What Makes an Online Marketplace Disruptive?

New distribution channels make it possible to reach more customers with a wider range of products than was previously available. New producers and sellers can take advantage of emerging distribution channels to transcend geographic proximity, leading to an increasingly fragmented producer market that is no longer limited by the scarcity of shelf space.

Throughout history, technological advances in transportation and distribution have spurred market expansion. For example, in the 1890s, the combination of robust rail service and the Sears, Roebuck and Co. mail-order catalog enabled a broader assortment of goods to reach rural farmers. The same railroad infrastructure helped bring a broad product array together under one roof in the department store until widespread use of the automobile led to the creation of the shopping mall and the discount store. Today, technological advances in the form of platforms and digital distribution channels are creating even more direct links between buyers, sellers, and producers. The resulting cost structure is such that a significantly broader product array can be offered to a significantly larger audience.

In recent years, we have seen this pattern play out in two phases. First, new distribution channels that aggregate niche supply and demand (such as Amazon, eBay, or app stores) challenge traditional brick-and-mortar distributors. These new channels feed the growing demand for personalized products and are enabled by advances in digital platforms, shipping, and payment systems. As these digital marketplaces grow, they rapidly consolidate as a result of network effects—the more likely customers are to turn to a specific site, the more likely sellers are to use its digital storefront services.

Disruption Meets Marketplaces

Many markets don’t work well. The costs of accessing the market and/or identifying and communicating with potential transaction partners can limit who participates or make it hard for participants to transact with each other. Asymmetric information about sellers’ offerings or buyers’ needs, meanwhile, can make parties less willing to transact, lest they end up being taken advantage of. Under such market failures, there are opportunities for beneficial exchange that are inevitably overlooked. Marketplaces address these problems by providing rules and infrastructure that facilitate and improve transactions, and mitigate market failures — creating value in the process.

But when is a marketplace disruptive ?

A disruptive innovation underperforms on traditional measures that current market participants value, but is “good enough” for a different set of prospective consumers who value affordability, accessibility, and convenience. Disruptive innovations thus target those who were previously left out of existing markets — people Christensen referred to as nonconsumers .

In the marketplace context, we have found it useful to separate nonconsumers from what we call nonproducers , i.e., individuals or businesses that are constrained in their ability to offer supply in the market. For a marketplace to be disruptive, it must identify either new supply, new demand, or both — targeting individuals or businesses who were unable to profitably produce or consume goods and services in incumbent channels. And the most powerful disruptive marketplaces are often those that simultaneously connect nonconsumers with nonproducers.

Consider Outschool . It’s a marketplace of online courses for children that allows parents, educators, and others to create their own courses. Though certainly used by families who would otherwise be able to afford and access enrichment programs, Outschool’s business model also enables an entirely new population of families to take advantage of these opportunities. It not only enables new families to consume educational content, but enables a whole new population of educators to monetize their passions and expertise in algebra, ballet, or Pokémon arts and crafts through the platform.

Put another way, disruptive marketplaces make good on famed Silicon Valley investor Bill Gurley’s observation that internet marketplaces “literally create ‘money out of nowhere’” because “in connecting economic traders that would otherwise not be connected, they unlock economic wealth that otherwise would not exist.” When nonproducers and nonconsumers come together, tremendous opportunity awaits.

Bundles, Trust Wrappers, and New Ways of Transacting

Many marketplaces target existing supply and demand in a more efficient or trusted way — they improve existing transactions. Disruptive marketplaces, however, expand market participation by creating new types of transaction altogether.

Amazon displaces Borders

Retail giant Amazon began as a bookstore in 1995, just five years after the introduction of the Internet. Over the next decade, Amazon capitalized on the rapid growth of the Internet to scale and displace leading brick-and-mortar bookstores, including Borders—the second-largest book retailer in the world at the time. Improvements in shipping (for example, speed, cost, and parcel tracking) and digital payment systems enabled Amazon to create a digital marketplace that addressed the long tail of the book market and fed customers’ growing expectations for personalized products.

Historically, the diversity of the book market made it hard for a bookstore to serve all customers—almost more overwhelming than the number of books available from publishers is the wide range of customer demand, spanning backlist and new products. The long tail of demand was poorly served by the big-box book retailers because it was difficult and unprofitable to stock and maintain inventory across the vast range of niche titles across multiple brick-and-mortar locations. Amazon’s online retail platform simplified inventory management by allowing inventory to be held against an aggregate demand and reduced the overhead costs to offer a much wider range of books than its brick-and-mortar counterparts. By 2008, 30 percent of Amazon’s book sales came from titles that were not available in even the largest offline retail stores. Amazon amplified its market reach by using on-demand fulfillment and leveraging third parties to sell inventory it didn’t even own.

