THE BLOG

7 Strategies for Solving the Chicken and Egg Problem as a Startup

03/05/2015 08:47 pm ET | Updated May 05, 2015

Customer acquisition is a core challenge for any startup. But for platforms this is doubly true, thanks to the chicken-and-egg problem.

Unlike a traditional, linear startup, a platform doesn't need to acquire just one group of customers. At a minimum it needs two, its consumers and its producers.

But a new platform doesn't initially create enough value to attract new users. It's not economical for consumers to join the platform when there are no producers, and vice versa. This is called the chicken-and-egg problem.

This problem is common to all platforms, and the key to overcoming it is to subsidize value to your early users. As we explained in a previous post, there are three main ways for platforms to subsidize value. These are

· Monetary Subsidies,
· Product Features
· User Sequencing.

Monetary subsidies include decisions about pricing as well as things like loyalty programs and referral fees. For product features, many platforms create special functionality for key users in order to increase loyalty and usage among particularly valuable user groups. Both of these types of subsidies are guided by decisions on user sequencing, which involves deliberate prioritizing the acquisition of certain users groups that others will want to interact with.

Combining these ways of subsidizing value allow a platform to offer enough value to early users to overcome the chicken-and-egg problem and reach the point where positive network effects to kick in and drive future growth.

But what do these methods look like in action? Based on our experience working with countless platform startups and our extensive research into successful platforms, we've uncovered seven essential strategies that combine these ways to subsidize value to overcome the chicken-and-egg problem and help your platform reach scale.

These strategies are not all mutually exclusive, so you use any one of them on its own or you can use several at the same time, depending on your platform's resources and goals. All of these strategies involve user-sequencing decisions, so we've sorted them by whether they primarily involve using monetary subsidies, product features or both.

Monetary Subsidies

1. Enter with Significant Pre-Investment

Significant upfront investment in your platform can signal to your producers that it's safe for them to join your ecosystem.

This strategy is especially common for development platforms, where developers incur considerable upfront costs to join a platform and high switching costs if they decide to leave. For the platform, making a big up front investment signals that you aren't going anywhere and makes these producers more comfortable making a long-term investment.

A great example of this strategy is Microsoft's launch of the original Xbox. Microsoft made a big deal about its commitment to spend $500M promoting the platform, thereby signaling that the company was fully committed to its platform for the long haul. This was one way Microsoft attracted third-party game developers, who would then feel more comfortable developing games for the Xbox early on.

2. Build a Cooperative Strategy

Back in 2007, Google was in a precarious position. The company owned desktop search, but the mobile Internet was starting to take off. With the iPhone's runaway early success, Google was worried that mobile would become Apple's walled garden. Luckily, it wasn't alone. Handset manufacturers and telecoms not named AT&T shared the same fear. So Google created the Open Handset Alliance (OHA), a group dedicated to advancing Google's Android operating system.

In essence, Google used a cooperative strategy. Rather than trying to build a network all on its own, Google tapped into the existing sales channels of the companies in the OHA to spread Android to consumers. With Android enjoying more than 80 percent worldwide market share for mobile OS's and having more than 1.3M apps on its Play Store, the strategy worked out pretty well.


Product Features

3. Act as a Producer

Why bother getting two users groups at the same time when you can only focus on one? That's the idea at the heart of this strategy, where the platform acts as the producer to attract an initial group of consumers. It then uses its existing consumer base to attract its producers.

In essence, this strategy means you start out as a traditional linear business and then open up your ecosystem as you start to scale.

The iPhone is a classic example. When it first came out, Apple didn't allow third-party apps. Once Apple had attracted a large group of consumers, it opened the App Store to enormous success.

Another example is Amazon, which started out fulfilling all customer orders on its own. However, as Amazon grew, the company opened up the Amazon Marketplace platform. Third parties on the marketplace sold over 2 billion items on Amazon last year, a new record. They now make up 40 percent of the site's annual sales.

