eBay: How big can you go?

eBay is a notoriously dominant property in the online auction/marketplaces space, where the market value of an item is uncertain. The most significant element of this dominance is attributed to network effects in its marketplace business.

In eBay’s business, the money side of the platform is the marketplace sellers and the subsidy side is the marketplace buyers.

Analysing the network effects present in the marketplaces business, we find:

Moderately negative same-side network effects on the money side — the more sellers that enter the marketplace, the more difficult it is for them to get their items viewed by buyers and the lower the prices at which their auctions close (price is inversely related to supply for a given demand level). Thus, sellers find listing their items on eBay becomes less effective.

Minimally positive to moderately negative same-side network effects on the subsidy side — increases in the number of buyers in the marketplace assists in creating platform credibility, but also discourage buyers from entering the marketplace as bidding becomes more competitive, pushing up the auction closing prices.

Strong cross-side network effects in either direction (from the subsidy to the money side and vice versa) — the more sellers that enter the marketplace, the more buyers will enter too, because the more items that are listed, the more likely it is for buyers to find what they are searching for.

eBay’s cash engine is dissimilar from Google’s engine in that the former is driven by strong cross-side network effects in both directions, whereas the latter is driven by relevance and very strong cross-side network effects from the subsidy to the money side.

eBay is much less likely to be unseated by a copycat in a marketplace category that it already dominates (unlike Google), because there are no naturally occurring positive same-side network effects on the subsidy side of similar platforms that could drive the cross-side network effects that increase the value of the new platform for marketplace participants. eBay has the crucial first-mover advantage and it is already entrenched. Consequently, buyers don’t have enough incentive to switch to a platform that provides less value and sellers won’t switch to a platform where there aren’t enough buyers.

Let’s consider this by way of example — if a new marketplace operator charged zero listing fees (eBay’s primary income), then almost all sellers would immediately move to the new platform, right? Wrong! Unless the majority of the sellers in a given category moved at the same time to the new platform and removed their listings on eBay, there would be no incentive for the buyers to change platforms, because they would still have a better chance of finding what they are looking for, at the right price, on eBay.

If the buyers didn’t move to the new platform, then neither would the sellers. Most likely, only the most proactive sellers would create listings on both platforms, the buyers would still get more value out of the eBay platform and continue to use eBay more often than the competitor, and the competitor would wallow in obscurity or go out of business. I suggest that almost the only way for a new competitor to gain market share in established markets is to target those categories that are least competitive in a given eBay marketplace. This could enable the competitor to establish a beach-head, so that cross-side network effects have an opportunity to arise at the category level.

Unfortunately for eBay, its dominance has natural limits — it suffers from same-side negative network effects on the subsidy side, not seen in Google’s case. These network effects will tend to reduce the rate of growth in the numbers of new buyers entering the marketplace, as the marketplace grows. A reduction in the rate of growth of buyers will similarly result in a reduction in the rate of growth of sellers. In systems theory, this is referred to as a limits-to-growth systems archetype. In other words, there is a limit to the size of eBay’s individual marketplaces, whereas Google suffers from no such limit. eBay’s marketplace revenue growth would thus tend to come from one of two places:

increased geographic coverage (in other words entering more markets); or

increased activity in less competitive product categories.

I hypothesise that the limit to the size of the eBay marketplaces will tend to be at a lower level of supply than that capable of meeting market demand in more developed marketplace categories. eBay’s market share thus has a diminishing tendency as market demand grows in a given product category.

I believe that eBay’s very strong cross-side network effects have a good chance of maintaining its dominance in online auctions for items with uncertain value (and profitability) for many years to come — it is a very difficult business to disrupt or compete against if you attack it head-on. Unfortunately for eBay, it can’t fully exploit this dominance in its primary business — its size is limited by naturally occurring network effects that I believe make it incapable of earnings growth from new marketplaces or underdeveloped categories in line with expectations associated with the price/earnings multiple of close on 39 that is currently trades on.

Time for a new play, eBay … or else Facebook is going to kick your %#* ;)

Based on a previous post by the author at corpv2.com