Under the Hood - Demystifying VC | 0.07

Today's topic: B2B Marketplaces

Hi, it’s Aarzoo from the HEC Paris Alternative Investments Society VC teamUnder the Hood is a newsletter about recent developments in the Venture Capital industry, our perspective on key trends, and deep dives into how VC works.

Today, we’re covering the B2B Marketplaces space with a knowledge deep dive.

🔎 8 Notes on B2B Marketplaces

(by Aarzoo Sharma)

This deep-dive is an attempt at better understanding the complexities of B2B Marketplaces and the different factors driving a potential ‘B2B Marketplace Startup Explosion’ in the coming decade. We also look at some of the factors VCs might consider when evaluating early-stage startups in the space.

The complete deep-dive is hosted independently on a Notion page and you’ll find below a summary of the key points we address! Check out the market deep dive HERE.

1) B2B e-commerce has lagged behind B2C e-commerce

Over the past two decades we've seen an explosion of B2C marketplaces that started with Craigslist and eBay and gave way to giants such as Amazon, Shopify, Stripe and Etsy. The covid-19 pandemic accelerated consumer spending online (in the US, for instance, e-commerce spending jumped by 44% YoY to $861bn+). We're also experiencing a trend of verticalisation in B2C marketplaces, marked by the success of companies such as Uber, Lyft, Airbnb, GOAT and Rent the Runway (go further with TechCrunch and CB Insights' coverage on the unbundling of Craigslist).

Here is where B2B e-commerce stands in comparison:

  • B2B commerce is much larger in terms of total global payments volume: Despite being much bigger than B2C markets, B2B markets have lagged behind in terms of digitisation and are still much more offline (orders and payments in wholesale and logistics are still processed via email, SMS, fax and checks). Moreover, there is high information asymmetry in industries such as freight forwarding and a lack of focus on customer experience (unlike in B2C). The annual global cross-border payments volume was estimated to be $133 trillion for B2B and ~1.2 trillion for B2C in 2019 (including internal payment flows will render larger figures).

  • B2B marketplaces have not kept up with buyer demands: Consumers also find a gap between the value sought and value offered on B2B marketplaces: "50% of B2B buyers and users report that they prefer making work-related purchases on B2C websites, suggesting that providers of goods & services for businesses aren’t responding quickly enough to their buyers’ demands." (Mirakl).

This indicates that there is significant untapped potential in B2B marketplaces and room for vertical-specific winners to emerge.

2) So, why haven't we seen a B2B marketplace explosion yet?

Despite there being several B2B e-commerce success stories such as Alibaba (1999), Global Healthcare Exchange (2000) and more, the global ratio of e-commerce Gross Merchandise Volume (GMV)/ global B2B payments volume is still quite small (an exact number is tough to find, but one can get an idea by comparing the $133 trillion of flows for cross-border B2B payments with the $12.2 trillion of global GMV in 2019).

  1. Legacy digital procurement vendors did not pick up on a large scale over the past two decades.

  2. Moreover, B2B commerce is very complex, making it incredibly challenging to set up digital marketplaces due to the large number of moving pieces and industry-specific processes. 

  3. On the other hand, procurement itself is another crucial piece and single transactions often consist of running a mini-RFP (request for proposal) process that involves several departments on both sides.

  4. Due to high AOVs and high expectations of quality, B2B marketplaces often need to be managed and face greater challenges when it comes to establishing trust, offering convenience and embedding themselves in the transaction flows of customers.

These dynamics necessitate a high level of commitment, patience and resilience on the part of founders and investors building/ funding these companies.

3) We might finally be on the cusp of a B2B marketplace explosion

In the recent years, there has been an uptick in both B2B e-commerce GMV as well as number of B2B marketplaces founded. "New marketplaces are offering complexity in width (scope of product offering, integration of services) and depth (increase in price range offering, granularity of SKUs available). The objective is not only to increase sales and provide a new user experience to purchasers, but also to decrease the cost to serve." Roland Berger

There are three key factors driving this trend:

  • Digital transformation and automation of workflows is percolating previously offline industries and the scale of the internet is huge today, offering unprecedented liquidity.

    • The pandemic exposed significant vulnerabilities in global supply chains while emphasising the need for operating models that are efficient, scalable, modular and interoperable on a global level. One such vulnerability stems from the risk of supplier failure and the need to maintain business continuity in times of shock (Aster Capital). B2B marketplaces can step in and help businesses diversify their procurement risk.

    • There is a push for the extension of excellent user experiences offered by GAFA and BATX into other areas of business, which is complemented by millennials taking up positions of responsibility in B2B companies.

  • The tech-stack for setting up a marketplace is much more accessible today, allowing experienced founders from industry to start marketplace businesses. One example of this is APIs offered by companies such as Twilio (communication), Stripe (payments) and Checkr (identity verification) that can boost vertical B2B marketplaces by creating smoother search, listing, checkout, and tracking experiences. Go further on the topic of APIs with our post on API-first companies.

