This town ain’t big enough for the two of us?

Hopefully, eBay will forgive us for stealing the above illustration from one of their presentations. It illustrates very well the basic nature of the network effect; the phenomenon whereby a service becomes more valuable as more people use it, thereby encouraging ever-increasing numbers of adopters. In the late 1990s the network effect was often used as rationale by dotcoms for focusing only on market share rather than revenues, as the winner would take it all, i.e. set technical and marketing standards. These days, it is argued that the winner has already taken it all in some markets, and that it is too late to enter.

The network effect, according to marketing literature, is often at first the result of word-of-mouth testimonials. The network effect can be perpetuated indirectly, as well, through analysis of a network's size and projected growth. In other words, you may adopt a service initially because someone you know uses it; later, you may adopt a service because "everyone" uses it. Although network effects and natural monopolies are separate phenomena in economic terminology, many goods have both properties; telephone networks are much-cited examples. So, since eBay, online classifieds sites and marketplaces in general (online, print, stock exchanges and town squares) obviously display network effects, should a natural monopoly be expected?

Arguments can be made that it should. For instance, many cities, like our hometown Oslo, have one newspaper that largely dominates the print classifieds market. And most countries have only one stock exchange of importance. But there are plenty of cities with more than one ‘classifieds newspaper’; and Spain, the United States and Germany all have more than one stock exchange and are apparently happy that way. Visitlondon.com shortlists 9 London markets well worth a visit; some have been around for more than a thousand years.

In most online classifieds markets monitored by FinnTech, many players exist, and many exhibit growth. Their degree of maturity varies, so some look more ‘settled’ than others. But even in the more consolidated ones, total dominance of a vertical by a player is rarely observed – more often than not, a handful of players battle it out, and in many cases the battle is still too close to call. In some cases where a clear number one has emerged, others live comfortably beside it. Without going into too much detail, we wager three propositions:

-For the majority of publishers, it is still not too late to enter the race.

-Further consolidation in online classifieds markets should be expected

-The time for action is now – for publishers in North America, most of Europe and parts of Asia because it may soon be too late; for publishers in the rest of the world because experiences from the most mature markets show that first-mover gains can be substantial.

Much of the debate surrounding network effects in online classifieds revolve around the brief discussion above; whether there is room for more than one or a few players in a market. But there is another, more basic implication that should be given attention - as some online classified ventures launched by publishers suggest that it is not fully recognized.

The basic illustration from eBay is that buyers attract sellers, which in turn attract buyers and so on. It is very intuitive that it makes no sense to have one without the other, but still we observe efforts that seem to focus only on attracting one.

Attracting traffic without having objects is probably the least serious error, as traffic, for a C2C portal at least, usually translates into objects to some extent (but people will not keep visiting your site if they do not find anything interesting there, so if you start with nothing, your ad database probably needs to grow fast). The most usual error made by publishers is focusing only on sellers. This may be because few publishers start off with no objects – in some cases choosing to feed their three-line ads directly to the web offering – and because publishers are used to having the luxury of having their classified ads bundled with a newspaper full of interesting editorials and delivered to buyers’ doorsteps every day.

Understand that sellers advertise because they expect sales effect, and that many on-line players deliver this already.

The Internet is not magical; unless you attract potential buyers, there is no reason to advertise with you. And yes, classifieds is content; it is interesting, valuable content, but that does not make distribution unimportant.

You would probably not expect your readers to turn up at your print facility to pick up your real estate section, and you would not expect many to advertise in a print product that was distributed that way.

The introductory illustration could be misinterpreted to mean that eBay rely solely on buyers to attract their sellers, and vice versa. In fact they do anything but that; they are among the top web advertising spenders in their key markets; huge in paid search, affiliate marketing and display as well as natural search engine optimization. All of which, of course, are available strategies for everyone with an internet site but no traffic yet.

Pay-per-click search engine advertising has reduced barriers to entry, particularly for services like online classifieds, which rely on network effects and reaching critical mass fast.

Word-of-mouth testimonials, often cited in literature as the initial driver of network effects, are of course not the only way to attract enough users to reach the much-coveted critical mass. Pay-per-click advertising is the most direct marketing tool invented to date, and is very manageable; you pay for what you get, and get what you pay for. In other words, website traffic is available to anyone who is willing to spend. How you treat your visitors once they are there will be the deciding factor.

For in all the talk about network effects and market domination it is often forgotten that the dominant players in mature markets usually offer services that are excellent in one way or another. And describing the world in purely microeconomic terms usually underestimates the effect of clever product differentiation and consumer behaviour. In most cases in most markets, there is space left for the right product.

Fortunately, online classifieds providers have an easier time differentiating their product than telephone networks used to. That implies, however, that they must devote enough attention to getting it right.

investor.ebay.com; Pindynck and Rubinfeld (1999), FinnTech’s own research