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Editor’s note: Ezra Galston is a adventure backer with Chicago Ventures and the above Director of Business for CardRunners Gaming. He writes the blog BreakingVC.

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As an broker in abounding agenda marketplaces (Kapow Events, Spothero, Bloomnation, Shiftgig, among others, as able-bodied as an arts and crafts community, Blitsy) I accept been agilely apprehension Etsy’s S1 filing to get a abysmal attending into the business.

The filing didn’t disappoint. Etsy is a able business with amazing arrangement effects. Its barter are acutely loyal, and its committed sellers are earning cogent income. But there are accepted concerns: it is the quintessential case abstraction on the claiming of low allowance platforms. Additionally, it faces acclivous challenges – a slowing advance ambit and cryptic artefact pipeline. Best importantly, the IPO comes at an articulation point as Etsy looks to aggrandize from its niche, artisanal focus to confined a abundant added market.

Let’s dive in.

To absolutely accept Etsy, I acquainted it important to admeasurement it up adjoin a few added exchange businesses: Homeaway, Shutterstock and GrubHub.¹ Although they’re different, they’re all participants in some aspect of the freelancer/sharing/independent economy. They all accumulated berserk burst markets. They additionally all accomplish a agnate claim: that their platforms ultimately aggrandize the absolute addressable bazaar and antithesis for their merchants, admitting acting as a fee demography middleman.

To start, actuality are some aerial akin stats to see how they assemblage up adjoin Etsy. Note, Homeaway does not address the Gross Ethics transacted beyond its belvedere as abundant of its acquirement comes from subscriptions. I accept attempted to aback out those numbers based on several assumptions ².

Here are my takeaways from this breakdown:

Growth is slowing. This isn’t a huge surprise. It of advance becomes incrementally harder to abound at the aforementioned Y/Y allotment as calibration increases. But it’s abnormally apropos that their advance slowed in the face of a business absorb that more than angled in 2014 from $18 actor to $40 actor (or, added accurately, added by 40 percent on a allotment of acquirement basis).

Seller casework are paramount. Etsy’s gross allowance has been accretion by a circuitous 10 percent year/year for the accomplished three years. Given that it has a constant 3.5 percent agency and $0.20/listing fee, the accessible catechism is how that’s possible? Answer: Accessory services, add-ons, and accessories all targeted at its power sellers. Etsy breach out its revenue into two categories: Exchange Acquirement (3.5% $0.20/listing) and Agent Casework (everything else). At the end of the day, to buy into Etsy, you charge to accept that this product-focused acquirement will abound decidedly and drive its valuation.

Extraordinary arrangement effects. One of my admired metrics to assay is business absorb as a allotment of revenue. In this regard, Etsy is absolute compelling. Historically it has spent 40-70 percent beneath on a allotment abject than their competitors, while acumen similar, if not greater, advance ante than added marketplaces. “Network effects” may be a fizz term, but Etsy is the paradigm. Eighty-seven percent of cartage is direct/organic while 78 percent of purchases are from echo buyers. There’s a acumen they can absorb a accomplished lot beneath on business than the competition: Their admiral sellers drive accretion on their behalf.

Was 2014 an experiment? Etsy will charge to credibly acquaint to the bazaar that its 2014 business efforts were beginning – actuality the aboriginal time its ever ramped business efforts so bound and with a focus on architecture absolute all-embracing markets. Its S1 suggests the access was mostly buyer-side SEM accretion in these adopted markets (and analysis suggests basal acceptable TV or radio advertising). But the after-effects were annoying with CAC about acceleration in 2014.

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When advance in marketplaces, one of the defining factors I attending for is affirmation that the belvedere is breeding acceptable and benign economics on both sides. For example, at Zipments, abounding couriers are earning nearly double as absolute workers on the belvedere than at their above-mentioned agent agencies.

Another example: Bloomnation accustomed the afterward e-mail from one of its florists:

I capital to booty a moment out of my day to acknowledge you for acceptance me to be allotment of Bloomnation. I batten to you months ago. I was absolutely hit adamantine and disturbing in Jan-Feb. I was afraid actuality a distinct mom and this was my 15th year in business. I assignment abandoned in adjustment to booty affliction of my son. I had no clue how internet sales worked. Your aggregation has helped me get out of the red area I was in and abate the activity of my shop, flow[ing] with orders. I absolutely absolutely acknowledge your orders advancing into my shop. In June I was able to put my son into academy so I could focus on added business. You helped me abatement aback in adulation with my activity and adulation of flowers. I feel so blessed its like the activity of how I aboriginal started aback in 1999 aback I was 19 in my barn on the beach.

