Keystrokes of the ‘faint-hearted’ closet economist: Group-buying

About a year and a half ago, group buying was a phenomenon unheard of. Groupon did not exist. Today it has some 700 million odd members in 500 different countries making (perhaps) more than a billion dollars a year . India alone has some 30-odd group buying portals now. There’s obviously something clever and innovative behind group buying. Given that customers with coupons or deals are saving lots of money on goods and services, how can this possibly be a win-win for all?

There are significant network effects at play here: the more people sign up on a group buying site, the more targeted its deals can be. A product or a service displays positive network effects when more usage of the product by any user increases the product’s value for other users (and sometimes all users). The microstructure of an underlying network of connections often influences how much network effects matter. For example, a good displays local network effects when rather than being influenced by an increase in the size of a product’s user base in general, each consumer is influenced directly by the decisions of only a typically small subset of other consumers, for instance those he or she is “connected” to via an underlying social or business network (instant messaging is a great example of a product that displays local network effects).

The idea that the deals or coupons only become activated once a certain minimum number of people have signed up for them; This is essentially a guarantee for the merchant that the needle will be moved, that their effort won’t be wasted. That kind of guaranteed engagement is hugely valuable, and more or less unprecedented in the world of marketing and advertising. Then there’s the twist in the “coupon” or “deal” part of the name. No longer do merchants pay money for the privilege of giving coupons away for free in newspapers. Instead, they receive money. There’s something extremely gratifying about being paid to offer discounts to new customers.

Also, the most important aspect of a deal is probably that it’s local. Before group-buying sites came along, there was no effective way for merchants to reach consumers in their area, while excluding everybody else. If you’re a neighborhood restaurant, you don’t want to entice people who live miles away: you want to reach locals. And while group-buying sites aren’t quite there yet — it’s orders of magnitude better at targeting than anything which came before it. And it’s improving every day.

Beyond that, there’s an uncommonly large number of ways in which participating in a deal can benefit a restaurant or other merchant. For one thing, the offer will go out to a targeted group of people in exactly your neighborhood or a specific area in the city — which means that even if none of them sign up for the deal, they’ll still have seen customized advertising for you, from a company (group-buying site) which they trust. And when a few hundred people have signed up for your deal, you get a huge amount of mindshare from them. Many will redeem the deals or coupons very quickly, but a lot of them will wait a while, thinking about you in the back of their minds all the time. If a friend asks whether they know a good local restaurant, they might well think of your name even if they haven’t been yet. And after they’ve been, they know exactly where you are and what you serve — information which you want locals to know but which can be very hard to broadcast.

More generally, of course, it provide an important nudge to jolt people out of their day-to-day habits and try something new. A lot of us might see a new place open up and think to ourselves that we should try it some time; a group-buying site turns that vague sense into something we really must do if we don’t want to lose the money we spent on the deal or coupon. By forcing people to pay for their coupon or deal, restaurants lock in new customers in a way that old-fashioned coupons never could.

In that sense, from the consumer’s perspective, group buying is a commitment device: it’s a way of forcing yourself to do something you really want to try at some point, but know that you might otherwise never get around to. The merchant persuades the consumer to make that commitment right now by making sure that the offer only lasts a very short time — usually only a day or two. The consumer knows that if they don’t buy the deal now, they’ve missed their chance.

Deals and coupons can very good at driving traffic during slow periods. For any kind of business which needs a certain amount of volume to keep ticking over in fallow times, group buying can be exactly what the doctor ordered.

In the popular imagination, then, the idea behind group-buying is that it attracts new customers to a restaurant, some of whom become regulars and therefore very profitable. Long-term profits from the few, in this model, make up for short-term losses from the many who will never return.

And that is indeed a central part of how group buying works — it’s just not the only way that restaurants get value from the site. In that sense, restaurants are much like a discount deal or coupon itself. It makes money on every sale — but it will only see its margins start to rise impressively if and when its merchants start coming back on a regular basis. At that point, the cost of setting up and selling a new deal comes down dramatically, and the site’s profits on the deal — after accounting for the cost of their salesperson’s time — rise substantially. The group buying site itself, as much as its merchants, is counting on repeat business. And that comes from having a positive reputation which can spread like wildfire over social networks.

PS: A shorter version of this article appeared in Bangalore Mirror last month.

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