UNDRESSINGGROUPON

AnAnalysisoftheGrouponBusinessModel

AhmadaliArabshahi
December16,2010

Introduction

Grouponisfascinating.Howcanatwoyearoldstartupemployingsimpletechnologies(e.g.email
andawebsite)generatehundredsofmillionsofdollarsineconomicvalue?Whereisthevalue
comingfrom?Inthisessay,Itrytoprovideanansweranduncoverthebusinessmodels
underlyingprinciples.Ifind,andthinkthatyouwillagree,thatthemodelhasmanysubtle
intricacies.

Fromasimpleperspective,Grouponisamediationplatformthatconnectspeopleseeking
bargainswithmerchantswhoarewillingtoprovidethem.Fromanotherperspective,itisan
onlinecouponingsystem.Butneitherdescriptiondoesthemodeljustice.Abetterwaytogain
insightistothinkofGrouponasamonetizationstrategy.Thecompanyhasaverylargenumber
ofemailsubscribersandhasfiguredouthowtomonetizetheminaselfreinforcingvirtuous
cycle.Theydoitbyprovidingsomethingofvaluetomerchants.Ouranalysisbeginsbyexamining
thissomethingofvalue.

Beforethat,wetakeaquicklookatthesubscribers:

TheSubscriberBase

Grouponsmassivesubscribersbase40millionaccordingtonewsreportsisanemail
distributionlistsegmentedonthebasisofgeographicalboundariesandakeyfactorinthe
companysabilitytomobilizecustomers.

Emailisboththemechanismforreachingsubscribersandthebasisoftheconnections
persistence.Butmoreimportantly,itischeapsomethingthatcanbeappreciatedbycontrasting
itwiththepracticesofadvertisinginnewspapersorslippingflyersunderdoors.Withtraditional
methods,marginalcostsincreasewithgreatergeographiccoverage.Butwithemail,thecostof
sendingapromotionisthesameregardlessoflocation.

Becauseofthisproperty,Grouponcantargetthemaximumrelevantgeographicareawhen
promotingalocalmerchant.Eachdealregionusuallyadenselypopulatedurbanbestdescribed
asanexpandedlocalislargeenoughtocoveranysubscriberwiththepotentialtoparticipate.
TheharvestingofthemaximumgeographicareamaximizesGrouponsabilitytogenerate
customersformerchants.

Copyright2010AhmadaliArabshahi

ValuetoMerchants

MerchantsbenefitfromaGroupontransactionmostobviouslybecauseofalargeinfluxof
customersoverashortperiodoftime.Inthelongterm,amerchantcanalsobenefitfromrepeat
customersandreferrals.Weassumerationalmanagers,soaGroupontransactionpresumably
leadstogreaterimmediateprofit,greaterfutureprofit,orboth(i.e.notsacrificingoneforthe
other).

Inanutshell,Groupondeliverscustomersusingacombinationofapromotionalservice,aprice
discriminationserviceandasupportingprepaymentservice.Whatisspecialisthemassivescale
ofthebusinessbyvirtueofthelargesubscriberbase,theexpandedlocalsizeofeachregion,
andthenumerousmarkets,bothdomesticandinternational.

APromotionalService

ApromotionalserviceisanintegralpartofeveryGroupondealintheformofamarketing
messageembeddedinthedealemail.Thecreativeoftenfunnymessagesarepreparedbyexpert
writersandhighlighttheattributesoftheproductorservice.

Theproximategoalofthemessagesistodrumupexcitementforthedealandcoaxsubscribers
topullthebuyingtrigger.Itistrialinducementweareprovidingthissuperdiscounttogetyou
totrytheproduct.Butitisalsoanadvertisingmessagethatraisesawarenessofthemerchant
overagreaterexpandedlocalregion.

APrepaymentService

Grouponcollectspaymentforservicesprovidedinthefutureandpaysmerchantsinadvance.
Theserviceislikeaprepaidgiftcardandbenefitsmerchantsbecauseofthetimevalueofmoney.
Cashnowisbetterthancashlater.Amerchantcantheoreticallybootstrapitselfbydoinga
Grouponandusingthecashtostartorexpandoperations.Prepaymentalsobenefitsmerchants
becauseofnonredemptions.

Thelastcomponentofvalueisthemostsignificant:

AnEngineforPriceDiscrimination

Grouponscorebusinessispricediscriminationfornow,afancywordfordiscounteddeals.

ThefuelofGrouponsabilitytodelivercustomersisthemassivescaleofthesubscribersandthe
notionoftheharvestingofthemaximumgeographicregiontheexpandedlocalcoveringall
potentialcustomers.

Thesparkisthemaximizationofdealacceptance.

Copyright2010AhmadaliArabshahi

Grouponspromotionaleffortsareobviouslyimportantinconvincingsubscriberstobuy.But
ultimately,mostsubscriberspullthetriggerbecauseofasuperdiscountedprice.Price
discriminationisthereforethesecondkeyfactorinGrouponsabilitytogeneratecustomers.

