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Fickle customers hurt group buying sites
June 24, 2011, Friday
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WHAT customer wouldn't want to score a deep discount on dinner, beauty treatments and other services, especially during a downturn?
Barely three years old as an industry, online group buying sites are witnessing rapid growth, as more subscribers sign up, more partner businesses sign on, revenues climb and venture capitalists swarm to invest.
The most prominent group buying site, Chicago-based Groupon, has 2011 revenues estimated at between US$3 billion and US$4 billion.
But much of that òwild exuberanceó is miscalculated and could bring ruin to investors, warns Wharton marketing professor David Reibsteinin an interview with Knowledge@Wharton.
Taking Groupon as a case in point, he says the industry?s current growth rates are unsustainable. Here?s an edited transcript of the interview:
Q: More than 500 group buying sites have sprung up even though the industry is in its infancy. What is driving all this action?
A: Part of it is because the Internet has provided a lot of power to the customer. Group buying has provided the ability to pool customers together to give them much more collective bargaining power. That?s great.
There is an advantage to the merchants as well. The advantage is, rather than sell one by one and customer to customer and doing the marketing effort one by one, it is really allowing businesses to be able to sell a significant amount of volume with more of it being channeled through one customer.
Q: What exactly do venture capital investors find attractive?
A: Unlike the customer, the investors are attracted by the huge growth and the valuations that are going on in this industry. I believe there?s going to be a lot of money lost in some of these investments.
If you look at the total dollar volumes that are being passed through here, it looks like a tremendous amount ? and it is. But the question is: will it continue to grow and particularly, will it continue to grow at the rate at which the number of suppliers is growing?
The growth rate for each supplier will be negated by the number of suppliers. But investors are clearly attracted by the growth rate and the valuations.
Q: The biggest of these companies, Groupon, is estimated to post revenues exceeding US$3 billion in 2011. What is it about Groupon?s business model that drives such growth?
A: The way this works is they go to merchants and say, òI am willing to sell some of your inventory and I am going to take a cut out of the profit. But you?re going to have to give me a deep discount.ó
To some degree, they are operating just like a retailer. I am going to buy volume, I?m going to break that down and sell it to individual customers. And I?m going to sell it to those individual customers for more than what it cost me. That?s exactly how every retailer operates. The difference is they are not buying any of the inventories. They are just a re-seller.
Q: Why do you believe that business model will not support the current growth rates?
A: Let me talk about some of the fundamental weaknesses.
One is, however brilliant of an idea it is, there is also now a huge increase in competition. When Groupon had few competitors, it was more viable than it is now with 499 competitors.
But that is not the big weakness. The Groupon business model works better during a recession than it does during a vibrant economy. I will explain why, and this is where it gets intriguing.
The reason some retailers might be willing to provide supply to Groupon is because they have excess inventory.
That is particularly the case for services. One of the services I notice frequently offered on group buying sites is that of beauty salons. They have so many seats and so many beauticians. If I don?t sell that 3 pm to 4 pm time slot on Thursday afternoon, I cannot carry that time slot in the inventory tomorrow. It perishes.
It perishes in the same sense as an unsold airplane seat once a plane takes off down the runway. Because of the recession, there has been an abundance of people who are forgoing beauty salons and other sorts of luxury, discretionary services. As the economy picks up and there is less excess inventory, the availability of supply will go down. The willingness of the merchant to offer deep discounts will go down.
Q: A big chunk of Groupon?s subscriber base is said to be made up of educated young women, and that is one reason why Groupon features many beauty and wellness offerings. How crucial is the makeup of the subscriber base for the success of the business model?
A: If you look at the nature of the customers who are buying from Groupon, they tend to be younger, more white-collar, they may be better educated and may be a similar profile to those who shop at warehouse club chain Costco.
And so, they tend to be relatively savvy shoppers.
