With approximately $36 million in funding and a $280 million valuation, Groupon is the 900 pound gorilla when it comes to group buying sites. If you’ve studied economics, you’ve probably realized that these sites are successful because they allow local businesses to take advantage of economies of scale whereby average unit cost decreases as more goods are purchased. With the model’s success and lack of barriers, the group buying space has gotten crowed as the likes of LivingSocial, Homerun, Myjoffer, and a slew of smaller sites have set up shop. In fact, because the model is predicated mainly on “reach”, anyone with a large user database can start selling “groupons”. After carefully analyzing the group buying market, I’m convinced that we’re witnessing the first iteration of a new form of highly competitive commerce. Unlike social networks like Facebook and Linkedin which seem to operate as an oligopoly, the group buying market will have lots of players selling almost identical products. So with this being the first iteration, there are three distinct areas I've identified that need improvement.
- If group buying sites are based on economies of scale, then businesses should be allowed to limit the number of goods they’re willing to sell at their discounted rates. Given a fixed price, there’s an optimal output point where each addition unit produced by a business is too costly for the producer. By not implementing a cap, in many cases, local business owners will be forced to produce past this point.
- Secondly, local businesses should also be offered multi-tiered pricing platform. Because average unit cost will generally decrease as the quantities sold increase, business owners should not be locked into one price regardless of quantity. This would be an improvement on the minimum quantity threshold sites like Groupon’s currently have in place. A tiered pricing system would also make it easier for the smaller players with questionable reach to convince local business owners to give them a try. A business owner’s goal is not to sell heavily discounted goods to handful of people as total profits would be negligible but instead to sell to the masses. With a tiered pricing system, as a business sells more products, the discount gets deeper with ALL purchasers of the product getting the same price.
- Margins enjoyed by group buying sites have to decrease. Economists predict that in the longrun, “economic profits are zero”. In laymen terms, this means that when people make exorbitant profits, competition generally enters the market subsequently driving profits down to a respectable level. And as if on cue, there seems to be a new player entering the space everyday. Therefore, it’s reasonable to conclude that Groupon’s rumored 50% per sale payout will not last for the foreseeable future. After all, group buying sites are nothing more than a middlemen facilitating a transaction between a business and a consumer. Think about this, what do you pay other middlemen? Phrased another way, how much does your stock broker, real estate broker or financial intermediaries (e.g Paypal) skim off your transactions? To some degree, group buying sites can get away with charging these inflated fees because of the desperate situation local business owners currently find themselves in but that can’t last forever.
With regard to advice for new entrants, I’d urge current players as well as new prospects to not only focus on building out their email database but to also build an API that would allow 3rd party websites like Jippidy to syndicate their content. Since new entrants are not likely to build a 3 million email subscriber base like Groupon, it’s important that they setup a platform that allows other sites with reach to disseminate their deals. Ultimately, I imagine someone raising some VC and building out platform for local businesses to offer deals on their own terms in exchange for a sub 5% fee from these business owners.
My goal is to provide useful information to entrepreneurs working on shoestring budgets. There are a number of blogs that address the problems of the small business owner or the issues of funded startups, but I believe there's an underserved muddy middle of underfunded startups in need of guidance. My goal is to help this segment hit breakeven and ultimately profitability by sharing my experiences.
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