Firstaquickandsimplifiedoverviewofthemicroeconomictheory:

Inatypicalmarketwithoneprice,amerchantcanincreasecustomerdemandbyloweringprice.
Butthebenefitcomesatacosttheoriginalcustomerswhowerewillingtobuyattheoriginal
pricealsoreceivethelowerpriceandconsequentlyprovidelessrevenueasagroup.

Theanswer:pricediscriminationthepracticeofdistinguishingandseparatingpotential
customersonthebasisofpricesensitivityandofferingadifferentpricetoeachgroup.The
revenuefromtheoriginalcustomersisprotectedbycontinuingtoshowthemtheoriginal
price,whileadditionalrevenueisgeneratedfromnewpricesensitivecustomerswhowould
otherwisestayawaybecauseofthetargetedlowerprice.Themerchantgainsaslongasthe
lowerpriceishigherthanthemarginalcostofproducingtheirproductorservice.

Thechallengeliesinidentifyingpricesensitivepotentialcustomers,commonlyaddressedintwo
ways:

In3rddegreepricediscrimination,anobservablecharacteristicisusedasaproxyfortheprice
sensitivityofacustomer.Theobservablecharacteristicformsthebasisofsegmentationand
definesacoherentgroupfortargeting.Oneexampleisthepracticeofofferingstudentdiscounts.
Studentsarepresumablynonemployedandconsequentlymorepricesensitiveasaresultofthe
financialconstraint.

In2nddegreepricediscrimination,customersarecategorizedbasedonactionsthatrevealtheir
pricesensitivity,usedwhenobservablecharacteristicsarelackingorimpracticalasabasisfor
segmentation.Customersaretypicallyluredintosignalingtheirpricesensitivitybasedontheir
responsetoasetofchoicescraftedbythebusiness.Couponsareawellknownexampleasusers
whogotothetroubleofcollectingthemaretakinganactionthatsignalstheirpricesensitivity.

A3rdDegreePriceDiscriminationServicetoMerchants

TheprimaryGrouponservicetomerchantsisa3rddegreepricediscriminationservice.Fromthe
perspectiveofmerchants,Grouponsubscribersareareadilyidentifiablegroup.Theobservable
characteristicisthattheyareGrouponsubscribers.Theserviceprovidesawaytotargetthe
marketsegmentdirectlywithapromotionalmessageandoffer.Allamerchanthastodoisto
signacontractfortheservice.

Itcanbetemptingtothinkoftheserviceasblockpricingaformof2nddegreeprice
discriminationbecauseofthedealactivationthresholdrequirementofaminimumnumberof
customers.Blockpricing,however,isdesignedtoidentifypricesensitivityattheindividuallevel
bypresentingpotentialcustomerswithaquantitybasedchoice.WithGroupon,thejobof
identifyingpricesensitivecustomersisalreadydone.Furthermore,thegroupistargetedwitha
singleprice,notaselectiondesignedtoelucidatepricesensitivity.

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Onewaytoappreciatetheserviceistocontrastitwithanalternative.Acomparablemethod
wouldhavetoincludeadvertisingonagrandscaleperhapsahalfpageadvertisementinthe
NewYorkTimes.Andtheadvertisementwouldhavetoincludeapricediscriminationcouponing
mechanismtofilterconsumersbasedontheinconvenienceofclippingthem.Canyouimagine
couponsintheNYT?Itwouldlookterriblyoddeveniftheeditorsweretoallowit!

TwoTiersof2ndDegreePriceDiscrimination

Grouponprovidesmerchantswithaccesstoauniquetargetablemarketsegmentofprice
sensitiveconsumers.ButhowdoesGrouponidentifypricesensitivityattheindividuallevelin
ordertobuildthegroupinthefirstplace?

Asdiscussedpreviously,2nddegreepricediscriminationisthemethodofidentifyingprice
sensitivecustomersonthebasisoftheirchoicesoractions.Whenaconsumersubscribesto
Groupon,theyareessentiallymakingachoicethatsignalstheirpricesensitivity.Iftheprocess
wereaconversation,itwouldlooklikethis:

Groupon:Hey,Ihavesuperduperdeals,butyoumustgivemeyourname.
Consumer:Ohyeah!PutmedownbecauseImpricesensitive.

Grouponisthereforeaselfselectionmechanismforpricesensitiveconsumerstoreveal
themselves.Pricesensitiveconsumerscannotresistthebaititiscatnipforthem.Subscribers
providetheiremailaddress,whichconvenientlyservesasapipelineforcontinuedmessages.

Butthereismore.Thereisalsoasecondtierof2ndDegreePriceDiscrimination!

Whensubscribersarepresentedwithadeal,therearestringsattached.First,subscribersmust
prepay.Grouponprovidestheplatformtodoso.Secondly,theymustagreetobeboundbythe
limitationsofthedeal(e.g.admissionafter7pmonly).Lastly,subscribersmusttakeaction
withintheonedaylimitofthedealoffering.Incombination,theactionsareasetofchoicesthat
constituteanothertierof2nddegreepricediscrimination.Subscribersaresignalingtheirprice
sensitivitybyagreeingtothehurdlesplacedinfrontofthem.

Sointotality,Grouponisahighlyeffectivetwotier2nddegreepricediscriminationmechanism
thatfilterssubscribersinawaythatcrediblydemonstratesapricesensitivegroup.

