiency of gig work and ecommerce platforms that have fostered so much amazing innovation in the last twenty years.
On the other hand, it’s a problem.
Platforms legitimately do have superior information vs any given user. This means that a lot of (but not all of) the time, if they did tell their users what to do, the platform would be more efficient.
For example, if Uber told every driver where to be at what time as if they were employees, there’s a very good chance that pickup times would go down, driver earnings would go up, and Uber would make more money. That’s because Uber has all the data required to predict demand with high accuracy. But the company can’t (and won’t) order their drivers where to go for all the reasons we mentioned above.
This is all a new thing! Never before have:
- Businesses the size of countries
- Competed for profit
- While unable to direct their suppliers’/workers’ behavior
- Even though those “suppliers” resemble employees in a lot of ways
As a result, the relationships between buyer-seller-worker-platform often don’t fall into any of the old categories of work and employment. So we’re in uncharted economic territory. How, then, should platforms pay people? Or more specifically in industry jargon, how should they “transfer value?”
Conclusion: Incentives are everything
How do platforms keep the good parts of platform work while maximizing output and minimizing waste? They have to incentivize people to do stuff.
A major misconception is that “incentivizing someone” translates to “paying someone to do something.” That’s wrong. Incentives are about a lot more than money. They’re the whole package of cash, ownership, status, membership, priority, and emotional gratification that motivate people to buy or sell something. This complexity makes it hard to do properly.
And herein lies the crux of this article series: getting incentives right is really hard. Even the best and biggest platform businesses have issues with profitability and reputation, which shows up in stock price, regulatory run-ins, or media scandals. The root cause is almost always misaligned incentives.
That’s why I’m writing this article series: to share our knowledge on how to get incentives right.
Of course, I’d like people to buy my company’s products to do this. We will make money, and that’s great. But even if they don’t use our products and learn something from us anyway, then I believe the world’s a better place. That’s because good incentives means good economics, and good economics, in my opinion, is just good for the world.