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Investing In B2B Marketplaces: Mike Droesch (Bessemer)

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Michael Brown

August 05, 2020
7 29 20 Droesch BVP

The Bowery Capital team is embarking on a ten week journey to cover B2B Marketplaces. We are doing deep dives on various companies, interviewing founders and investors, and learning what it takes to build success in the B2B Marketplace arena. Below is a part of our content series focused on insights from successful VC investors in the space. This week, Mike Droesch, vice president at Bessemer Venture Partners, answers some of our questions. You can read all of the posts in our series by going here.

Mike Droesch is a vice president at Bessemer Venture Partners where he invests in early-stage cloud software, infrastructure, developer platforms, and B2B marketplaces. Mike has been with Bessemer since 2017 and currently serves as a board member at Cypress and Tackle, both of which are backed by the firm. He joins us today to discuss B2B marketplaces and offer up some insights on what he is seeing as an investor in the space.

Mike – what side of the market (supply vs. demand) do you encourage B2B marketplace founders to focus on when they are looking to build traction and why?

I have been focusing on high-friction marketplaces, which I think of as any marketplace where transactions are typically characterized by some sort of broker or an RFP-based quote/bid process. In those situations, where you are bringing an offline transaction online for the first time, it is important to provide some degree of quality assurance or vetting of the supply. This generally means having to start with the supply side in order to establish a base of managed, high-quality product. Scaling certainly requires balancing both supply and demand, but, at least in the early days of a high-friction marketplace, I would encourage founders to prioritize onboarding high-quality supply first and figuring out a scalable way to vet quality on an ongoing basis.

Successful B2B marketplaces can quickly find themselves supply-constrained if they are able to tap into a large unmet demand – what is your advice for founders trying to drive suppliers onto their platform? Are there any methods you would advise founders to avoid?

Generally, I think this is a good problem to have – the nice thing about B2B marketplaces is that most of the actors are pretty rational, so if you have a supply constraint, it is relatively easy to get supply to follow demand. One of the most efficient methods that we see for driving supply is to provide a product-led offering that draws suppliers on to the platform. An example of this would be a free SaaS tool that can solve a core problem for the supplier. In some cases, the demand side is actually willing to onboard their existing supplier network, which is super helpful and is the holy grail of efficient marketplace growth.

In other cases, we see industries with B2B marketplaces that resemble tech-enabled brokers – they might have a demand signal but they are supply-constrained at the beginning so they are going out and finding suppliers to meet specific demand. It can look as if they are brokering a bunch of one-off deals at the beginning, but that model can still make sense, if it’s the early days and you believe the supply is going to be really sticky going forward, allowing the marketplace to evolve into more of a self-matching platform as it gains traction.

Once a marketplace has some baseline supply in place, what are some of the successful tactics you have seen in the B2B space for attracting demand? How do you see this differ from B2C settings?

On the demand side, this is a harder problem to crack and we are often looking for marketplaces with cost-effective user acquisition tactics. This could mean offering a free (or relatively cheap) SaaS workflow tool within the marketplace setting. Another approach we have seen is marketplaces taking the data they already have and offering it up in an anonymized format to demand-side participants for benchmarking. Providing risk-free trial periods is another great way to bring someone online who might be otherwise hesitant to abandon their trusted relationships and transact in a marketplace. We believe it is really important for platforms to solve the trust problem – most B2B buyers do not want to risk quality or dependability just to get a cheaper price – so we think anyway a marketplace can alleviate those concerns can be really helpful for platform adoption.

The last thing I would say regarding demand acquisition is that, in some industries, there’s just no clever, cheap way around it – you have to use a more traditional enterprise sales approach. This is probably the case if you are trying to acquire Fortune 500 buyers who will be using the marketplace as a mission critical piece of their infrastructure. In those cases, we expect businesses will have to spend a lot and run a traditional, high-touch enterprise sales force which can also make sense if we believe the demand side is going to be super sticky. I think we’ve kind of seen everything along that whole spectrum work and it really is very industry dependent.

Once a B2B marketplace is getting traction and has product-market fit, what are the key growth levers you would encourage founders to pull on? Any you would advise them to avoid?

The obvious advice is that once you have achieved product-market fit, getting to scale quickly is one of the strongest competitive advantages that a marketplace can have. If a company has that conviction that the model is working, we would encourage them to try to go as fast as possible without breaking the business model.

In terms of levers for longer-term expansion, we typically look to see if there are any other product features or services that the marketplace can offer to reduce friction and provide an end-to-end experience. This includes everything from facilitating payments, to lending, to offering insurance. In marketplaces centered on a physical product, this could include expansion into things like arranging fulfillment or transportation. We have also seen some marketplaces doing interesting things around helping sellers with lead generation or better marketing their services. There is a whole ecosystem that you can build, and we look for marketplaces that are providing features to make it seamless for buyers and sellers to connect and manage the process end-to-end.

The one thing to be careful of is doing anything that could undermine trust in the marketplace – there are certainly opportunities that a lot of these marketplaces have to sell data or create odd incentives, and that can be dangerous to the extent it can potentially undermine your platform’s role as a neutral intermediary.

B2B marketplaces are increasingly highly specialized – what is your thinking around how much domain expertise the founding team needs to be successful?

