Vertical marketplaces in B2C e-commerce: a framework to think about categories for verticalization

Under what circumstances or under which categories, does it make sense to create vertical marketplaces? To address this on-going debate, Nitin Bobba, our AVP, shares a framework to think about categories for verticalization.

A few weeks ago, I was having a conversation with a friend about e-commerce (and marketplaces more broadly). One of the questions that came up in that discussion was around horizontal vs. vertical marketplaces¹. More specifically - under what circumstances or for which categories does it make sense to create vertical marketplaces? Incidentally, this is also a question I’ve been discussing with a lot of potential founders off late. So I started thinking a bit more about this and went down a bit of a rabbit hole. As is often the case, in contrast to the hard sciences, there are no axiomatic answers to most questions in the business / startup world. One can at best make highly context-specific “choices”. At first, this used to irk me, but over time I’ve started to appreciate that this is one of the reasons that makes entrepreneurship so hard.

Empirically, it appears that as long as markets are deep enough, vertical marketplaces can be created in almost any category. This is evident when we look at a very deep and mature market such as the US. In the US, vertical specialists (both online & offline) come in every hue and size that one can think of - from the usual suspects such as fashion to more esoteric ones such as home improvement, repair and gardening supplies. In fact, a few of these verticals such as fashion are so deep in the US, that multiple sub-specialists or archetypes of players exist, each catering to a very specific need or niche in the market (e.g., big box mass retailers, department stores, off-price discount stores, etc.). Indeed when we examine the evolution of internet marketplaces in the US, one of the key themes has been “unbundling” or what is popularly known as the “unbundling of Craigslist”². The theory goes that carving out niche products from broad horizontal networks like Craigslist leads to value creation as vertical companies are able to provide a superior user experience owing to their focus. And so around 2010 onwards, we’ve seen the creation of many successful vertical specialists both in commerce and services. Notable examples include include Zillow, Airbnb, Indeed & Upwork in services, and Offer Up, Stitch Fix, & Goat in commerce (goods).

Image credit: Late Checkout by Greg Isenberg

But what does all of this mean in the Indian context, and especially in e-commerce? How can founders think about these choices in a more structured way? While there are no immutable rules as I mentioned above, I’ve found that it’s always useful to have mental models and heuristics that are broadly applicable to questions in a given context. If nothing else, they help provide structure to one’s thinking. In this article, I’ve attempted to create a broad framework that can be applied specifically to B2C e-commerce in the Indian context.

Part-1: When does verticalization make sense?

The starting point in the framework is a set of 2 questions -

• Is it possible to provide a 10X better customer experience (via verticalization) than existing alternatives to some set(s) of users?
• Are there enough number of such users for whom this 10X matters to be able to build a large sustainable business?

If the answers to both these questions are yeses, then I’d argue, there is potential for creating a large vertical marketplace.

A small but important digression - what determines 'experience' in e-commerce?

But before we move further into the framework, an important digression. It’s critical to understand what does “experience” really mean in e-commerce? It’s useful to go back to what stalwarts such as Sam Walton and Jeff Bezos swore by and used so effectively to grow their businesses: the holy trifecta of retail / e-commerce - Price, Selection & Convenience. These are the fundamental growth and experience levers in e-commerce and retail, and any successful business has to play on one or more of these as their vector(s) of differentiation.

The fundamental experience & growth levers in retail / e-commerce

• Price: This one is self-explanatory. All things being equal i.e. when comparing apples to apples, customers want the lower-priced one
• Selection: Selection means the retailer or e-comm site offers the SKUs that the customer wants. Selection effectiveness is a combination of selection breadth and depth. Breadth is how many different categories or sub-categories are on offer (e.g., t-shirts, polo t-shirts, shirts, jeans). Depth refers to how many different variations within each category / sub-category are on offer (e.g., within t-shirts, variations of materials, designs, sizes, etc.). Breadth and depth are usually inversely correlated as companies have limited WC to deploy towards inventory or in the case of marketplaces, limited resources to deploy towards supply acquisition
• Convenience: Convenience usually means the shopping experience is streamlined, not confusing, and is easy to use. I find it useful to think of convenience at a slightly more abstracted level as it helps me see beyond the more obvious dimensions. It can be thought of as the sum of all non-price non-selection aspects that enable users to go from consideration to purchase in the most seamless manner possible. In e-commerce specifically, 3 particular aspects are especially important from a convenience standpoint - delivery or fulfillment experience, the overall UI/UX and post-purchase support (including seamless returns)

To differentiate on any of these levers, companies require capital and to painstakingly build the requisite capabilities. Therefore it is a game of prioritization and usually these move in opposite directions, as investment to build differentiation on one, by definition means less dollars for the other two. Only in the rarest cases, is a company able to differentiate on all. The most notable example of this is Amazon (widest selection available at lowest prices with unparalleled convenience), which is why it has become one of the most formidable retail businesses in history.

Part-2: How to think about categories for verticalization

Now that we understand the levers that determine experience in e-commerce, we can move to the next part of the framework - the question of which categories is it feasible to create a superior experience via verticalization. Or in other words, which are the categories where a vertical play is able to provide sufficiently better price, selection or convenience to users, thereby incentivizing them to switch.  

There are three broad characteristics that determine the amenability of categories to verticalization -

• Specialized buying behavior
• Specialized supply chains
• Fragmentation of supply

Let’s take a deeper look into each of these.

