Liquidity is a crucial metric for all marketplaces. But how can we truly evaluate this liquidity? The three keys to answering this question are density, appropriately balanced demand and supply and category concentration.
Density, geographic reach and distance between counterparts
The first step to analyzing the potential liquidity of a marketplace is understanding its geographic extent. For example, Upwork will see transactions filled between freelancers and employers all around the globe, while Tinder will (typically) only see two people dating within the same city. Tinder would therefore require a city per city launch and a city per city liquidity analysis.
In local marketplaces, there is a strong correlation between density and liquidity. The higher the number of participants within a relevant radius, the higher the liquidity of the marketplace. We define liquidity as the number of transactions filled out of the total potential transactions in a marketplace. We refer to density as the number of participants within a certain geographic area.
Let’s use Tinder as an example. If in a given week Tinder acquires 1,000 female participants in Chicago and 1,000 male participants in New York, Tinder’s number of total users increases, but its liquidity remains the same. Now, if Tinder acquires 1,000 female participants and 1,000 male participants all located in the borough of Brooklyn, this higher density of users (from both sides of the marketplace) will lead to higher liquidity.
To determine the density in a marketplace, you need to first define the limits of the geographic area within which its transactions can be filled. This distance threshold (“r” in the visual below) is different for every marketplace and you will identify it by understanding how far your customers are willing to travel to complete their transaction. For example, a seller at Letgo might not be willing to travel 30 minutes to sell a used skateboard for $30, but a babysitter at Care.com will likely travel 30 minutes to make $150 for a day of babysitting.
You start by optimizing your marketing strategy to achieve the highest customer acquisition within the established distance threshold. As a result, you will maximize the active participants within that distance of each other, and therefore maximize density, moving from the low-density to the high-density marketplace diagram above.
The evolution of a balanced marketplace
Maintaining the optimal balance of demand and supply in a marketplace is crucial to achieve liquidity. If a marketplace doesn’t have the right number of buyers per listing, or the right number of items listed per buyer, transactions will go unfilled.
How can we analyze what is the right balance of demand and supply? By looking at several ratios:
- The average number of buyers relative to the number of sellers needed to fill a transaction
- The number of bids per buyer required to fill a transaction
- The average of items listed per seller required to fill a transaction
Let’s base our example on a used furniture marketplace in which the average ratio of bids per item listed required to fill a transaction is 100 to 1. So, every item listed needs 100 bids for it to sell. Now the conversion from this ratio to the ratio of buyers to sellers is determined by the average number of bids per buyer and the average number of items each seller is selling. This is the key to the analysis.
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