4. Use an Evolution Strategy

Rather than trying to create a network from scratch, why not use one that's already there? An Evolution Strategy taps into an existing large network in order to attract a subset of its users. In order to attract these users away from the existing network, your platform needs to provide incremental value compared to the existing solution. In essence, you've recognized that you're creating the next evolution of an existing network, and you're appealing to a portion of its existing network to help seed yours.

Airbnb used this strategy to help grow its ecosystem early on. The company tapped into Craigslist's large network by offering an improved experience for finding short-term rentals. It then used features like its infamous (and now defunct) "Publish on Craigslist" button to make it easy for its hosts to publish their Airbnb listings on Craigslist. But anyone responding to the listings would still reach the host through Airbnb. Airbnb apparently also simply spammed Craigslist posters to get more hosts.

Don't think you can get away with repeating this same Craigslist trick now, though. Craigslist was quick to ban Airbnb's tactic once it discovered what was going on, and it has since banned any similar activity on its site, including a potential fine of up to $25,000 a day. Unlike with a Cooperative Strategy, the existing network you're siphoning users from isn't likely to take kindly to your activities.

Monetary Subsidies & Product Features

5. Create a Single- or Double-Sided Marquee Strategy

High-value users will help you attract other users who want to interact with them. Their participation on your platform brings extra value to your ecosystem, so many platforms will make specific efforts to subsidize the participation of these high-value users.

When Uber launched in Seattle, it subsidized town car participation by paying drivers even when they weren't transporting customers. This subsidy brought high-value producers into the ecosystem, which in turn attracted paying customers.

Dating websites are another classic example. Their populations tend to skew heavily male, so they often let women join for free. Other dating platforms, like Coffee Meets Bagel, go even further, deliberately designing the experience to appeal to women with the knowledge that if women join, men will too.

Facebook also used this strategy to great effect by gating access to its network and opening up to Ivy League schools first. It then used the prestige of the Ivy League to help market to other schools. Other college students wanted to join the social network that all the Ivy League kids were talking about.

6. Target a User Group to Fill Both Sides

The idea behind this strategy is similar to #3: try to make a two-sided market one sided. The goal here is to find a user group that can fill both your consumer and your producer roles. That way, you no longer need to worry about attracting and balancing two separate user groups early on.

This was the recipe for success for handmade goods platform Etsy. Etsy's early research indicated that the people most likely to buy handmade goods were the people that also sold them. So the company decided to focus on this user group to fill out both sides of its marketplace before expanding to other audiences.

The strategy worked pretty well, as Etsy is set to IPO soon.

7. Provide Single-User Utility (1 & 2)

Last but certainty not least is providing single-user utility. This is a "come for the tool, stay for the network" approach, where you attract one side of your multi-sided platform by offering that user group value even if the other side never shows up.

Many platforms that went this route were initially apps that provide their users with essential functionality even if the network never materializes. Early Instagram is a great example, as it provided its users with a way to take photos and make them look good long before it evolved into a full-fledged social networking platform.

Restaurant booking platform OpenTable used a similar strategy in order to get restaurants on board. The company realized that even the top restaurants in San Francisco didn't have back-end reservation systems. They were still using pen and paper to track reservations. So OpenTable built a software application to handle electronic booking and targeted the top 20 in San Francisco, offering to help these restaurants set the system up.

After these restaurants were on board, other restaurants became interested. And with this core group of restaurants on board, OpenTable was able to successfully open its platform to allow for consumers to book restaurant reservations online.

Of course, a less subtle way to provide single-user utility is simply to find a way to pay your users. Doing this can help remove any initial uncertainty a user might have about your platforms value, because whether or not the other users show up, they'll still get value from participating. But be careful, because these direct monetary subsidies can be hard to sustain long term. And once they go away, your users might too.

Conclusion
So those are the seven key strategies for getting your platform off the ground. While early customer acquisition is especially tough for platforms, creative use of these strategies should help you overcome the chicken-and-egg problem and attract your first users. After that, it's time to start building your network effects to rev your long-term growth engine.

At Applico we help CEO's build disruptive tech companies. For more information on startup traction and other platform-related topics please visit our platform innovation page.