  • There is a general trend towards the hyper-verticalisation of highly successful marketplaces (think Craigslist, eBay, Amazon and even LinkedIn). Jeff Jordan and D'Arcy Coolican of a16z summarised it really well: "In all but a few circumstances, the broad horizontal verticals eventually break. They become a victim of their own success. As the platforms grow, their submarkets grow too; their product gets pulled in a million different directions. Users get annoyed with an experience and business that caters to the lowest common denominator. And suddenly, what was previously too small a market to care about is a very interesting place for a standalone newco. Like clockwork, a new wave of innovation begins to swell, picking off the compelling verticals the new horizontal players cannot satisfy."

    This trend could be more exaggerated within B2B, given the highly specific nature of processes and high level of complexity in different verticals.

    🚀 Some successful vertical B2B marketplaces are ManoMano (DIY, renovation and gardening; $350mn+ raised), Xometry (3D printing for manufacturers; $197mn+ raised), Transfix (FTL trucking; $128mn+ raised). Science Exchange (R&D services; $91mn+ raised), Upwork (freelance services; $168mn+ raised, IPO) and HackerOne(hacker powered security marketplace, $110mn+ raised).

Given the highly specific needs and processes within different verticals, marketplaces will have vastly different go-to-market and monetisation strategies. There is, hence significant diversity and opportunity when it comes to innovating on the business models. Go further on the topic in the deep-dive hosted here.

4) Incumbents and corporates will seek to defend their positions

The importance and challenges for incumbents when it comes to digitisation are well understood. Businesses on the 'sell-side' will have to choose between a make or buy strategy (or some hybrid of the two) to step-up their e-commerce offerings and service level, while businesses on the 'buy-side' will seek to diversify their procurement risk.

  • Embrace a digital-first strategy to increase trustworthiness, offer locally-adapted products (esp. for B2B industrial), enhance their portal’s technical specificities & features.

  • Establish partnerships with B2B marketplaces and marketplace enablers to offer platform services, like Siemens Mobility did with Mirakl in 2018 to create a one-stop-shop for material requirements in mobility (MoBase).

5) Where can B2B marketplaces add value?

  • Set new standards in traditional industries: Marketplaces can act as data aggregators with a UX/UI layer for largely-offline businesses in fragmented industries. By bringing data-driven technologies and customer-centricity into the fold, marketplaces can set new standards for how transactions happen, reduce the cost of transacting and have positive externalities on the environment.

    🚀 Flexport, for instance was able to reduce double-booking (for freight-forwarders) and no-shows (for businesses shipping goods) by streamlining processes and setting up a 'protocol for freight forwarding'.

  • Bring underrepresented players into the fold: Marketplaces can enable SMEs and businesses in emerging markets to (1) access customers across the globe, and (2) learn from the know-how & best practices employed by larger players

    Supply chain finance is a good example of a solution that has been a staple of corporate finance for decades. However, SMEs and EM players often don't have access to these solutions because of problems such as failing KYC checks. Streamlining these highly complicated and regulated processes can help democratise access for these players.

  • Sectors of interest: The potential of B2B marketplaces in traditional industries such as heavy machinery, logistics, retail, agriculture and commodities is well documented. In addition, there are opportunities in the following 'newer' industries as well: B2B software (SaaS/ API discovery), data access and processing, cybersecurity, climate change.

6) Many marketplaces will be SaaS and/or Fintech enabled

Bypass risk (sellers and buyers transacting independently off the platform after having discovered each other on the platform) and low frequency of transactions are common issues in marketplaces. Exploring freemium models, designing seamless experiences (especially important as customer expectations are evolving) and offering task/ process automation some ways to provide 'day 1 value' and lower the barrier to adoption.

  • SaaS enabled marketplaces: The use-cases for digitisation in the B2B space are endless, and by building a SaaS-enabled tool that helps customers improve their workflows, marketplace startups can boost retention and add value beyond simple transactions. Foregoing a simple take rate based model for a subscription based model could also provide a predictable stream of revenues.

    🚀 Check out this interview with Alexander Reichert, founder of AgVend to go further on how value added features can help avoid disintermediation and mould consumer behaviour in marketplaces.

  • Fintech-enabled marketplaces: The benefits of businesses complementing their core value propositions with a fintech layer have been well explored - check out Alexandre Dewez's deep-dive on Shopify and Sar Haribhakti's love-letter to fintech.

    B2B transactions involve tasks such as pricing/ quotes, compliance, insurance, KYC (know your customer) + checking customer solvency, establishing payment terms (which comes with the risk of accumulating bad debt) for transactions, invoicing and so on. Pricing, for instance is especially complicated in B2B transactions - procurement decisions are usually made based on several quotes, especially for high AOV trades. Volume-based discounts are widespread and expected, and pricing grids might differ based on the customer segment.

    Embedding financial services can help marketplaces reduce the risk of disintermediation. Integrating personalised banking products, early payment discounts, pre-approved financing and insurance policies with better underwriting can help marketplaces offer financial services to customers.

    🚀 Ankorstore is one such B2B marketplace using embedded financial services to add value to customers. Vertofx is a YC company building a B2B marketplace to enable B2B forex payments.