PriceDiscriminationDegreeTransformation/Arbitrage

WecannowbegintoappreciatethebeautyoftheGrouponbusinessmodel.

Onthemerchantside,Grouponprovidesaconvenient3rddegreepricediscriminationservicein
theformofacoherenttargetablemarketsegment.Onthesubscriberside,Grouponidentifies
pricesensitiveconsumerswithatwotier2nddegreepricediscriminationmechanismcomprised
ofaselfselectionfilterandasetofhurdlesconsistingofprepayment,acceptanceoflimitations,
andrequiredactionwithinthetimelimit.AndGrouponsitsinthemiddle.

Thebusinessmodeltransformsthemorepowerfulbutdifficultmethodof2nddegreeprice
discriminationtoamoreconvenientandpalatable3rddegreepricediscriminationservice.The
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arrangementisessentiallyanarbitrageplatform.Intheprocess,Grouponextractsapremium.
Onewaytovisualizeitisfromtheperspectiveofthefinancialflow.Grouponsellsaproductora
servicetoindividualconsumersatadiscountedpricebuttheneffectivelybuysitfroma
merchantatanevenlowerprice.ThedifferenceisrevenuetoGroupon.Thenotionofarbitrage
stemsfromthefactthatGrouponrisksnothingintermsofhavingtoaccumulateinventoryor
assumeanyobligations.Conventionalwisdomstatesthatarbitrageshouldnotpersistinthe
longterm.TheincreaseincompetitionfromGrouponclonesmakescompletesensewhenseenin
thislight.Grouponsmarginsthearbitragespreadwilllikelyerodeovertime.

ImportantFunctions

TherearesomesubtletiesintheGrouponbusinessmodelthatmightnotappreciatedby
imitators.Anumberofimportantproblemsmustbeaddressed.Whetherbyaccidentordesign,
theGrouponbusinessmodeladdressesthem.

TheQualitySignalingProblem

Businessesfaceafundamentalproblemindiscounting.Alowerpricecanbeinterpretedasa
signalofinferiorquality.Priceandqualityaretwosidesofthesamecoinandreflecteachother.
Ifthereisamismatch,consumerscanbecomesuspicious.Itstheoldadageofifthepriceistoo
goodtobetrue,thenitprobablyis.Becauseofthis,merchantsmustprovideanassuranceof
qualitywhenrunningadiscountprogram.

Grouponservesanessentialfunctionbyprovidinganassuranceofqualityfortheirdeals.The
marketingmessagestatesitexplicitly,talkingabouttopratedlocalsdealsandthebestlocal
businesses.Customersmustbepersuadedthatadealpriceislowbecauseoftheexclusivityof
theofferingratherthanbecauseofaproblemwiththeproduct.Thisisaccomplishedinseveral
interestingways:
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ThePromotionalMessage

Thepromotionalmessagesindealemailsprovideassurancesofqualitybyhighlightingthe
attributesoftheproductorservice.Butbeyondthat,amoresubtleconfirmationbiasreinforces
thequality.AnaturalinterpretationofaGroupondiscountisthatamerchantbelievesso
stronglyinthequalityoftheirproductthattheyareprovidingadeepdiscounttoencourage
peopletotryit,confidentinthebeliefthatbuyerswillbecomerepeatcustomers.Byframingthe
promotionalmessageinawaythatconfirmsthisviewpoint,Grouponcantakeadvantageof
peoplesnaturalsusceptibilitytoconfirmationbiastovalidatetheinterpretationandto
reinforcethepremiseofproductquality.

TheDealActivationThreshold

Grouponclaimsthatthedealactivationthresholdisvaluabletomerchantssinceitguaranteesa
minimumnumberofcustomers.Theclaimsoundsplausibleandisintegratedintothedeal
buyingexperienceasthenumberofcustomersiscounteddown.

Butintruth,theguaranteeofaminimumnumberofcustomersisnotreallyvaluableto
merchants.Withmostdeals,justificationofthediscountedpricerequiresfarfewercustomers.In
fact,assumingrationalpricing(i.e.Price>MC),amerchantshouldbewillingtoacceptany
numberofadditionalcustomers.Soeventhoughmerchantsvaluelargenumbersofadditional
customers,thereisnogoodreasontovaluetheguaranteeofalargenumberofcustomers.

ThenwhydoesGrouponpromotetheclaimsoprominently?

Theansweristhattheclaimreassurescustomersbypreemptivelyaddressingthequestion
whatisthemerchantreceivinginreturnforaspecialdiscount?Byprovidingafalse
explanationthatthemerchantisprovidingaspecialdealinexchangeforaguaranteeofa
minimumnumberofcustomersGrouponstrengthensthepremiseofthespecialnessofthedeal
anddisplacespotentialdoubtsastothequality.

AOneDayLimitontheAvailabilityofEachDealandLimitedMerchantExposure

Acontinuousorconstantlyrecurrentdiscountprogramcansendanegativesignaltopotential
customers.Itsuggeststhatthediscountpriceisnotspecial.Perhapstheproductqualityislow
andthemerchanthasbeenforcedtodiscountinordertosellit.

