Excerpts from an interview with YourStory.com

Disruption

What advice would you give to startups and entrepreneurs starting a business today? How can they identify industries that are ripe for disruption?

The best way to identify an industry for disruption is not to do something of that sort at all. Focus on solving a real inefficiency and you’re bound to replace the guys who’re thriving on account of the inefficiency, namely the incumbents.

In the process of solving such a problem, the startup often needs to figure out structural characteristics of the industry that give rise to inefficiency. That’s when a knowledge of industry structure helps.

There are three structural characteristics of industries that are ripe for disruption:

1. These industries have inefficient gatekeepers: Look at the media industry. The entire editorial model is breaking down as community curation tools become more widespread. YouTube changes how we discover new talent. Amazon allows anyone to self-publish. Gatekeepers thrive on controlling market access. The internet just blows that out of the water allowing startups to disrupt such industries.

2. Companies in these industries compete because of privileged access to supply: Just as gatekeepers have privileged access to market demand, some industries have privileged access to supply. Hotels, for example, are the only entities that have spare rooms to let out. Taxi companies are the only ones with fleets of taxis. Both these models are being disrupted by startups that allow anyone to market a spare room or a spare car or even spare space in a car.

3. These industries are extremely fragmented: Internet startups often aggregate highly fragmented industries. Look at what LinkedIn is doing to the hiring industry or what Yelp and OpenTable did to the restaurant or local information industry. Or what redBus has done to the bus industry and CommonFloor is trying to do to the apartment/condominium landscape. This aggregation is typically impossible without the internet, and that’s where these startups create unique value.

Failure

What do you see as major problems facing startups and entrepreneurs building platforms?

Regulation, as I mentioned, is a major problem facing startups trying to compete with large incumbents. Traditional incumbents tend to lobby well with regulators and force them to protect their interests.

The other problem that comes up especially while building platforms is the fact that the management and administration of the platform can be very tricky. Every platform design has users trying to game the system. Houses get ransacked on Airbnb, copyright infringement happens on YouTube, naked hairy men start appearing on ChatRoulette and people actually die while using Craigslist.

So what all is a platform responsible for and how much can it control? If the platform doesn’t give a minimum guarantee on quality of service and safety, it risks losing users. But often, giving a minimum guarantee may destroy the business proposition that makes the platform approach viable in the first place. Hence, governance can be a challenge, especially for small startup teams with low funds.

Failure: Why do you think most internet businesses with network effects fail and so few succeed?

I believe most such businesses fail because they erroneously believe that their job is to build and ship technology and that technology is the end product. Building technology is definitely a critical part of running an internet platform, but a startup’s work doesn’t end there. Enabling users to create value and interact with each other is an extremely important and poorly understood part of building internet businesses with network effects.

Consider Twitter. The technology itself doesn’t provide value. Twitter is a tool to write 140 characters, not much value for anyone using it. The value is in the community and the content it creates. The value of a marketplace, similarly, lies in the network of buyers and sellers, not in the technology itself.

If your business relies on network effects, as a lot of internet startups do, technology alone has no value until a network of interacting users is created.

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Secondly, running an internet business with network effects is not just about finding customers for your products, it’s about building interactions on top of your product. You need to rethink how you market your product if you’re building a platform business model.

So…

Build Network Effects…

And Focus On Interactions…

A lot of internet businesses fail because of three points of failure in their attempt to build interactions:

1. They never get a critical mass of users that interact and build value. Most marketplaces, social networks, and P2P startups never take off because of a failure to achieve critical mass. I’ve written quite a bit about how one goes about solving this.

2. As the community scales, they fail to scale curation to regulate noise and negative behavior. I’ve written about this in detail as well.

3. Their monetization depletes value for the community. Think of what advertising does to social networks.

Metrics

What are the keys to successful marketplace businesses?

There are three broad factors critical to the success of marketplace businesses:

Liquidity: Liquidity is a state where there are a minimum number of producers and consumers in the marketplace, and there is a high expectation of transactions taking place. There is enough volume of supply and demand, for transactions to start sparking.

The first and most important metric to watch out for is the percentage of listings that lead to transactions within a certain time period. This serves as a proxy for the efficiency of the marketplace. Merely increasing the number of buyer and seller sign-ups doesn’t serve a purpose unless this metric starts rising. To get to liquidity, the marketplace also needs to solve the chicken and egg problem and get both buyers and sellers on board. Marketplaces leverage a variety of tactics for circumventing this problem including building single user utility, stealing traction and piggybacking other platforms.

Curation of Products/Services (Quality): Users visit a marketplace with a highly transactional intent and want to find what they’re looking for at the earliest. In this aspect, transaction businesses are remarkably different from engagement businesses. A user visiting Airbnb or Yelp has a specific intent in mind. Hence, the quality of the search algorithm and the intuitiveness of the navigation are critical to delivering value. The efficiency of discovery and matching is critical to a marketplace’s success.

Curation of Participants (Reliability/Trust): Building trust is central to marketplaces where transactions carry risk. Focus on the trust metric is very important to move from appealing to an early adopter audience to appealing to a mainstream audience. While early adopters use new marketplaces because of the novelty, opening up to a larger market requires the trust and reputation management systems to be alive and kicking.

I’ve written in greater detail on all three aspects.

Tweetable Takeaways

Optimize for Liquidity, Quality and Trust while building a platform business. Tweet

The value of a platform lies in the community and exchange, not in the technology. Tweet

Industries with gatekeepers and supply hoarders are most prone to platform disruption. Tweet