It is always great if someone on the founding team has industry experience, in most of these sectors there are so many nuances and relationships are so deep – it is difficult for an outside team to fully comprehend why an industry operates the way it does. That being said, I think that it is definitely not a hard and fast rule. We have seen plenty of teams that have come from the outside to build really interesting businesses in unfamiliar industries. I can think of one company we met with recently and the way they got around this domain expertise issue was they would invite buyers and sellers from industry to come work out of their office, for one week every month, just so they could observe how they operate day-to-day. If you don’t have full empathy for why people operate in what can seem like an archaic way, it’s easy to dismiss the reason that they work the way they do, but often in these industries, you find the incumbent processes exist for a reason. For example, if there are brokers, they are probably providing more value than an outsider might assume, acting as trusted advisors to their buyers rather than just match-makers.

You are a board observer at ACV Auctions – one of the companies we have recently featured on the blog – what have been some of the key factors behind ACV’s success in building out its wholesale automotive marketplace? Have there been any unexpected challenges to building this market?

ACV was not the first company to try to bring this industry online, but in my opinion, they were the first to really get the quality component right. It is very difficult to get somebody comfortable making a large purchase of an item that they have not seen in person, particularly a car where people are used to using their own senses to evaluate quality. I think it was super helpful that the founders came from the industry and had lived the pain points of the buyers and sellers, so they really understood what mattered to them. From day one, ACV was focused on providing buyers with enough detail about its vehicles to feel comfortable paying the full fair market value; this meant buyers were not wildly discounting cars out of fear they might get a lemon. Ultimately, this level of quality makes ACV the best place to buy a car, which creates a virtuous cycle where you have much more liquidity on the platform, which then in turn makes it the best place to sell a car. That quality component and understanding the nuances of what buyers care about have been key factors to ACV’s success.

In terms of challenges, many B2B marketplaces have a regional component, and there is definitely a locality component with used car sales; one challenge ACV faced was trying to sustain growth at the pace that they did, while operating in an industry that required opening up many local markets across the country, and then needing to hire and maintain a culture of quality in all of those different locations. This was no small feat and I was really impressed with how they handled that.

BVP led Tackle’s Series A round in June and as part of that investment you became a member of their board. Can you speak to us a little about how you see Tackle fitting into the increasing utilization of marketplaces for B2B purchasing decisions and what drew you to the company as an investment?

Tackle is an interesting example of a company that is trying to help bring more efficiency to the process of businesses purchasing software online, which is still a bit of a new phenomenon in the enterprise software arena. I think we are still in the early innings of this sector shifting to fully online, frictionless marketplace-based purchasing. If we look at the spectrum of B2B marketplaces, there are wholesale marketplaces that focus on distribution, high-friction marketplaces that I spoke about earlier, and then there are infrastructure platforms that are providing the fundamental rails that power marketplaces. Tackle is in this third category and they have built a really impressive platform that makes it much easier for software vendors to integrate with the large public cloud marketplaces. Tackle is well-positioned to play this fundamental infrastructure role and remove a lot of friction for sellers looking to transact online. We are really excited to see how this transformation to public cloud marketplaces evolves over the next 10 years.

How are you thinking about the increasing verticalization in the B2B space? Do you see this trend continuing or beginning to reverse over the next 3-5 years?

I definitely see this trend continuing – one of the things that we see in these marketplaces is because the buyers and sellers are experts in their industry, there’s so much nuance to the way things are done and it is very hard to crack them without being super focused on a specific vertical. Over the next three to five years or longer, I would imagine that most of these marketplaces will remain highly verticalized and hyper-focused on matching high-quality demand and supply. Many of the industries B2B marketplaces target are so large that there is the potential to support huge businesses without ever extending beyond their core verticals. There are also lots of compelling opportunities to expand into adjacent service offerings, such as payments and lending and the other opportunities I mentioned, without having to expand the marketplace itself into a new arena.

What is your thinking around B2B marketplace take rates and how do you see them changing over the lifecycle of a marketplace?

We probably think a little bit less about the nominal take rate, and more so about the overall effective monetization rate. We have seen many different flavors of this – a lot of marketplaces are just trying to bootstrap liquidity without charging a take rate at all, which I think can be viable if you’ve got other paths to monetize the platform and bring in different revenue streams over time.

We are often comfortable with B2B marketplaces that will have a monetization rate in the 1-5% range, as opposed to consumer marketplaces, which might need to have a take rate closer to 20-30%. In B2B marketplaces the transactions are much larger, and you can build a really powerful business with something in that 1-5% range. We also believe that as time goes on many marketplaces could stand to lower their take rate, if they believe it can help them to build a stickier, more powerful network by locking people into other offerings like payments, lending, etc. – these ancillary services can combine to potentially achieve a higher effective monetization rate than a typical commission-driven take rate model.

Do you see payments and lending as the most effective monetization approaches outside of a traditional take rate, or are there other ones that you also encourage entrepreneurs to explore?

Payments and lending are probably two of the more interesting monetization approaches that are directly related to a marketplace’s transactions. Some marketplaces have also been able to monetize off of suppliers’ desire to advertise on the platform or by monetizing data assets. Fulfillment or transportation of goods can be another area to monetize, but it is often more commoditized which can make it hard to generate a substantial incremental margin.

In addition to payments, there are opportunities around invoice factoring, and there are even companies like LeafLink that are making small business loans to marketplace participants because they have so much insight into their businesses via their transactions. I think this is a trend we are just scratching the surface of, and I imagine over the next 10 years most of the successful marketplace businesses will have big, embedded financial services arms.

If you liked “Investing in B2B Marketplaces: Mike Droesch (Bessemer)” and want to read more content from the Bowery Capital Team, check out other relevant posts from the Bowery Capital Blog. Look out for more content on B2B Marketplaces from us in the coming weeks.

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