Toavoidtheproblem,thedurationandfrequencyofdiscountprogramsmustbelimitedinthe
samewayasonedayonlysalesintherealworld.Butthereisacostinthatthelimitationalso
limitstheextracustomersfromalongerdiscountprogram.

Grouponprovidesasolutionbecauseofitsabilitytogenerateamassivenumberofcustomers
fromasingledaypromotion.Amerchantcanreceivethesamenumberofcustomersinoneday
aswithperhapsacontinuousmonthlongdiscountprogram.Andthemerchantavoidsthe
negativesignalingpitfallsofoverexposurefromalongdurationdiscountingcampaign.

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Asanaside,thenatureofthemerchantdetermineshowwellitcancopewiththeadditional
customers;therearethreecategories.Thefirstarebusinessesthatcanscaletoaccommodatethe
massiveinfluxofcustomersonanimmediatebasis.Afitnessclubwithhugesurpluscapacityis
anexample.TheybenefitfromaGroupontransaction.Thesecondarebusinessesthatcannot
scalebutareexpectedtoprovideservicenontheless.Asmallcupcakeshopwithlimitedsurplus
productioncapacityandcustomerexpectationofondemandsatisfactionisanexample.They
mightnotbenefitfromaGroupontransactionandinfactmightsuffer.Andthelastare
businessesthatcannotscaleandarenotexpectedtoprovideondemandservice.Massage
therapistsorotherbusinessesthatrequireappointmentsareexamples.Theybenefitthemost
fromaGroupontransaction.Sincethereisnoexpectationofondemandservice,theadditional
customersaretimeshiftedviaanappointmentmechanismforexampleandservicedovera
longerduration.

TheCredibilityProblem

Wouldyoutrustacarpetdealershipthathasbeenadvertisingagoingoutofbusinesssalefor
overayear?Sinceadiscountmeansnothingwhenappliedtoaninflatedprice,merchantsfacea
credibilitychallengeandmustassurepotentialcustomersoftheauthenticityoftheirdiscounts.

Asanindependentthirdparty,Grouponservesanessentialfunctionbyprovidinganassurance
ofdealvalue.Subscribersmustbeconvincedthatthedealsarevaluableandauthentic.

ThefirstwayGroupondoesthisisbyensuringthatthedealsareinfactvaluable.Thisisprobably
thereasonthedealsareoftensoextremefollowingtheoldsovietadageofwhenindoubt,add
moresteelormorelike,whenitdoubt,shaveanother10%.

Theotherwayistomanageperceptions.Intheirmarketing,Groupontalksabouthuge
discountsandincrediblylowprices.Butbeyondjustsayingit,theymustensurethatalltheir
activitiesarecongruentwithamessageofdealvalueandauthenticity.Severalelementsstand
out:

ASingleDealEachDay

Grouponrunsasingledealadayineachcity.Whynotseveral?BecauseGrouponneedsto
promoteanauraofexclusivityforeachdeal.Theimplicitmessageisthatthedealsaresorare
andspecialthattherecanonlybeoneaday.

Thisseeminglyinnocuousdetailgovernsthescalingstrategyofthebusinessmodel.The
limitationofasingledealadaylimitstherevenuepotentialfromeachcity.Sotoscalerevenues,
Grouponmustexpandgeographically.

TheMythoftheCollectiveBuyingPower

TheGrouponmarketingmessagetalksaboutcollectivebuyingpower.Thecompanyclaimsto
negotiateasuperpriceonbehalfoftheirsubscribers.Itmakessubscribersfeelwarmandfuzzy
andreinforcesthemessagethatthepriceisspecialbyprovidingaplausiblereasonforit.

Copyright2010AhmadaliArabshahi

Butinreality,thecollectivebuyingpowerdoesnotbelongtosubscribers.Itactuallybelongsto
Groupon.Powerimplieschoice,andGroupongetstochoosethemerchants.Grouponalso
negotiatesaverysignificantmarginforitselfbyleveragingthecollectivebuyingpower.

AcarefulexaminationshowsthatGrouponsinterestsarenotperfectlyalignedwiththatoftheir
subscribers.Whilesubscribersbenefitfromthelowestpricepossible,Grouponhasanincentive
forahigherpricebecauserevenueisapercentageofthetransactionamount.Theconflictof
interestmustbemanagedtoavoidanydamagetoGrouponscredibility.

TheGrouponPromise

TheGrouponpromiseisessentiallyaguaranteeofsatisfaction.Thecompanyprovidesarefund
outofitsownpocketifacustomerisnotsatisfied.Theguaranteeisafantasticwaytoreassure
customersandcostsverylittleinpractice,especiallyinrelationtomargins.

TheCustomerQualityProblem

Oneoftheproblemswithdiscountingisthatitcanattractlowerqualitycustomers.Theterm
lowerqualitycustomerisnotmeanttobepejorative.Socialhierarchyisafactoflifeand
merchantsarenaturallysensitivetothekindofclienteletheyattract.Becauseofthecorrelation
betweenincomeandsocialclass,priceisoftenusedasamechanismtoenforcestandards.

