A couple of weeks ago I brought you ZIGExN, a Japanese media company that grows through the acquisition of smaller marketplaces and aggregators.

The day after posting that write-up I had lunch with a friend who has recently become CFO of a real-estate marketplace.

We talked about business models, competitive advantages, competition, and the road to profitability.

Of all these things, one stuck with me: The fact that his company was being threatened by a deep-pocketed competitor who was under-pricing them.

My friend didn’t have many tools available to him and he was considering going down the rabbit hole of “we’ll match any price that our competitors give you”. This tells me a few things: 

First, that there is no differentiation between his product and his competitor’s. 

Second, that he hasn’t yet reached the level of brand awareness and “liquidity” that allows him to “not care” about competition. You see, once a marketplace reaches a certain level of liquidity and brand awareness users will identify the product with the marketplace (think ETSY for handmade goods or Skyscanner for flights), thus making it much harder for competitors to enter the space.

And third, that his marketplace is doomed to be unprofitable (I didn’t tell him this, but I get the feeling that he knows it).

On my previous write-up I talked about how network effects work, but what I failed to mention was how to get them.

I’ve read extensively about the subject, but contrary to my belief a couple of weeks ago, I haven’t reached a conclusion… or should I say, I haven’t found the reasons, the components, that allow me to understand which marketplace will “make it”.

Also because of that, it’s hard for me to know which marketplaces will keep being profitable. 

On the other end of the spectrum, I think I can roughly assess which marketplaces will never be profitable.

So what makes ZIGExN highly profitable?

The truth is I don’t know. 

And because I don’t know why they’re profitable, I also don’t know how they can stop being profitable. And that’s an important thing to know before investing in any company.

The fact that all of ZIGExN’s marketplaces cater to the Japanese public also make it difficult. I am yet to find the tool that allows me to discover and talk to a ZIGExN user from across the globe.

I thought that researching ZIGExN’s competitors could shine a light on its competitive dynamics.

It didn’t. 

I could talk about how ZIGExN is able to undercut its competitors and have lower gross margins while having higher net margin (meaning that it offers a cheaper product to its clients while running a much leaner operation than its competitors), but that’s the consequence, not the cause of its competitive advantage.

A fellow investor told me that the competitors can’t lower their prices because if you’re a big player with 30 stores and then comes a new competitor with one store selling the same product but cheaper, will you lower the price of all of your 30 stores? The answer is, probably not. Maybe. I need to think about it.