Creating a marketplace is tough, but the rewards are high.

One of the challenges new companies offering domain name services face is that of creating a market. It’s the age old question of the chicken and the egg. Which comes first, the supply or the demand? To get sellers you need buyers and vice versa.

This isn’t limited to domain marketplaces in terms of buying and selling domain names.

Starting a parking company. Consider the typical domain name parking company. First you need to get a contract with Google or Yahoo for an ad feed. To do this, you need to monetize a substantial inventory of domain names just to get a meeting. And the more domains, the better your payout from Google or Yahoo. But how can you get more people to park their domains with you when you are getting a lower cut from the ad provider, making it hard to compete with larger parking companies?

A typical solution for parking companies is for them to own their own substantial portfolio. A number of domain parking companies have sprung up thanks to the parking company’s own domain portfolios. One option for newer parking companies: offer a higher percentage of your cut to the domainer. Even if Google is paying you less because of your volume, you can come close to matching the revenue paid out by bigger companies. As you get more domains you can decrease your payout percentage without lowering the domainer’s take.

New Monetization. Another example of a company that is facing the market challenge is Root Orange. The company leases category killer domain names on a city-by-city basis. If you’re the owner of one of these domains you could, in theory, make more money in the long run on Root Orange than with traditional PPC or using the domain for only one “site”.

But what happens the first day your domain goes live on Root Orange? It’s not like 50 cities will be leased in the first month.

Root Orange tries to “pre-sell” certain domains before bringing them onto its platform, but this is also challenging. It’s hard to get business owners to lease the domains before they’re even on the system.

Another solution is to allow domain owners to continue to park the domain and earn PPC revenue for any city that isn’t sold yet.

Aftermarkets. Of course, the prototypical marketplace in the domain industry is a place to buy and sell domain names. Asking domainers to spend time uploading inventory is fruitless if you can’t guarantee buyers on the other end.

There are several solutions to this. Consider Bido, which started with one auction a day. By offering only one auction, it was able to ease the supply side of the equation while focusing on building the demand side. Once it attracted buyers, it was able to open up the supply side.

Another tact is to focus on a smaller niche. 4.cn is proving successful by focusing on the Chinese domain market.

Although the challenges of creating any marketplace are plentiful, the results of executing it are powerful and profitable. Once an effective marketplace is operating, the owner can sit in the middle while the economic forces of the market do the work.