Two’s company, three’s a crowd
Here’s how the group-coupon model works. In every city in which it is present, LivingSocial sends offers to purchase goods and services from local businesses at a sizable discount (typically, 50%) to its massive email list. The user pays for the product/service via the website, which then shares the revenue with the business. The benchmark split in revenue is 50:50 for Groupon. LivingSocial reportedly practices less onerous terms, keeping approximately 30% to 40% of the revenue.
As Tim O’Shaughnessy described it:
Every single offer that we run has three people involved: It has LivingSocial, it has the merchant and it has the member. And, you know, ninety-plus percent of the time — I don’t know what the exact numbers are — but over a huge percentage of the time, it’s a win-win-win for all three parties. When that happens, you have a pretty healthy ecosystem. I mean, every person is happy in that triumvirate at the end of the day.
That sounds wonderful, but Sucharita Mulpuru, a vice president at Forrester Research, Inc. (NASDAQ:FORR) and an expert on e-commerce, multi-channel retail and consumer behavior, offers a less rosy assessment: “What was good for Groupon and the daily deal companies was not good for the merchants and vice-versa. There’s only a fixed amount of margin there and either it goes to Groupon or it goes back to the merchant; if it goes back to the merchant, Groupon makes less money,” adding: “They never figured out — and they still haven’t, I’d argue — how to get to that balance of win-win — it was always a zero-sum game.”
Here’s how the deal works out for the three parties:
Users: The advantage is not hard to spot here; what’s not to like about a 50% discount on goods and services?
Deal site: The group-buying website acts as an intermediary in matching consumers with local businesses. Here again, the benefits of this model are clear: The company carries no inventory, it gets paid upfront and, as we saw above, it earns massive gross margins.
Merchant: When it comes to the third party in this transaction, the upside — or “value proposition” in marketing-speak — is slightly more nebulous. Depending on the marginal cost of the product/service in question, some businesses may still be able to earn a profit in the deals they offer. However, given that they get hit by a double whammy in the user discount and the revenue-sharing with the deal website, that’s not the base case. Instead, most businesses accept that the deals are a form of advertising with a cost that ultimately needs to be recouped through repeat transactions at non-discounted prices.
Where’s your marginal profit?
A simple concept from economics, that of marginal profit, is enough to illustrate why the economics of the group-buying model for the merchant can vary wildly, depending on the sector in which they operate. Let’s take two types of businesses that are superficially similar: A boutique hotel and an upscale restaurant. Both are part of the hospitality industry and may appeal to heavily overlapping sets of consumers; however, they differ vastly in terms of incremental profitability.
