Remember the kid’s story “The Little Engine That Could.” That describes what goes on with a lot of startups in two-sided markets. The train is trying to get up the mountain, but it needs to accelerate to offset the force of gravity that’s pushing it down. If it picks up enough momentum it can make it. But if not it stalls, and worse, slides back down the mountain. Unfortunately, saying “I think I can, I think I can” won’t get a two-sided business off the ground.
The basic problem for a two-sided business is that it needs “critical mass” to get ignited. That’s a concept from nuclear physics and a pretty good analogy to what goes on with two-sided platforms. To get an atomic reaction going there needs to be enough fissionable material, enough neutrons banging around, to set off a chain reaction. Too few and nothing happens.
Platforms create value by helping two kinds of customers who need each other get together. It takes two to tango in these businesses. When the right customers get together they can benefit each other. eBay, for example, creates value early on because it helps people who want to buy things find people who want to sell things. It created tremendous value in part because it initially specialized in fairly obscure items for which it was hard for buyers and sellers to find each other.
This is a numbers game. One of the reasons platforms create value in the first place is that they make it easier for those who come to the platform to find someone that they can engage in a mutually advantageous trade with. That’s easier for members of each customer group if there are more members of the other customer group. If eHarmony had only one man and one woman it is very unlikely they would be attracted to each other. Dating platforms have to have a lot of prospects to have any possibility of finding a match.
Critical mass is known as liquidity in financial markets. There have to be enough participants who want to buy or sell for the market to discover a price efficiently. Most of the B2B exchanges learned about this concept the hard way. They couldn’t attract enough participants, particularly sellers who didn’t look forward to having their prices beaten down, to make the market liquid. Markets that are too “thin” perform poorly or collapse.
Here’s how critical mass and ignition usually works. As with any new product there are early adopters who for whatever reason like trying new things or get an exceptional amount of value by participating. Some of them may give the platform a try expecting that it will get bigger and become more valuable to them. With any new product there’s attrition as people learn about and decide it doesn’t have enough value. But with platforms participants attract more participants. If the rate at which new participants join exceeds the rate at which early adopters leave by enough, then the platform can grow. The goal is to get to a tipping point when there are enough participants that this growth is explosive. This is just like a chain reaction in nuclear physics. Once there are enough participants they release so much value that even more participants join, leading to explosive growth.
Timing is everything here. So just like the Little Engine That Could there’s a race up the mountain. If the platform can get enough participants to join at a rapid enough pace, then the forces pulling it up will offset the forces pulling it down. Just as the Little Engine That Can gets to the top has an easy ride down, the platform that gets to critical mass accelerates rapidly. If the platform cannot get enough participants to joint at a rapid enough pace, then it stalls or loses customers. Just like the Little Engine That Can’t gets stuck on the side of the mountain or falls back down, the platform stops growing and more likely implodes.
When we talk about critical mass for platforms it is important to distinguish between the two sides. To ignite, platforms need enough of both sides and in the right proportions. This is easiest to see with exchanges. A platform that had a lot of sellers but few buyers wouldn’t be very interesting to the sellers. There need to be enough participants on both sides to make it likely that there will be profitable match-ups. (That doesn’t mean that platforms need equal numbers of both sides since one side might be more valuable: the obvious example is any dating venue.)
Critical mass is different from the so-called chicken-and-egg issue that both sides need to be on board to create any value at all. Instead, critical mass refers to the phenomenon that a platform has to reach a critical size in order to grow explosively, and that if it doesn’t reach this critical size, it will probably implode.
For payment cards, critical mass requires having “enough” merchants who want to take cards and “enough” people who want to use cards to make it valuable for more merchants and people to join and thereby rev up the network effects. It is hard enough to get both sides on board a new payment system. It is even harder to get critical mass. Most payments startups don’t get to critical mass. They implode. A few do—when they get to critical mass they ignite, really following the same principles as a chain reaction.
Next week, we’ll look at how a mobile payments platform blasted off.
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Filed Under: Other, Payments, New Business Models, two-sided market