Posts from Peer-to-peer

MBA Mondays: Revenue Models - Peer to Peer

We've covered advertising, commerce, and subscriptions so far in this series on business models. And while they are the big three of Internet business models, they all existed well before the Internet. They are not Internet native business models.

If there is one thing I have learned investing in Internet businesses over the years it is to pay attention to things you can't do without the Internet. And that describes peer to peer pretty well. Like the Internet, a peer network empowers the edges and devalues the middle. I like peer networks very much.

If you look at the revenue model hackpad, you will see a list of some interesting peer network businesses, including our portfolio companies Lending Club and Etsy. They all take a similar approach to revenue generation. They connect one or more people together to conduct a transaction and take a fee for doing so. In Etsy's case the transaction fee is 3.5%. In Lending Club's case, the fee is generally 4% to the borrower and 1% to the lender. In Kickstarter's case, the fee is 5% to the project creator if the project is successful.

But there are ways to generate revenue outside of the transaction fee in peer networks. Etsy is a great example. In addition to the 3.5% transaction fee, they charge a 20cent listing fee, a payment fee for payments processed on their direct checkout service, and they have an advertising marketplace so sellers can promote their items on Etsy. It is possible to sell on Etsy and share less than 5% of your revenue with Etsy. It is also possible to sell on Etsy and share more than 10% of your revenue with Etsy. It all depends on how many of their services you are using to run your business.

I like this approach very much. I think the basic fee for participating as a seller in a peer network should be as low as possible. This allows the marketplace to develop as much liquidity as possible. Increasing transaction fees will push sellers out of your market into other ones. The better approach to increasing revenues is value added services that sellers can avail themselves of but are not required to. If these services allow sellers to sell more or if they make selling easier, sellers will adopt them and your take rate can ultimately be much larger than your transaction fee.

The purpose of the revenue model in a peer network should be two fold. First it should incent as many participants in the peer network as possible (ie the lower fees the better). Second, it should produce enough revenue so that the business will produce significant profits at scale.

The thing about peer networks is most of the value is created by the participants in the network. The business doesn't do that much. It provides the basic infrastructure so that the market can work. It provides trust and safety and governance. And it provides customer service and support. The participants in the network do most everything else. That means these businesses can and should operate very efficiently at scale.

Craigslist is a good example of a peer network leveraging the power of the model. I have no idea how much revenue Craigslist makes and how many employees they have. But I would not be surprised if it were a $200mm annual revenue business with $150mm or more of annual profits. And yet it is capturing a tiny amount of the economics in its peer network. It should easily be the case that billions of dollars a year are transacted because of Craigslist. So what you see is a huge amount of transactional volume, a relatively small percentage of which is captured in terms of revenue, but a huge percentage of the revenue that is collected drops to the bottom line. That is what a peer network business model should look like.

And it scales really well. Because so much of what a traditional business would do is being done by the peers on the network instead of the company. Compare an online retailer with Etsy. An online retailer needs to have buyers and merchandisers. It needs to have inventory and warehouses. It needs to ship and track. It needs to spend a large percentage of revenues on marketing, customer acquisition and retention. Etsy doesn't spend much money on those things. Their sellers do. And as a result, their sellers keep more than 90% of the value of the transaction as opposed to giving up 50% as a wholesaler.

So peer networks are powerful businesses that when constructed well have great defensibility and staying power. The key is keeping the take rate as low as possible and incenting participants to transact with you instead of someone else. If you can do that, you can build a large and sustainable business with this model.

#MBA Mondays

Bitcoin

I've mentioned Bitcoin a number of times on this blog. It is something our firm is watching closely. We thought briefly about making a Bitcoin specific investment earlier this year but ended up deciding to sit on the sidelines for now.

We are quite taken with the idea of a currency that is not controlled by governments and central bankers and that is based on faith in an algorithm and a network instead of the "full faith and credit" of a country.

Wired has a good post on the history of Bitcoin. It's a quick read. If you are at all interested in this topic, I suggest you check it out.

The Wired post has this chart in it:

Bitcoin

You could take that as a sign that Bitcoin has failed. Or if you put that chart in the context of the Gartner "hype cycle" chart, you could say that we just went through inflated expectations and now we are into the real work.

Hype cycle

The hype cycle model rings so true to me because it maps out what has happened with the commercial Internet over the past fifteen years. In 2002/2003, so many people thought the Internet was "over" as an investment opportunity. And they were wrong.

So it seems to me and my colleagues at USV that an alternative currency with roots in peer to peer networks and based on an algorithm that is transparent to everyone is an idea whose time has come. The question remains if the Bitcoin algorithm or some other algorithm (possibly a derivative of the Bitcoin algorithm that deals with some of Bitcoin's weaknesses?) will ultimately win out. That's an important issue that has a lot to do with when this space becomes investable.

But Bitcoin or something else, I'm confident we'll see the emergence of currencies that are not controlled by nation states in my lifetime. Whether that is a good thing or not remains to be seen. I think it is, but there are significant ramifications that will result from the decoupling of currencies from governments. And one of them is an interesting investment opportunity that we hope to participate in.

#Web/Tech