Thiscreatesaproblemforpricediscrimination.Consideranupscalerestaurant.Supposethatthe
restauranthasexcesscapacityandwantstoincreasecustomers.Nowimagineifthemerchant
indiscriminatelyofferscouponswithsteepdiscounts.Thereisagoodpossibilitythatthe
restaurantwillattractundesirablecustomerswhowillalienatetheirexistingfullpriceclientele.

Grouponprovidesasolutiontothecustomerqualityproblem,albeitincidentallyperhaps.

ThedemographicsoftheGrouponsubscriberbasearehighlyfavorable.Aconsumermust
possesssomedegreeofcomputerliteracyinordertosubscribe,somethingthatcorrelates
stronglywitheducation,socialclass,anddiscretionaryincome.EventhoughGroupon
subscribersarepricesensitive,theyarenotpriceconstrained.Subscribersaretypically
educated,young,urbanprofessionals.Mostmerchantsaremorethanhappytocatertothem.

TheSegmentationProblem

Twoconditionsarenecessaryforsuccessfulpricediscrimination.Apricesensitivemarket
segmentmustbeidentified.Butimportantly,thesegmentmustbeisolatedfromtheexisting
customerbase.Amerchantmustpreventexistingfullpricepayingcustomersfromtaking
advantageofthelowerdealpriceasituationthatlowersrevenueanddefeatsthepurposeof
pricediscrimination.

Grouponmeetsthischallengeintwoways.First,dealofferingsarenotpublicknowledge.They
aretargetedemailstoGrouponsubscribersonly.Regularcustomersareexcludedunlessthey
alsohappentobeGrouponsubscribers,whichisunlikelybecauseofthesecondreason:a
minimaloverlapbetweenGrouponssubscribersandmerchantsregularcustomersbecauseofa
naturalseparationbasedonpricesensitivityandgeography.Grouponsubscribersareprice
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sensitiveanddrawnfromalargerexpandedlocalregionalarea.Incontrast,merchantsregular
customersaremostlypriceinsensitivebecauseofthehigherendnatureofmostmerchants
anddrawnfromthelocalvicinity.

TheBigPicture

Grouponisasolutiontoahithertounderappreciatedproblem.

Qualitymerchantswanttopricediscriminatetoincreaseprofits.Likewise,qualityprice
sensitiveconsumerswanttoconsumemoregoodsandservices.Grouponprovidesaplatformto
mediatebetweenthetwogroupsandtoincreasetheutilityofboth.Thebusinessmodelisa
constructwhereinformation,incentives,signals,andotherfactorsareallalignedinsuchaway
astoachieveabetterequilibrium.

AVirtuousGrowthCycle

Whenasystemexhibitsexplosivegrowth,apositivefeedbackloopisofteninvolved.Groupon
owesitsrapidgrowthtoaselfreinforcingvirtuouscycle:

Theprocessisasfollows:

TheGrouponbrandsignals:
o Anassuranceofquality
o Anassuranceofdealvalue
o Anexcitingwaytodiscovernewexperiences
Themessageresultsinsubscribergrowth
Copyright2010AhmadaliArabshahi

 Becauseofthesubscribergrowth,Grouponsabilitytodelivercustomersisenhanced
Asaresult,thereisgreatermerchantdemandforGroupon
Becauseofthegreatermerchantdemand,Groupongainsleveragein:
o Choosinghigherqualitymerchants
o Negotiatinghigherdiscounts
ThehigherqualityanddeeperdiscountsreinforcetheGrouponbrandandreputation
Thecyclerepeats

Resources

Grouponhasbeengrowingrapidlyandmaintainingsuperhighmarginsdespitearidiculous
numberofcompetitors.Sowhatgivesthemanedge?Certainly,beingthefirstoutofthegatehas
beenanadvantage.Butwhatisthemanifestationoftheadvantage?

Thekeyresourcesbecomeapparentbylookingatthevirtuousgrowthcycle.

TheSubscriberBase

Grouponssubscriberbaseislargerthanallitscompetitorsandadistinctcompetitiveadvantage.
Asseeninthevirtuouscyclediagram,thesubscriberbaseiscentraltoGrouponsabilityto
delivercustomers.Thevalueofthesubscriberbasecriticallydependsonthepermissionfor
continuedmessages,whichisimplicitlygrantedwhenasubscribersignsup.Theprivilegeof
intrudingonapersonsconsciousnessisveryvaluable.Butitisalsoveryfragile.Grouponmust
becarefulnottoabusetheprivilegeascustomerscaneasilyunsubscribe(i.e.Grouponicus
emails).

HowhasGrouponmanagedtoaccumulatesomanysubscribers?Theansweristhenextkey
resource.

BrandandReputation

Grouponsmostimportantresourceisitsbrandandreputation.

Asseeninthevirtuouscyclediagram,subscribergrowth,whichiscriticalforthesuccessof
Grouponbusinessmodel,reliesonassurancesofqualityandcredibility.Subscribersmust
believeGroupon.Bymanagingsignals,stayingcongruent,anddoingtherightthingsconsistently,
Grouponhasaccumulatedbrandequityandcanthereforemakesassurancesasatrusted
independentthirdparty.

