Airbnb and the Markets

Two sided markets are bad now?

Hi. Can here. Today we talk about two-sided markets and Airbnb

Part of the allure of traveling is having to deal with mishaps. You want some stuff to go wrong, so you’ll have stories to tell about them. There’s nothing more boring than telling your friends how you flew to the Maldives and chilled on a beach for a week. It’s the “we had to sneak into a train in Thailand after losing our luggage in Malaysia” stuff that makes it interesting. Stuff going wrong is fine. But I guess there’s a limit? Airbnb has ideas:

When they arrived, they realized it wasn’t. The front door had been left unlocked, which Patterson described as “creepy,” and it was dirty and filled with furniture that looked like it had been picked up off the street. The couches were tattered, the armchairs were burned by cigarettes, and the tables were banged-up—details I confirmed through photos she’d taken at the time.

The entire thing reads like a crime novel partly because there appears to be an actual crime syndicate behind all this. Some people post some listings. Others book them and make travel arrangements. Then the hosts cancel the listings last minute, even the guests end up having to stay at a much, much shittier place. You can see the arbitrage for the hosts immediately. When the hosts reach out to Airbnb, they generally get not much in terms of attention or money, but the scamming hosts walk away with both a rent differential and possibly some cash from Airbnb too.

There are multiple ways to react to this. 

A cold, economics-as-abstraction way to look at it is at Airbnb’s scale, this kind of stuff is bound to happen. According to its website, Airbnb has more than 7 million listings, with 2 million people staying per night. At that scale, as my former boss liked to say, you are going to run into one-in-a-million events multiple times a day. Should each and every one of those incidents be a crisis?

Ugh, yes? I talked about having empathy for your users before. The good thing about technology companies is that they can deliver stuff at a tremendous scale with basically pressing some buttons. But with that ability to abstract out complicated things like humans into rows in databases, it’s essential not to lose sight of what those rows represent. You would imagine a company who is in the business of hospitality would be, like, woke about this? No?

Anyways. But there are also other ways to look at this. Somewhere around 2015 or so, we stopped calling these companies part of the “sharing economy” but instead switched to a somewhat cooler sounding “two-sided marketplaces.” It’s also more accurate. The term is mostly used to describe the relationship between credit card processors, vendors, and end-users, and it does apply pretty cleanly to model Airbnb also.

The main idea is pretty simple; you have hosts, and you have guests. You bring them together, ask them to negotiate a price for a stay, and take a little cut. There are pretty significant network effects. The more hosts you bring, the more attractive your platform becomes for guests as there are both more options and price goes down with a larger supply. And the more guests you bring, the more hosts want to get on the platform to get on that action. Pretty simple!

You have to do a bunch of things to make sure hosts and guests don’t take the transaction out of your platform (disintermediation is the technical term). Generally, you can wrap those things under Trust and Safety, which you can read as “aligning of incentives.” I mean, you should really invest in trust and safety anyway since that’s kind of a pillar of any hospitality business.

I am stylizing things a bit here, but the point is this is how it’s supposed to work on paper, but my god, it never does. The whole abstraction is what it is, a model that eschews many of the working details that make or break these businesses. The technology that goes into these businesses, having worked on them, is not *that* complicated. It’s big and gnarly, and there’s a lot of things, but you can see it all as a very fancy CRM with some real-time ERP. The operations side is where the magic happens.

Free Market All The Things

The free market types like to imagine a world where you just build a marketplace of things, and people automagically come to it and negotiate a price. Like, why don’t we do that for everything? Wouldn’t that be super efficient?

Let’s go back to Airbnb. You have guests, who need to come to your website or download your app, and browse around a bit. There is a bunch of customer acquisition things you can do here, and historically (while maybe not always ethically) Airbnb folks have been pretty good at that. I am not saying customer acquisition and conversion are hard problems, but they are problems that you can generally throw money at.

The hosts, however, are trickier. You can employ many of the same customer acquisition tricks to get people to look at your service, but getting people to list their homes is a much, much higher bar than getting people to click on. You need to earn those people’s trust, have them take decent photos, enter all the details, and, ugh, I guess to make sure they aren’t doing anything too illegal. There are a lot of steps involving a lot of humans doing a lot of human things that you can’t throw money at. I mean, you can, but it’s a whole lot more expensive than spamming Craigslist users.

