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How 'Collaborative Consumption' Is Transforming Startups

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Collaborative consumption market places are everywhere: media, car rental, lodging, staffing, textbooks, apparel, custom graphic design and even finance. Netflix shares DVDs among a large subscriber base. ZipCar and GetAround make car sharing easy. Travelers rent a local's apartment for a few days through HomeAway and 9Flats. College students rent textbooks from Chegg. Moms exchange children's clothing on ThredUp. Graphic designers create beautiful paper products and fulfill orders through Minted. Short term borrowers find loans from a community of individual lenders on Zopa and LendingClub.

Loosely defined, collaborative consumption is a business model in which shared goods or services are distributed via a market place to a community of users. Collaborative consumption reshapes markets by changing supply and demand economics. These new market places shrink consumer retail demand. Each shared car eliminates five to 20 cars from circulation. A college textbook rented 10 times over its life will replace between five to seven new copies. At the cost of market size, reuse liberates the environment from excess consumption.

But these models also have the capacity to increase demand and the total market size by addressing new previously unaddressable segments. Netflix serves customers anywhere in the US by managing a single collection of movies and delivering DVDs through the mail. Blockbuster cannot compete with this model or serve sparsely populated, rural America well. The capital required to replicate video libraries across hundreds of additional stores is expensive and unprofitable.

Other collaborative consumption manage two sided market places and use the capital efficiency of these models to address larger, cost-conscious populations. HomeAway and 9Flats allow anyone to rent a room or an apartment to a traveler, typically at a lower price than a hotel. This offering is very attractive to a young, cost-conscious segment of the market and has the potential to cannibalize hotel revenues. In addition, the revenue generated for property owners is meaningful.

As a result of their transformative nature, collaborative consumption market places are rising to preeminence. Rachel Botsman and Roo Rogers recently published What's Mine is Yours, a global survey of collaborative consumption efforts. In the book, the authors extrapolate three categories of collaborative consumption:

1. Product-service systems enable products like DVDs, cars, books or homes to be rented;

2. Redistribution markets are exchanges for used items including clothing;

3. Collaborative living services broker relationships for individuals with service providers.

Spanning goods and services, rental and purchase, geographies and demographics, collaborative consumption is a pliable business model that can be applied to many sectors to great effect. Even the business model itself is evolving.

The first wave of collaborative consumption companies pursued business-to-consumer (B2C) go-to-market strategies. In this model, a company acquires, maintains and rents products. Zipcar buys, services and rents cars to members. Chegg replicated this model for college textbooks. But the costs of managing car fleets or a library of books are substantial. For example, ZipCar spent 71% of 2010 revenues acquiring and servicing cars.

Of late, peer-to-peer (P2P) collaborative consumption models are blossoming. P2P models are much more capital efficient than their B2C counterparts because they do not require any capital investment to acquire assets. Instead, they rely on a community to supply them, typically in exchange for a revenue share of the transaction.

P2P car sharing enables car owners to rent their own cars. GetAround, a San Francisco based company, operates a market place for P2P car sharing at a fraction of the cost of ZipCar. Car owners use the income from rentals to cover car payments and maintenance costs. A P2P system is much more efficient - fewer cars on the road that are used more often. Nearly everyone benefits.

However, P2P models are more complex than B2C. P2P market places are two sided exchanges and require careful management of demand and supply growth. As a market place grows and strangers begin to transact, eliminating transaction friction by building trust and quality metrics is critical. Similarly, ensuring consistent transaction experiences is essential to building brand and leads to word-of-mouth marketing. Lastly, each exchange must decide whether to guarantee customer satisfaction. While a guarantee will increase liability of fraudulent returns, this promise increases a consumer's propensity to buy.

A pioneer in P2P exchanges, ThredUp has built a community of tens of thousands of moms who exchange children's clothing. Clothing buyers rate the quality and style of the clothes and the data feeds a seller's reputation informing future buyers. ThredUp guarantees satisfaction to decrease initial buyer fear. With careful management, ThredUp has grown their P2P market place successfully.

Technology is the key enabler for this resource allocation optimization. Market places attract customers and build communities using the web. Social networks, proprietary and public, underpin trust among users. With Facebook, it's easy for a host to vet a potential apartment guest's identity, particularly if they have friends in common. When it's time to pay, mobile phones coupled to payment mechanisms, enable transactions to happen anywhere. Since technology enables this resource allocation shift, as smartphones and mobile payments reach mass market penetration in 2011 and 2012, the disruptive potential of collaborative consumption markets will only increase.

One of the biggest challenges when starting a P2P market is delivering initial market liquidity through customer education and brand building. Most successful market places have sought to replicate an offline behavior online. P2P exchanges lend themselves to close interpersonal reactions. Consequently, these market places resonate with customers for emotional reasons. Ask the mothers on ThredUp who wrap their donations in tissue paper before sending the clothes on to the next mom. Or the brides who work with a stay-at-home mom on custom wedding invitations on Minted.

As these markets develop, cost, convenience and selection scale adoption en masse. Why pay for two Tuscan hotel rooms during your family's vacation when you could rent an apartment from a local on 9Flats for less? Why buy a college physics book only to sell it a few months later when you can rent one for a semester? Why pick up a drab economy car at the airport when you can rent a fire red Tesla located just two blocks from your San Francisco hotel? This is the power of the model.

When applied to the right market, collaborative consumption market places effect dramatic changes. To date, the most successful efforts have involved digital currency (lending), goods that can be mailed (clothes, DVDs), time & cost sharing of expensive goods (cars, apartments and books) and services (graphic design, commodity labor).

With time, collaborative consumption market places will continue to grow in these segments. Because many of these services reduce market size dramatically, the most successful market places will need to pursue multibillion dollar markets to generate millions or tens of millions in annual transactional revenue. Services like transaction insurance, additional background checks, and paid-promotion for suppliers present additional, higher margin lines of revenue.

But the revenue models for these exchanges shouldn't be a concern. More interesting will be the incumbent retailers and manufacturers' response to successful P2P markets. I wouldn't be surprised to find automobile dealers offering their cars for rental on collaborative consumption market places. Or hotel chains acquiring apartments to rent them on P2P exchanges.

The ultimate beneficiaries of this competition and additional selection will be the consumer and the environment. Optimizing our resources will change the way we live. In 1900, 41 percent of the natural resources entering the US economy were recycled. Today, that figure is 13 percent. Meanwhile, the US population has increased 357 percent. We simply cannot continue on this path.

One of the best ways to return to a sustainable way of life is to maximize asset use through collaborative consumption market places. By providing economic incentives to maximize efficiency, binding large communities to shared causes and decreasing total consumption, collaborative consumption will become a keystone of a sustainable American society.

This post originally appeared on the MIT Entrepreneurship Review. It is written by Tomasz Tunguz, an Associate with Redpoint Ventures where he focuses on consumer Internet, online marketing, digital media and software investments.

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