TheGrouponbrandalsoattractssubscribersbecauseofitsassociationwithdiscoveringfun
activitiesinyourcityandfindingcoolnewexperiencesasdescribedbytheGroupon
marketingmessages.WhoknewyoucouldgetaBrazilianwaxwhiletakingaboattourofNYC?
Thefeelingofcoolnessisareflectionofthecultureofthecompanyandcannotbeimitatedeasily,
embodiedineverythingfromthewittypromotionalmessagestothefreshcolorschemeofthe
website.

MerchantRelationshipsandExpertise

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Grouponhasinvestedheavilyinsalesandcustomerservicecapabilities.Thefunctionsgenerate
revenuedirectlyandarethereforeveryimportant.Theaccumulationofknowledge,experience
andrelationshipswithmerchantscanbeconsideredaresource.

OperationsandExecutionExpertise

ThegrowthofGrouponhasbeenphenomenal.Scalingabusinesssoquicklyisnojoke.It
demonstratesoperationalchopsandmanagementprowess.Butdoesitdemonstrateanabilityto
innovate?ItcanbearguedthatGrouponstumbledontoitsbusinessmodel.Soperhapsthejuryis
stilloutonthequestion.

TheCompetitivePicture

Grouponfacestwodistinctcompetitivethreats.

Thefirstisfrombusinesseswithsimilarbusinessmodels.Therearehundredsofthem,butthe
impacthasbeenminimal.Marginswillprobablysufferinthefuture,buttheyaresohighthatit
willtakealongtimeforanyseriousproblemstoemerge.AfactorinGrouponsfavoristhatthe
marketisstillgrowingandfarbeingsaturated.AnotheristhatGrouponsmassivescaleprovides
ahugeadvantageintheirabilitytodelivercustomersandwillprotectmarketshareinamore
competitiveenvironment.

Forthetimebeing,Groupondoesnothavetoworryaboutimitators.Therealthreatisfromthe
emergenceofasuperiorbusinessmodel.

LetusrevisitthefundamentalproblemsolvedbyGroupontheneedtomediatebetween
merchantswhowishtopricediscriminateandpricesensitiveconsumers.Grouponsbusiness
modelisaversion1.0solutionthereisalotofroomforimprovement.

Oneproblemisthemodelchannelsaninordinatenumberofcustomerstoasinglemerchant
(sometimestoomany)attheexclusionofallothers.Anotheristhatitisveryexpensive,
extractingofaheavy50%shareoftherevenueironicsinceGrouponisinthebusinessof
providingapricediscriminationservice.

Asuperiormodelwouldbemorepluralandlessonerousintermsofprice.Orstateddifferently,
itwouldproducehigherquantitiesoftheserviceatalowerprice.

Whatwouldsuchamodellooklike?

First,alittlegroundwork:

TheEquivalenceofAdvertisingandPriceDiscrimination

Productandpricearetwosidesofthesamecoin.Theworthofaproducttoaconsumerits
utilityissubjectiveanddependsonhowmuchaconsumerdesirestheproduct.Price,onthe
otherhand,isanobjectivemeasurethecostoftheproductintherealworld.
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11


Thetwoareintimatelyconnectedinthattheybothdeterminethevalueofaproductthespread
betweenthesubjectiveworthofaproductandtherealworldprice.Valueincreasesnotonly
whenaproductisdesiredmorebutalsowhenthepriceislowered.Considerasilvernecklaceat
abargainpriceoftendollars.Itisactuallymorevaluablethananidenticalgoldoneatamillion
dollars.

Inthesameway,advertisingandpricediscriminationareintimatelyconnected.Bothhavean
equivalentobjective:increasingaconsumersperceptionofvalue.Advertisingdoesitbyraisinga
consumerssubjectiveperceptionoftheutilityoftheproduct.Pricediscriminationdoesitby
loweringtheprice.

Onethingtonote:pricediscriminationismuchtrickier.Unlikeadvertisingwhichmovesthe
valueneedleinonlyonedirection(unlessamarketerreallyscrewsup)pricediscrimination
caneasilylowervalueifdoneincorrectly.Becauseofthecomplexitiesofsignaling,alowerprice
canperverselylowerthesubjectiveworthoftheproduct.Superluxurygoodswherepricesare
completelydisconnectedfromtheinherentworthoftheproductsaregoodexamplesinthat
customersactuallyseekahighpriceinordertosignalwealth.

TheGoogle

TheequivalenceofadvertisingandpricediscriminationmeansthatGoogleandGrouponare
essentiallyinthesamebusinessasurprisingrealizationsincethebusinessmodelsareso
different.Bothcompaniesprovideaservicetoinfluenceconsumersperceptionofproductvalue
GoogleviaadvertisingandGrouponviapricediscrimination.Andbothaimtodeliver
customersonevirtually,theotherinthephysicalworld.

Itbegsthequestion:canGooglecompetewithGroupon?Ifso,how?

Theshortansweristhattheycan.Moreover,theycandoitwellbecausetheypossessallthe
necessarytoolsandresourcestoinnovateandcreateasuperiorbusinessmodel.