Specialized buying behavior: Categories in which the customer purchase journey has some unique traits or is non-standard lend themselves well to verticalization as a vertical platform can create tailored user journeys and a superior UI/UX, making the consideration to purchase journey more efficient. A few commonly seen examples of this are below -

• Strong need for ‘touch & feel’ - some categories such as grocery have a very strong need for ‘touch & feel’. In such cases, a vertical solution can incorporate elements that facilitate this (e.g., via offline touchpoints³, try ‘n’ buy, etc.)
• Assisted or consultative purchase journeys - certain categories involve assistance / consultation in the purchase journey. For example, in Beauty, user education about which products to buy, which styles / colors to use for particular skin tones, etc. play a critical role in driving purchases. In pharmacy, a large chunk of purchases are fully consultative, meaning they do not happen without a doctor prescribing what exactly to purchase.
• Discovery-based categories - some categories are more discovery-based than intent-based i.e. intent is generated more via a continuous process of discovering newer SKUs rather than due to a specific point-in-time need arising. The classic example here is fashion (esp. for some cohorts like women, gen Z, etc.). Such categories tend to have a very wide selection and high view depth (number of SKUs browsed before making a purchase). For such categories, vertical solutions can create a differentiated experience by focusing on building the right selection width & depth, a feed-based experience that is conducive to discovery-oriented behavior (e.g., an FY feed) and a tailored UI/UX to facilitate a more efficient consideration to purchase (e.g., the right filters) journey. Such categories also have a need for relevant curation for different cohorts of users, given the very wide selection.

Specialized supply chains: This one is more straightforward. Categories that need purpose-built supply chains (e.g., grocery, pharmacy, large furniture, etc.) are amenable to verticalization as they can potentially provide both superior pricing (driven by lower costs) and convenience (via faster deliveries).

Fragmentation of supply: Categories that have highly fragmented and non-standardized supply can also benefit from verticalization by differentiating on price (driven by reduced costs via aggregating supply) and/or selection (via curation and building relevant width & depth).

Finally, it’s also important for founders to think of whether an economically sustainable business can be built in a particular category with scope for providing a 10X better experience. This comes down largely to the LTV/CAC characteristics of the category. A category where it’s hard to have a high LTV/CAC (typically 3 & above), will find it tough to see successful verticalization even if it’s possible to otherwise provide a 10X experience via verticalization, as the business will find it difficult to become profitable. A healthy LTV/CAC is usually found either in categories with a high natural repeat rate (e.g., grocery, BPC) or in high intent high AOV categories (e.g., mattresses, furniture, etc.)

Backtesting the framework

Backtesting the framework, we can see that categories that have seen successful creation of vertical players typically have two out of the three characteristics - specialized buying behavior, specialized supply chains or fragmentation of supply. In categories that have specialized buying behavior, vertical players are typically able to differentiate on selection and convenience (e.g., in fashion, by building relevant depth & width and creating the right UI/UX to enable discovery-oriented behavior; in BPC, by enabling assisted buying via content and by building the widest selection). In categories with specialized supply chains, vertical players can differentiate on price, selection or convenience, depending on the exact category. Finally, in categories with fragmented supply, vertical players usually differentiate on selection, and in some cases also on price.

Summary and Final Thoughts

Let’s summarize and take a look at the various steps we outlined to help us answer the question of which categories are relatively more suitable for creating vertical marketplaces in the B2C e-commerce context in India -

• Step-1: When does verticalization make sense? → when a vertical player is able to provide a 10X better experience over existing alternatives to some group(s) of users, and there are enough such users to build a large business
• Step-2: Under what circumstances can a vertical player provide a 10X better experience? → in categories in which there is specialized buying behavior, specialized supply chains or highly fragmented supply
• Step-3: Can an economically sustainable business be built in a category that meets one or more of the 3 criteria outlined above? → if LTV/CAC characteristics of the category are good
• Step-4: What type of categories usually have good LTV/CAC characteristics? → either those with a naturally high repeat rate/ purchase frequency or high intent high AOV categories

When we back  tested the framework, we saw that most categories in which there were large vertical marketplaces created, met two or more of the aspects highlighted in step-2, as those aspects helped the vertical marketplaces differentiate either on price, selection, convenience or some combination thereof.

So what does all of this mean when we take a forward looking approach? While it’s always hard to predict exactly, but one difference I potentially foresee is that there aren’t too many large categories left that meet two of the three aspects highlighted in step-2. So future verticalization might likely have to be in categories that are large and have very fragmented supply. One good example is Home & Kitchen. Home & Kitchen is a large $8-10B category with low online penetration (only ~7%), is highly unorganized and fragmented. It also has some facets of discovery-oriented buying behavior, particularly in certain sub-categories such as decor. It also has some need for touch & feel in a few sub-categories. Additionally, it also has moderate purchase frequency when put together across its multiple disparate sub-categories. All of these aspects combined, make it a good potential candidate for verticalization, in my opinion. New vertical marketplaces in Home have an opportunity to differentiate on selection, convenience (e.g., shortening the consideration to purchase journey by leveraging content for styling & assisted purchasing) and also price to some extent. Players that are able to provide a 10X better experience across some combination of these could build the next billion dollar B2C e-commerce marketplace in India. That said, this is just one example. There will also be other categories, and eventually sub-categories (as the market deepens), which meet some of these criteria and hence, will be ripe for disruption.

Footnotes

1. I’m using the term ‘marketplace’ in a slightly looser sense than the strict definition, to also include e-commerce companies that hold inventory or follow a hybrid approach
2. This phenomenon of various vertical marketplaces attacking different categories on Craigslist was first highlighted by Andrew Parker of Spark Capital in his now seminal 2015 blog post
3. While theoretically this is possible for horizontal marketplaces as well (as has been seen in a few cases), I’d argue that vertical marketplaces are likely better placed to execute this owing to their sharper focus and ability to dedicate the required bandwidth