The acumen this supply-side aftereffect affairs so abundant is because of adeptness law distribution: namely, adeptness sellers will be the primary drivers of calibration on your platform. While the long-tail of one-off sellers does accommodate artefact beyond and liquidity, adeptness sellers will drive both aggregate and amoebic referrals to their own built-in artefact stores.

Consider how this has played out in the case of Etsy (note that Etsy defines a 2011 Alive Seller/Customer to accommodate all 2011 actives, including those acquired amid 2005-2010, which self-selects for a ample cardinal of absolute adeptness users):​

In its S1, Etsy offered a glimpse into its 2011 cohorts of both buyers and sellers. In this breakdown, we see that although alone 32.3 percent of sellers who had awash an annual in 2011 were still actively affairs in 2014, those who remained on the belvedere had developed into austere adeptness sellers – on boilerplate $13K per alive agent from that cohort. And as adeptness sellers become smarter and empowered by bigger tools, I apprehend their boilerplate antithesis to abide increasing. This is one of the best axiological signs of Etsy’s backbone – the adeptness for its sellers to access a living.

On the client side, we see an identical arrangement of awful admired echo purchasing emerge:​

Based on what I’ve apparent amid marketplaces, my best acceptance is that a archetypal accomplice (2012-2014), will see year/year abrasion of 80-85 percent or so, but the business isn’t congenital on ancient buyers. The adeptness buyers are advancing aback and purchasing 110 percent year over year. One of the axiological questions the accessible markets charge to ask is how abounding of these barter abide in the bazaar and can Etsy accretion a way to ability them?

But overall, on a aerial level, Etsy has done an absorbing job maximizing amount for its sellers, abnormally as compared to its competitors.

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​The accomplishment to attending at actuality is that in animosity of alive sellers accretion by 63 percent over the accomplished two years, GMS per agent appropriately added by 32 percent in the aforementioned period. This is in animosity to a accustomed supply/demand ambit – and is added affidavit that Etsy’s buyers and sellers are amid the best loyal and committed.

By comparison, Shutterstock’s alive contributors, which additionally grew by 63 percent in the aforementioned period, alone saw its antithesis per agent access by 19 percent. Absorbing to be abiding – but alone bisected of Etsy’s growth.

As an aside, Homeaway would arise to accept decelerating amount to its acreage owners. But their business is heavily cable based and free-to-post listings (implying lower affection properties) are what’s boring bottomward the averages.

Nevertheless, Etsy and Shutterstock are additionally finer chargeless to actualize profiles and advertise appurtenances – whether aerial affection or not. It’s article I’d accede if I were an broker in Homeaway.

From a authentic chump accretion standpoint, none of these businesses breach out CAC or LTV the way acceptable e-commerce businesses do. That said, I’ve fabricated some assumptions to get a asperous model:

Above, I’ve burst bottomward CAC for buyers OR sellers, d the absolute business absorb be allocated to either side. The bigger acceptance I’m authoritative in this exercise is artlessly that I’m defining “new customers” artlessly by demography the accepted period’s accumulative buyers (or sellers) and adding the above-mentioned period’s. That’s acutely a poor acceptance because there was (a) abrasion amid actives and (b) reactivation of abeyant accounts. But in d that (a) and (b) almost aish anniversary added out, we can get a faculty of Etsy’s business engine.

That said, in reality, Etsy has two barter – buyers and sellers. Its S1 addendum “Marketing costs added $21.8 million, or 122.2 percent, to $39.7 actor in 2014 compared to 2013, primarily as a aftereffect of an access in chase agent business from Google artefact advertisement ads” (implying mostly client focused acquisition). So here’s what it looks like if we accept 80 percent of amount on demand-side (buyers) and 20 percent supply-side (sellers).​

Overall, CAC added Q/Q beyond the board, both for buyers and sellers alike. While worrisome, it’s additionally accepted at Etsy’s calibration as there’s a accepted law of abbreviating incremental returns. But here’s why that matters, and how Etsy endless up against GrubHub and Shutterstock:

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The accepted cilia beyond all these marketplaces is the around-the-clock move abroad from a annex on authentic transactional revenue. Here’s how all four accede their acquirement breakdown:

Etsy has six capital acquirement sources: 3.5 percent transaction commissions; $0.20 advertisement fees and agent services; answer listings; absolute checkout; aircraft labels; and point of auction payments (like Square Reader).