Twopotentialscenariosarepresentedhere.ThefirstisanevolvedversionoftheGroupon
businessmodel.Thesecondisamoreprofoundintegrationofpricediscriminationintothe
existingGoogleAdsenseandAdwordsplatforms.

Anextgenerationbusinessmodel

TheGrouponpricediscriminationdegreetransformationmodelhastwosidesthemerchant
facingsideandsubscriberfacingside.Themerchantfacingsideistherealworldandinvolves
themerchantsalesandservicefunctions.Thesubscriberfacingsideisdataorientedand
involvesthefundamentaltaskofidentifyingpricesensitivity.

Onthedatasideoftheequation,Grouponstwotier2nddegreepricediscriminationfunctionis
arelativelycrudewayofidentifyingpricesensitivity,relyingonselfselectionandseveral
hurdles.Itworksinabinarywayandcannotmeasurethemagnitudeofpricesensitivity.

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Google,ontheotherhand,hasaccesstovastamountsofdata,includingGmailuserdata,search
queries,clickthroughdata,andallmannerofotherinformationfromtheirvastconstellationof
services.Ontopofthat,theyareexpertsatcomputationalalgorithms.Theycaneasilyimplement
sophisticatedanalysistoidentifypricesensitiveusersandtomeasurethemagnitudeofthe
pricesensitivityasaquotientassignedtoeachuser.Forexample,ifauserfrequentswebsites
withinformationonhowtosavemoneythenGooglewouldknowthattheuserispricesensitive.
ButifaGmailuserreceivesareservationconfirmationemailfromaveryexpensiverestaurant
thenGooglewouldconcludethattheuserispriceinsensitive.

TheGooglesystemwouldbemuchclosertotheidealof1stdegreepricediscriminationandfar
superiortoGrouponstwotier2nddegreepricediscriminationfunction.ItwouldgiveGooglea
competitiveadvantageintheirabilitytotargetusersandtomaximizeprofitsformerchants.

Allthatwouldremainistogrowasubscriberbase.Googlecoulddothatcheaplybyadvertising
onitsownplatforms.Moreeffectively,theycouldgetpermissionfromGmailuserstomessage
themeasilydonewithaprominentTurnondailylocaldealsbuttoninGmail.Amassive
subscriberbasewouldinstantlyspringtolife.

Onthemerchantsideoftheequation,GooglecouldeasilyimitatetheGrouponmodel.They
possessthefinancialresourcestobuildtheirownsalesandcustomerserviceorganizationinthe
samewayasGroupon.Buttheyhaveamuchmorepowerfuloption:toexternalizethemerchant
facingsalesandservicefunctionstoindependentlocallybasedaffiliates.

Theweprovidetheplatformonlymodelwouldbesuperiorfortworeasons:

First,adistributedcollectionoflocalaffiliateswouldholdaninformationandrelational
advantageoveracentralizedarmyofnonlocalsalesandserviceemployees(i.e.Groupons
Chicagooffice).Nativefolkknowtheircommunitiesbetterandaremoreeffectiveincultivating
merchantrelationshipsthanoutsiders.

Secondly,anexternalizedmodelwouldhaveafinancialandscalabilityadvantage.Internalsales
andcustomersupportemployeesneedcareandfeedingandrequireahugeamountofworking
capitaltosupporttheiroperations(lookatthefundingthatGrouponissoakingup).An
externalizedmodelwouldbemorecapitalefficientandthereforemorescalable,absentthe
investmentrequirementsofgrowingasalesandserviceorganization.Externalindependentlocal
affiliatesproperlyincentivizedwithaprofitmotivewouldbefarmoreeffectiveandcost
efficientincoveringthemanysmalllocalareasthatarecurrentlybeingignoredbytheGroupon
model.

Toillustratethis,imaginealocalnewspaperwitharestaurantreviewcolumn.Theycould
becomeaGoogleaffiliateandbegintoofferadealadayforafeaturedrestaurant.Theywould
handlethesales,customerservice,andpromotionalemaildesignallthefunctionsperformed
bythemerchantfacingsideofGroupon.TheywouldthenusetheGoogleplatformtoofferadeal.
Theplatformwouldtakecareofallthenecessarytechnologyfunctions,includingsendingemails,
runningthewebsite,andpaymentprocessing.Andbecauseofloweroverhead,theaffiliatewould
shareintherevenueformuchlessthantheonerous50%Grouponfee.

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ThishypotheticalGoogleplatformwouldrequireconsiderablethoughtanddesign.Allthe
importantissuesdiscussedinthispaperwouldhavetobeaddressed.Butitcouldbeagame
changer.Thereistremendousroomforinnovation.Onepossibilityistheintegrationofan
auctionmodel,inthesamewayasthecurrentAdwordsprogram.Thirdpartyaffiliateswould
competeforaccesstotheGoogleplatform.Thecompetitivedynamicswouldensurethatonlythe
bestdealaffiliateswouldcontinuetothrive.

TheintegrationofpricediscriminationintoAdwordsandAdsense

Apotentiallymoreprofoundapplicationoftheprinciplesofpricediscriminationisintegration
intotheexistingflagshipGoogleAdwordsandAdsenseplatforms.