7) Many verticals could be characterised by winner takes most dynamics

Marketplaces must ultimately focus on all stakeholders to successfully grow their platforms. However, deciding between building supply vs demand in the early stages can be a key consideration - the reviews here are mixed and generally depend on the market dynamics the startup is targeting. Additionally, in all cases, going hyper-local and hyper-vertical (targeting a niche and having a very narrow value offering) is essential to achieve scale initially.

  • For instance, in automotive and manufacturing (when the demand side comprises OEMs), sales cycles tend to be long and using the marketplace might entail a significant behavioural shift for buyers. In such a situation, aggregating demand in one place before targeting the supply side (and optimising time-to-value by matching demand with supply quickly) could help founders be efficient with their time and efforts early on.

  • In high-friction marketplaces (high transaction costs, lengthy processes for transaction such as dealing with brokers/ RFP based quote processes), vetting the supply and ensuring high quality are essential. Moreover, in industries where supply is very fragmented and spot transactions are common (food delivery for example), building a large volume of supply to enable discovery will encourage customers to gather on your platform.

However, ultimately, both sides grow hand in hand, and when those effects kick in, there might end up being space only for a few dominant players in the market. Building defensibility based on brand, access to data, logistics partnerships and low cost + low retail margins also hinge on having a lion's share of the market. Achieving initial traction often involves doing things that don't scale in order to ultimately get the flywheel in motion (check out Airbnb's scale story).

Considering that unlocking scale as a B2B marketplace is a very challenging task, first mover advantages would accord to players who are able to be the first ones to unlock scale (and not necessarily the first ones to enter the market). This is especially valid since the playbook for B2B marketplaces has not yet been invented.

8) What you would need to believe in: a checklist for VCs

  1. Value proposition: Simplifying elements of complex processes to remove friction from the transaction process (procurement & sales) is how most marketplaces can add value. It is important to understand what this friction is and what the offline solution for it looks like - investors look for significant improvement as opposed to marginal/ incremental improvement over the status quo.

    It is also important to understand which part of the process is being impacted - marketplaces can add value to discovery, order fulfilment, pricing, payments, authentication, insurance, quality control and more.

    Moreover, investors want to understand how the take rate compares to the value being added to customers - this is especially relevant since businesses tend to be wary of marketplaces as they are afraid to give away their (typically thin) margins. B2C marketplaces typically have take rates between 20-30%, whereas in B2B, rates between 1-5% work, owing to the large AOVs.

  2. Background and unique insight of the founding team: Having hands-on experience in the industry could be a competitive advantage for founders as it would give them a deep insight into the friction they are solving for. Moreover, having pre-existing relationships with buyers and seller could come in handy when tackling long sales cycles and understanding customer mindsets. However, this is certainly not a hard and fast rule.

  3. Market dynamics: The market structure plays a critical role in understanding how much value a marketplace can actually create. Factors to consider are level of fragmentation (ideally high), stakeholder relationships (low loyalty), information asymmetry (low), pricing mechanism (inefficient), transaction costs (high), balance in supply and demand (poor). Founders should consider key questions around building liquidity, seamlessly fitting into existing workflows and unlocking new revenue streams for 'ignored' players (particularly on the supply side). Go further with a16z's coverage on perfect competitionHighly regulated sectors such as aerospace, defense and nuclear power are much harder to break into than sectors where buying behaviours are quite close to B2C standards. Moreover, establishing trust in sectors where products have to meet high safety/quality standards is very complex and customers are wary of third-party platforms.

    Monetisation strategies and go-to-market approaches will differe based on the business model as well.

  4. Product-market fit: The ability for buyers and sellers to complete end to end transactions on the marketplace without any hand-holding could be a good signal of PMF. When this is complemented with steadily growing (organically acquired) transaction volume, marketplaces really start to catch on, according to Charles Hudson of Precursor Ventures (link).

  5. Key Metrics: Check out the following resources - Bowery Capital's list of metrics, Creandum's list of metrics

  6. Exit opportunities:

    • The picture so far: According to research by Bowery Capital, there has not been much liquidity in the space to date and the prospect of IPOs has been very weak, leaving acquisition by industrial players or Private Equity as viable exit routes. Some big exits have been Elemica (sold to Thoma Bravo for $1bn+ in 2016), Iron Planet (sold to Ritchie Brothers for $758mn in 2016) and Truckstop.com (sold to ICONIQ Capital for $1bn in 2019).

    • Going forward, there might be more M&A activity and IPOs in certain areas (in labor marketplaces, for example, according to Sarah Tavel of Benchmark) as winning businesses achieve market dominance.

    • Another key consideration is that, unlike B2C marketplaces where there is potential for hyper-growth, B2B marketplaces grow more gradually and work very well at scale (15%-30% annually) and hence the exit timeline might be longer. Early-stage investors might need to focus more on qualitative factors (especially team and unique insight) and have relatively lower expectations for traction-related metrics (vis-a-vis B2C).

Thank you for reading! Don’t hesitate to write to me at aarzoo.sharma@hec.edu to share feedback, resources, or to submit requests for future deep-dives!