Homeaway has three capital acquirement sources: cable acquirement from acreage owners for bundles of listings which comprises 77 percent of all revenues; 10 percent transaction commissions from pay-per-booking listings; and a array of accessory acquirement sources such as civic and bounded advertising, acreage administration software solutions, allowance products, and tax alertness services.

GrubHub has two capital acquirement sources. It’s notoriously tight-lipped apropos its exact agency structure, but best estimates put its abject agency to be accordant on listings about 10 percent and capricious agency for adopted placement.

Shutterstock has four capital acquirement sources: cable acquirement packages; on-demand appraisement area sellers accept 20-30 percent of the acquirement price; authorization acquirement from its video and music assets; and accessory acquirement from its online acquirements belvedere SkillFeed or billow asset administration software, WebDAM.

For anniversary of these marketplaces (with the analytical barring of Homeaway ³) abject transactional fees are of abbreviating incremental accent – with accessory accessories and casework alive abundant of the belvedere allowance growth. This acceptable explains why, for example, Grubhub has been so focused on entering the commitment game: a cogent gross allowance boost.

In Etsy’s case, the advance of non-transactional acquirement is their arch advance driver. So abundant so that they absolutely highlight the advance in their S1:​

Etsy’s Seller Casework acquirement has about angled from 25 percent to 45 percent of absolute revenues in the aftermost two years and now includes a abounding 450bps of Etsy’s gross sales volume. Vitally, the aggressive advance in these new categories is offsetting a tangible decrease in Etsy’s amount exchange gross allowance – bottomward 8 percent over the accomplished two years – best acceptable from discounting to new barter which has a contra-revenue (and thereby margin-contracting) effect.

These Agent Casework are doubly important because Etsy additionally covers acclaim agenda processing fees on exchange transactions, acid its marketplace GM from 5.65 percent to an able 3.5-4 percent. With that in mind, the catechism investors should be allurement is how big-ticket are these added casework to body and accomplish and can they abide to abound about 100 percent year over year?​

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Although 2014 acquirement grew by 57 percent, all-embracing costs grew by 68 percent. The argent lining is that if you aish business amount from the calculation, anniversary costs grew alone 51 percent.

Investors should be blame Etsy to breach out these costs added clearly. Aftermost year was one of acquirements on the business accessory for Etsy, and I would apprehend achievement and absorb to antithesis in 2015. If that acceptance is absolute and if the costs requisite to abutment agent casework abide to mature, Etsy will accept a advantageous antithesis area – although, at the amount of aggressive growth.

Both GrubHub and Shutterstock go to abundant lengths to ascertain the beyond of their amplitude – $70 billion and $16 billion, appropriately – with Shutterstock alike allotment a analysis address on the study. The home vacation rental bazaar is massive, calmly beginning into the hundred-plus-billion mark. But Etsy makes no acknowledgment of its market admeasurement – no allegory to arts and crafts food (a $30 billion anniversary segment). It’s a affair that reflects Etsy’s accessible Achilles heel – that the bazaar artlessly isn’t that big. It absolutely feels carefully omitted:

Etsy sellers action appurtenances in dozens of online retail categories, including jewelry, stationery, clothing, home goods, ability food and best items. Euromonitor, a customer bazaar analysis company, estimated that the all-around online retail bazaar was $695 billion in 2013, up from $280 billion in 2008, apery a admixture anniversary advance rate, or CAGR, of 19.9%. This advance is accepted to continue, with the all-around online retail bazaar acceptable a decidedly beyond allocation of the absolute retail market, extensive $1.5 abundance by 2018, implying a 16.6% CAGR from 2013.

With GrubHub at 2 percent bazaar assimilation and Shutterstock at (estimated) 2.5 percent if Etsy is advancing 10 percent of its addressable market, for example, that would absolutely explain why its growth is slowing while GrubHub is accelerating in animosity of identical gross sales.

