How do marketplaces work, how do they make money?

Online marketplaces have been growing rapidly for years, so it is not surprising when retailers also consider making use of them. This is particularly true for those that already have a large reach, such as Zalando or H&M. In Switzerland, for example, Manor recently started to follow this path. So what is the marketplace trend all about?

It caused a minor sensation when mail-order business Otto announced its intention to become an online marketplace around three years ago. After all, the company had a 70-year tradition as a successful catalogue and mail-order business. Today, the group finds itself in good company, as younger businesses like Zalando are also opening up to the marketplace idea. And when even brands like H&M announce that they will also be opening up to offers from other brands, this is basically the same thing as a marketplace model.

The basic marketplace concept

The marketplace approach is similar to the basic concept behind the department stores that emerged at the beginning of the 20th century. Instead of customers having to search for products in different shops, marketplaces provide a variety of products from different retailers or manufacturers. This means they work like the shop-in-shop concept in the retail sector.

Operators do not have to bear the up-front costs of purchasing goods, instead the entrepreneurial risk is taken on by the sellers in the marketplace. This analogy can also be extended in terms of appearance of a marketplace. Some retailers are clearly identified in a marketplace, while others act anonymously for customers. From the customer’s point of view, this “one-stop shopping” experience is the main advantage of shopping at a marketplace.

Amazon is the blueprint for online marketplaces

At an abstract level, it can be said that a marketplace brings suppliers and buyers together on its platform. And if that is too abstract, it is also important to remember the main advantages of using a marketplace: it saves time and creates transparency.

The advantage for a retailer is that they can use the marketplace to connect with customers or interested parties who they might not have reached in any other way. This is also true for retailers who convert their online shop into a marketplace. It gives them the option of selling products or brands that they did not previously include in their range. This could be, for example, because the prospect of building up their own division would be too much of an economic risk. Or it could be because it opens up new sales opportunities with products that complement their core range.

Amazon’s success as a marketplace still serves as a model. It tells us a lot when we consider how much Walmart in the US came under pressure from Amazon because a retailer that grew with a clear discount strategy and a focussed product range developed into a marketplace.

Advantages and risks of the marketplace business from the retailer’s perspective

Amazon is also an example of another aspect of the marketplace model. Because the platform has all the advantages and disadvantages from a retailer’s perspective.

Platforms such as Amazon, Galaxus or Zalando have enormous reach, and marketplaces are now central starting points for product searches. If a product is missing from a marketplace, a retailer risks becoming less visible to customers. To develop a comparable level of brand awareness and reach using their own resources, retail companies would have to dedicate huge sums of money to marketing – with questionable chances of success.

This is also the core problem that explains why regional and local marketplaces have so far failed to achieve significant sales. Their product range is far more limited and they lack the financial means to appear at the top of search engine results.

A second advantage of the collaboration is that the retailer benefits from the technical infrastructure of the marketplace operator. The major platforms usually have an app for smartphones, or at least a website that is optimized for mobile devices. This means that retailers don’t have to build their own. The marketplaces also handle the payment processing.

Finally, participating in the marketplace also makes it easier to expand internationally.

From the retailer’s perspective, the marketplace enables them to connect with many customers that they probably would not have been able to reach on their own. And it saves them the administrative effort of processing the payments themselves.

However, these advantages are offset by disadvantages that retail companies should be aware of.

From their perspective, customers are buying from Galaxus or Amazon. There are hardly any opportunities for creating a branding or shopping experience. This is especially true when making use of additional services provided by the marketplace (e.g. shipping). The sender of the goods is then Amazon, for example, the product comes in a box with the Amazon logo, and Amazon also charges the customer account. The retailer becomes an anonymous and therefore interchangeable product provider.

The more intensively the marketplace is used, the more sales move in its direction and the greater the dependency on the platform. This presents a dual danger: if a product category does particularly well, the marketplace operator can take on the business for themselves and sell their own strong brand with a lot of advertising pressure. There have been cases in the past where a retail company was excluded from the marketplace.

Ultimately, the retailer faces tough competition. There is hardly any product category where they will be the only one offering the products. In some cases, they are also competing directly with the marketplace, which is not only a marketplace for relevant products, but also a retailer in its own right. Without active price adjustments, ideally with an automated system, their offers risk being drowned out by the competition.

Revenue models for marketplaces

From the perspective of an established marketplace operator, the business model is very attractive. Without necessarily having to build up their own inventory, they benefit directly from the fees generated by each sale. Depending on the product category and marketplace, these are between 7 and 20 percent of the sales price. This is a factor that retailers should also consider when calculating their prices so as not to pay extra on every sale.

Other sources of income are the additional services that the retailer can benefit from, as mentioned above. In many cases, this includes direct processing of shipping by the marketplace operator. In return for a fee, the retailer delivers their goods to the operator’s warehouses, and the operator takes over the entire shipping process, also in return for a fee.

Finally, more and more marketplaces have started developing their own advertising formats on the platform (retail media) to give retailers the opportunity to stand out from the competition.

A vendor is usually invited to do this by the marketplace operator. This is followed by intensive negotiations on the conditions. For example, the marketplaces want to secure certain branded articles and their distribution via the vendor. As a vendor, the company becomes the supplier to the marketplace; it has to deliver its products to the various warehouse locations. The company is then also closely bound by obligations pertaining to delivery quantities and delivery times.

To boost the sales of vendors, the platforms ensure better visibility for those companies (e.g. by highlighting the articles in “brand shops” on the platform). In this way, the brand can at least partially control the brand experience, but it must forego direct customer contact.

The use of marketplaces is equally tempting for retailers and brand manufacturers, but it is an option that should be carefully considered and assessed.