tl;dr Marketplaces extract value when they generate demand. The Booking.com low rake plus bidded auction model is the playbook modern marketplaces should follow.

Background

People know Booking.com as a behemoth in the travel industry but it wasn’t always the case. Priceline’s purchase of Booking.com in 2005 looks brilliant with Booking.com driving > 2/3 of PCLN’s revenue and accounting for a large portion of their $60B market cap.

Booking.com path to success is a fascinating story (see How Booking.com Conquered the World). It was started in 1996 with a revolutionary new agency model as an OTA. The agency model is much lower friction vs the previous standard merchant model driving Expedia and Travelocity’s success. Booking.com lowered the reserve rake from 25-30% to 12% and innovated on a more favorable cash flow for suppliers. This low friction model allowed Booking.com to acquire nearly every small hotel in Europe as there was no reason for a hotel not to join. This resulted in comprehensive selection for consumers and aligned incentives with hoteliers.

The difficulty with a high rake model is that you introduce a selection bias. Good suppliers that can sell well independently don’t need to participate in the market and cannibalize organic sales. This bias results in a poor consumer experience with only bad suppliers. You can see this effect in markets like Groupon, where participation is a signal for supplier quality in itself.

Auction

After achieving supplier ubiquity, Booking.com introduced a bidded marketplace where hoteliers bid on margin competing for placement (and production). There are a number of variants for these auctions for example Google AdWord’s modified GSP or the efficient VCG that aligns incentives. The theory should be to rank based on expected value created where the rank is inversely correlated with likelihood of conversion.

The auction works to maximize platform revenue and both supplier and user value. Suppliers are efficiently allocated bookings based on implied value based on bidding a greater margin. Suppliers that are of high quality and more likely to book will be ranked highly and accessible to consumers. Booking is evidence of consumer utility.

Model

By starting with a low rake, the marketplace can reach ubiquitous supplier adoption. An auction format then allows for market-drive pricing allowing suppliers that value an incremental booking to bid their utility. The increase in margin isn’t ascribed to unfair platform behavior but rather competition with other subscribers. The incentives are aligned between the marketplace and suppliers and allows for the marketplace to capture the value they create with their demand generation.

Examples

Looking at Etsy’s successful public offering or OpenTable’s acquisition, we see successful examples of very low rake marketplaces with revenue growth coming from demand generation products.