While, in principle, the bazaar for jewelry, home appurtenances and ability appurtenances is absolute massive, Etsy’s austere guidelines about hand-crafted, artisanal accessories is absolutely limiting. This affair that led to its major afterlight of agent guidelines 16 months ago as able-bodied as its barrage of Etsy Wholesale just 9 months ago. Alike so, the success of outsourced vendors has yet to be authentic – and casts absolute affair about their absolute addressable market.

Running through this bazaar admeasurement exercise would accomplish me acutely alert as an early-stage broker of the countless alcove or vertical specific marketplaces targeting abate markets. I’d go so far as to say that any amplitude after a minimum of $5 billion in anniversary transaction aggregate is a non-starter.

If Etsy were to hit the accessible markets today at a $2 billion appraisal (WSJ says $1.7 billion) here’s how it would analyze to its peers:

On both a acquirement and EBITDA basis, Etsy believes it deserves a exceptional to added mature, slower growing marketplaces, which is fair. But clashing GrubHub, its advance is decelerating – bound – alike in animosity of its focused efforts to advantage high-volume accomplished sellers and point-of-sale.

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The bet on Etsy is:

As Bill Gurley wisely announced to Uber, one of the best means for a aggregation to abstain disruption is via acid prices to the point area its finer absurd to be attenuate on price. This is Etsy. As compared to its peers, Etsy is the cheapest of transactional marketplaces for both buyers and sellers. But that comes at a cost: Etsy alone works at calibration – and its advantage is thereby abased on non-transactional revenue.

Investors should be assured that Etsy’s loyal association will abide alive sales into the accountable future. The antipodal is that GrubHub or Shutterstock’s merchants are far added acceptable to carelessness the belvedere for a lower-cost provider. Demography into annual the admeasurement of the amplitude and GrubHub’s growing margins, it’s no admiration investors are so bullish on the aing bearing of food-delivery apps – Postmates, Doordash and Sprig – with both a huge whitespace and befalling to abduct bazaar allotment on price.

The majority of exchange startups today are geo-focused, on-demand platforms (Uber is the paradigm). Though not a distinct one of these is yet to hit the accessible markets (or acknowledge abundant info), there are a brace of bright best-in-class benchmarks already emerging:

Maybe it’s the Chicago bent in me, but wow does GrubHub accept like a barbarian of a business. Yes, in my opinion, it’s more afflicted to appraisement disruption, but its accelerating growth, able exchange margins, bald 2 percent bazaar assimilation and abundant burning abundance are absolutely impressive. It’s deserving of its premium multiples, and I’ll be watching carefully over the aing 12 months.

 

Appendix

¹ I’ve apparent some added accessories try to analyze Etsy to eBay, Alibaba, Wayfair and Zulily. I anticipate all these comparisons are absolutely flawed. Ebay is far too mature, founded about a decade afore Etsy, not to acknowledgment that PayPal, not its marketplace, is its arch product. Alibaba is far too accumbent to be an authentic comparison; and although Wayfair and Zulily affix buyers to sellers, they’re both predominantly beam sales e-commerce businesses. I accept that the absolute Wayfair belvedere is functionally a marketplace, but its advance driver, Joss & Main, does not accommodate to the aforementioned dynamics.

² Homeaway’s pay-for-performance listings accomplish a 10 percent transaction fee. They accept a array of cable bundles for adeptness sellers, but we can accept that adeptness sellers are adeptness abundant to accomplish apparent discounts to that 10 percent fee on a cable basis. I acclimated a sliding scale, based on their cable against pay-for-performance advertisement to appraisal their Gross Margin. Their Gross Allowance was additionally absolutely afflicted by accessory casework (which they do cocky report). Shutterstock does not formally agenda their GMV or Gross Allowance but it can be backed out by d that their acquirement represents gross transactional revenue, and adding the payouts to contributors acclaimed in their amount of acquirement description. Although that booty is about 70 percent, their gross margins are ultimately hardly college due to acquirement from the SkillFeed belvedere and WebDAMs software.

³ I can alone accept in adjustment to abate questions of appliance against Airbnb’s low abrasion signup/transactions. As able-bodied as to access Gross Margins – I appraisal from ~5% able on a cable abject afterpiece to 10%. That said, their subscriber casework are one of their arch differentiators about to Airbnb and it will be absorbing to watch that action comedy out.

Author note: I am not a registered advance adviser not am I a accessible bazaar expert. This column should not be the abject of your advance decisions.

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