Optimal pricing for market places and platforms

By April 30, 2013 No Comments

A couple of weeks ago veteran Benchmark VC Bill Gurley posted a typically excellent and thorough analysis of pricing for market places and platforms. Bill calls the money that platforms take from transactions the ‘rake’ and you can see from the table above that there is a wide range out there. Rakes comprise a mix of straightforward take from transactions and other fees imposed upon merchants and/or consumers. In the case of eBay the rake comprises listing fees, fees to make listings more premium (e.g. more photos) and Paypal fees.

Bill’s central argument is that setting the rake too high is often a mistake. Short term revenues and profits will be maximised, but if the rake is too high marketplace participants will be constantly on the look out for other places to transact making the business will be vulnerable to competitors, and many potential customers may simply choose to avoid the platform altogether. He quotes Jeff Bezos’ famous saying ‘Your margin is my opportunity.’. To hammer the point home he quotes management guru Peter Drucker:

Number one on the list of Peter Drucker’s Five Deadly Business Sins is “Worship of high profit margins and premium pricing.” As Drucker notes: “The worship of premium pricing always creates a market for the competitor. And high profit margins do not equal maximum profits. Total profit is profit margin multiplied by turnover. Maximum profit is thus obtained by the profit margin that yields the largest total profit flow…”

Bill cites the example of oDesk stealing the market from Freelancer and others because their rake was 10% rather than 30% to argue that the optimum headline rake is around 10%. He also cites Apple’s 30% take and how that forced Amazon and Facebook to adopt non-IOS strategies as further evidence that 30% is usually too rich.

Finally, low headline rakes can be increased with mechanisms like additional fees for premium listings. The real trick, he says, is to have a model which makes people think ‘the marketplace is fair, but competitors activity on here makes me spend more than I would ideally like’. That way competitors get the blame and nobody leaves the platform. Google Adwords is a great example of a platform that is thought of in this way.