Some are More Equal than Others

So, this is all to say that in these two-sided marketplaces, both sides aren’t really created equal, and they do not occupy the same mindshare in an organization. You can see this by the sheer amount of trouble companies will go to acquire one side. Uber (not very successfully) got into car leasing business, and Airbnb ended up building hotels, to keep their marketplace liquid and balanced.

“Forget Hotels” says Airbnb in 2008

Ok, look, I said you couldn’t really buy “hosts” in Airbnb’s case the same way you buy guests, but that’s also a bit of an over-simplification. One of the open secrets (not so secret to drivers) of Uber, for example, is that in some markets, more than half of the driver’s income is incentive payments, paid on top of trip fare. The riders pay some fare, and Uber tops it up. This is way, way more complicated in reality, but the point is there’s a lot of money involved that’s outside the market players negotiating a price for the exchange. And wherever there’s money, there’s fraud.

One way to think about this “incentive” is the marketplace actually pressing its thumbs on the scale by injecting some inefficiency. You generally do this at the beginnings of a market’s lifecycle, when there are not enough supply to keep the demand around, but doesn’t mean you won’t do this later either. In Uber’s case, drivers are harder to recruit, and you can occasionally “pay” them out of your own pocket to keep them around for later profits.

At Airbnb’s case, if you can read between the lines to see where Airbnb is pressing its thumbs on the scales to keep the hosts happy. In the case of a cancellation, which is inherently a messy business, Airbnb has vast incentives to err on the side of the host and pay them a tiny bit more attention (and maybe money) than they do the guests.

Markets Strike Back

This isn’t a redemption of what the hosts are doing, but rather the point is that in these kinds of markets, people on both sides are shockingly good at discovering riskless profits. There are entire fraud departments at companies like Airbnb and American Express that employ thousands of people, and people still not only find ways to exploit the known loopholes but discover and sometimes for years benefit from these hidden flows. When you move money around, you will have to deal with fraud. When you press your thumbs on the scale, you are picking winners and losers.

The larger point in all this is that Airbnb exists not because these marketplaces are efficient, but because they aren’t. If they could come to exist, without Airbnb having to build it all and then take a cut, where hosts and guests could find each other and negotiate a price, you’d not need to build a giant HQ with beautiful vertical gardens to facilitate all this.

It’s a nice office!

But the flip side of that coin is that these marketplaces are pretty fragile, and they need to maintain a decent amount of slack while maintaining reasonable margins to satisfy the investors who want those “software margins.” This is not easy, and it’s not even clear to anyone if possible. It isn’t a surefire bet.

And the larger point is that these markets, or many, aren’t some naturally occurring phenomenon. There is no universal law of markets, no subatomic dynamics that govern these interactions. All these markets, like any other, remain as creations of ourselves that should benefit everyone involved. They are designed by humans. They should also be designed for humans.

Airbnb Shooting

This wasn’t the only Airbnb-related news this week. Unfortunately, 5 people were shot and killed in an Airbnb in Orinda, California, just 30 minutes out of San Francisco. Airbnb decided to ban party houses in response. I do not want to make light of a deadly incident, and speak on a complex issue I am not qualified to speak. I am sure Airbnb felt a humane need to act. It’s not their fault this happened. However, as an immigrant to this country, it makes me uneasy that the way we handle shootings is now making sure people do not gather at parties.

Reader’s Comments

Last week, my co-author Ranjan wrote about Gawker. In that piece, he wrote Peter Thiel came clean first to New York Times about funding the lawsuit behind the scenes. Long time Margins reader Ryan Mac reached out and pointed out that he and his colleagues first reported on Thiel’s funding of the lawsuit on Forbes.

What I’m Reading

Rajeev Misra Built SoftBank’s Huge Tech Fund. Now He Has to Save It: SoftBank and its Vision Fund was on the news a lot lately. This profile of Rajeev Misra, the man behind the fund, is…wonderful. It starts crazy, and then goes to 11.

Inside Joe Biden’s 2020 Presidential Campaign: Olivia Nuzzi gives the Biden campaign a balanced look. There’s a lot here, and it’d be a wonderful piece by the anecdotes but Nuzzi’s writing is so, so good that you just want to keep reading.

I Got Access to My Secret Consumer Score. Now You Can Get Yours Too: AAAAAAAAHHHHHHHHHHHHHH!