TheentirebasisofGooglesadvertisingbusinessisrelevance.Advertisementsareprimarily
targetedonthebasisofsearchandcontextrelevanceaswellaslocation,languageandother
parameters.Asdescribedalready,Googlepossessestheresourcestoalgorithmicallyidentify
pricesensitivityonanindividualbasis.ConsiderifthisparameterisaddedtoGoogles
advertisingplatformasatargetingoption.Inadditiontorelevance,advertiserswouldbeableto
tailortheirmessagesbasedonthepricesensitivityoftheviewer.Apricesensitiveusermightbe
shownanadvertisementthathighlightsadiscountwhereasapriceinsensitiveusermightbe
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targetedwithamessagethathighlightsthehighendfeaturesofaproduct.Theplatformcould
alsobeusedtodistributedailydealsbutwithevengreaterflexibility.

IfGrouponspowerisderivedfromthescaleofitstargetaudience,onecanonlymarvelatthe
possibilitieswithGoogleinthisscenario.

CreditCardCompanies

Perhapsnootherbusinessisinabetterpositiontoidentifypricesensitivitythancreditcard
companies.Offermatic,anewmarketentrant,usescreditcardtransactioninformationasthe
basisofdistributingdailydeals.Butitappearsasthoughtheytargetdealsbasedonrelevance,
whichwouldmeanthattheyarecompletelymissingthepoint.Unlessthedealsarecouponsfor
specificproducts,thentheservicewillactuallyharmmerchants.Byignoringpricesensitivity,
merchantsarechasingtheirowntailsinazerosumgameofstealingcustomersfromeachother
orworst,possiblycannibalizingtheirexistingfullpricepayingcustomerbase.

Nonetheless,creditcardcompanieshaveaccesstodatathatcanyieldpricesensitivityquotients
forconsumers.Whethertheycanbuildabusinessmodelarounditisanothermatter.Thefirst
challengeisgettingpermissiontomessageusers.Perhapsitcanbedone,butconsumersare
generallynotfavorablydisposedtowardcreditcardcompanies.

BuildingaBetterModel

Wecouldplayagameofbuildthebusinessmodel.

Ourgoalwouldbetoengineerabusinessmodelthatiscoolerandmoreefficientinconnecting
pricediscriminatingvendorswithpricesensitiveconsumers.Thereisalotroomforcreativity.
Conceptsandtoolssuchascrowdsourcing,openAPIs,notionsofdisintermediation,mobile
platforms,twitter,theFacebooksocialgraph,andahundredotherresourcescanbemeldedinto
abetterplatform.Itjusttakesimagination.

LookingtotheFuture

Ifyouthinkaboutit,thehumanconditionisveryinefficient.

LetusconsiderourprivilegedexistenceastypicalAmericancitizens.AsIwasleavingmy
apartmenttodaytodrivetothegrocerystoreonaverycoldday,aneighborwasleavingthe
buildingonfoot,probablyheadedtothesubwaystation.Thesubwaystationisonthewaytothe
grocerystoreanditwouldhavecostmenothingtogivethepersonalift.Perhapshewaswilling
topayseveraldollarsfortherideandperhapsIcouldhaveforwardedthepaymenttosome
charity.Ifonlytherewasaplatformtomakeitpossible.

Thereasonformytriptothegrocerystorewastobuymilk.Unknowntome,anotherneighbor
wasthereatthesametime.Shecouldhaveeasilypickedupanothercartonofmilkanddropped
itoffatmyplace.Iwouldhavebeenmorethanhappytopayasmallfeefortheservice.And

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perhapsshewouldhavebeenhappytodoit.Itsurewouldhavesavedsomegas.Ifonlythere
wasaplatformtohelpmakeitpossible.

AtthegrocerystoreIstartedwonderingwhathappenstofoodoncetheexpirationdatepasses.
Googlegavemetheanswer.Itisthrownaway,eventhereallyexpensivefreshcrabmeat.Iwould
haveboughtitifitwerejustabitcheaper.Ifonlytherewasaplatformtohelpmakeitpossible.

Andthesewereobservationsfromjustonemorning.

SowhattheheckdoesthishavetodowithGroupon?

Withallthetalkofpricediscrimination,socialthis,andFacebookthat,itiseasytolosetrackof
whatisimportant.Onanabstractlevel,Grouponfunctionstopromoteamoreefficientusageof
economicandhumancapacity.Thereisanincreaseinsocialwelfareasbothmerchantsand
consumersendupwithahigherutility.Thepricepointrightnowmightbealittlehigh,butthat
isnormalfortheearlystagesofanyproductorservice.WhatGrouponhasdoneisto
demonstratetheeconomicpotentialofleveragingsimpletechnologiestoaddressdeeply
embeddedinefficienciesinlife.Andtheeconomicpotentialishuge!

AsGrouponlookstothefuture,itmustfinditspurposeinthegreaterhistoricalcontext.Willthe
companyselloutorwillitembraceagreatermission?Theyseemtobegoingforthelatter.But
dotheyhavetheinnovationchopstosucceed?Theopportunitiesaretheretocreatenext
generationplatformstoleveragetechnologyandtheInternettomakelifebetterforall.

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