Unmet customer needs may have fueled Amazon’s digital marketplace, but its viability was initially based on the characteristics of the book market. The book was the perfect product for e-commerce—the book was durable, easy to ship, and didn’t require hands-on interaction prior to purchase. Books, as with other media, are frequently purchased and quickly consumed, which allows for the low margins, yet high turnover required for profit in an online marketplace. All these advantages point to the viability and the success that brought millions of customers to Amazon’s digital marketplace.

The shift in the way customers approached book buying mirrored their growing familiarity with the Internet and online purchases elsewhere in their lives. Over time, customers gained trust in online reviews, which disintegrated the in-store customer experience that was traditionally the pride and focus of brick-and-mortar retailers. As customers gained access to more niche products, those who had previously settled for mainstream products began to expect products that better fit their personal needs. But this wasn’t the only customer mindset shift—lowered barriers to entry opened up new options for producers. By facilitating discovery and transactions between customers and niche publishers, Amazon reduced barriers to entry for smaller publishers, leading to fragmentation in the publishing market. In 2013, a quarter of Amazon’s top 100 Kindle books were written by self-published “indie” authors.

“Crucially, there are far too many books, in and out of print, to sell even a fraction of them at a physical store. The vast selection made possible by the Internet gave Amazon its initial advantage, and a wedge into selling everything else.” 
—George Parker

Borders paid little attention to the threat of Amazon. It may be that Borders did not see online marketplaces as a threat to the in-store experience it assumed its customers preferred. In 2001, Borders handed over its online operations to the very competitor that would later be its downfall, citing that its online marketplace “will continue to be utilized as a convenience retail channel.” In turn, Borders focused on driving more revenues by investing in store real estate and inventory, a strategy it would later cite as “problematic” in its 2011 bankruptcy filing.

Netflix displaces Blockbuster, 2000–2010

Between 2000 and 2010, Blockbuster Entertainment went from being a movie rental giant with 9,000 stores across the United States to declaring bankruptcy, as Netflix expanded the reach of the movie rental marketplace, first with physical movie rentals, and then with streaming services in 2007. Rather than replicate Blockbuster’s focus on “hit” movies, Netflix brought unique films to viewers searching for niche titles, such as documentaries and Bollywood films. As of March 2008, Netflix had an inventory of 90,000 DVDs, and 25 percent of Netflix’s sales were from products not available in even the largest offline retail stores. Blockbuster did not go down easy. In an effort to match the appeal of Netflix, Blockbuster began to discontinue late fees and invest in a digital platform—this move cannibalized two core revenue streams, hurting profitability and resulting in the ousting of CEO John Antioco. Unable to compete, Blockbuster fell from boasting a company value of $5.9 billion in 2003, to holding a value of just $24 million immediately prior to filing Chapter 11 bankruptcy in 2010.

Indie music labels displace major music labels

Between 2004 and 2014, as digital tools for production, marketing, and distribution matured, the major US music labels (Universal, Warner, Sony, and EMI) lost 29 percent market share—from 82 percent in 2004 to only 53 percent in 2014. They were displaced by non-major labels, who tapped into the long tail of supply and demand in the music industry and brought niche artists and genres to customers via a growing digital distribution channel.

The music market was rapidly transforming during this time as digital distribution channels disrupted brick-and-mortar record stores. Customers have a diverse range of music tastes, and there were large segments of the market that were underserved due to both brick-and-mortar inventory limitations and the lack of niche offerings represented on radio stations, which are often controlled by major music labels. Digital distribution channels, enabled by the switch from analog to digital consumption, expanded the reach of the market and brought the long tail of music to customers, resulting in a diversification of what is “popular.” Consider that most of the top 50 albums of all time were created in the 1970s and ‘80s, with none made after 2000. The last decade has seen a fragmentation of preferences, which makes smaller players sustainable in a way that was not previously possible without the aggregated demand from digital channels.

This transition not only brought niche artists and genres to customers, but also unbundled the single from the CD. This unbundling decreased overall market revenue, challenging independent record stores, such as Tower Records, which relied on the high-margin CD to support its large inventory and infrastructure requirements.

Using the new digital distribution channels, new artists entered the market, fragmenting the producer marketplace. The proliferation of affordable digital audio workstations and easily accessible learning platforms helped musicians produce and improve the quality of their recordings. Through community organizations and learning platforms, “musicians are providing the same sort of guidance previously offered by major labels—for themselves and for one another.” At the same time, digital distribution platforms (such as SoundCloud or YouTube) made non-label artists visible and discoverable by the listening audience. As a result, the number of new albums produced 2011 was nearly double the number produced in 1999.

This proliferation of artists highlights a shift in mindset as more consumers also act as creators who produce and share content. However, large labels have continued to focus on hits that would warrant the management and financial resources for promotion and marketing. This has opened the door for smaller labels to capitalize on the increase in available artists, content, and means for finding, managing, and distributing them. Non-major labels have become increasingly more viable as new digital distribution platforms make it easier for consumers to find and support niche music offerings.