Many of the merchants offer these deep discounts, not with the hope of perpetually offering them, but given that they have excess inventory right now, it would be nice to let people sample their product or service with the hope that they are going to like it and subsequently will come back and buy it when it is not being offered on Groupon and is at its full retail price.
Unfortunately, the people Groupon is attracting are those who are referred to as òdeal prone customersó? who are, to put it differently, price-sensitive customers. These customers tend not to be the most loyal of customers. And because you have attracted them with a low price, you are more likely to lose them because somebody else offers a lower price.
Merchants are going to discover that the Groupon customer is not where you build your future business.
(Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original, full version, please visit: http://bit.ly/jmRE8B)
Barely three years old as an industry, online group buying sites are witnessing rapid growth, as more subscribers sign up, more partner businesses sign on, revenues climb and venture capitalists swarm to invest.
The most prominent group buying site, Chicago-based Groupon, has 2011 revenues estimated at between US$3 billion and US$4 billion.
But much of that òwild exuberanceó is miscalculated and could bring ruin to investors, warns Wharton marketing professor David Reibsteinin an interview with Knowledge@Wharton.
Taking Groupon as a case in point, he says the industry?s current growth rates are unsustainable. Here?s an edited transcript of the interview:
Q: More than 500 group buying sites have sprung up even though the industry is in its infancy. What is driving all this action?
A: Part of it is because the Internet has provided a lot of power to the customer. Group buying has provided the ability to pool customers together to give them much more collective bargaining power. That?s great.
There is an advantage to the merchants as well. The advantage is, rather than sell one by one and customer to customer and doing the marketing effort one by one, it is really allowing businesses to be able to sell a significant amount of volume with more of it being channeled through one customer.
Q: What exactly do venture capital investors find attractive?
A: Unlike the customer, the investors are attracted by the huge growth and the valuations that are going on in this industry. I believe there?s going to be a lot of money lost in some of these investments.
If you look at the total dollar volumes that are being passed through here, it looks like a tremendous amount ? and it is. But the question is: will it continue to grow and particularly, will it continue to grow at the rate at which the number of suppliers is growing?
The growth rate for each supplier will be negated by the number of suppliers. But investors are clearly attracted by the growth rate and the valuations.
Q: The biggest of these companies, Groupon, is estimated to post revenues exceeding US$3 billion in 2011. What is it about Groupon?s business model that drives such growth?
A: The way this works is they go to merchants and say, òI am willing to sell some of your inventory and I am going to take a cut out of the profit. But you?re going to have to give me a deep discount.ó
To some degree, they are operating just like a retailer. I am going to buy volume, I?m going to break that down and sell it to individual customers. And I?m going to sell it to those individual customers for more than what it cost me. That?s exactly how every retailer operates. The difference is they are not buying any of the inventories. They are just a re-seller.
Q: Why do you believe that business model will not support the current growth rates?
A: Let me talk about some of the fundamental weaknesses.
One is, however brilliant of an idea it is, there is also now a huge increase in competition. When Groupon had few competitors, it was more viable than it is now with 499 competitors.
But that is not the big weakness. The Groupon business model works better during a recession than it does during a vibrant economy. I will explain why, and this is where it gets intriguing.
The reason some retailers might be willing to provide supply to Groupon is because they have excess inventory.
That is particularly the case for services. One of the services I notice frequently offered on group buying sites is that of beauty salons. They have so many seats and so many beauticians. If I don?t sell that 3 pm to 4 pm time slot on Thursday afternoon, I cannot carry that time slot in the inventory tomorrow. It perishes.
It perishes in the same sense as an unsold airplane seat once a plane takes off down the runway. Because of the recession, there has been an abundance of people who are forgoing beauty salons and other sorts of luxury, discretionary services. As the economy picks up and there is less excess inventory, the availability of supply will go down. The willingness of the merchant to offer deep discounts will go down.
Q: A big chunk of Groupon?s subscriber base is said to be made up of educated young women, and that is one reason why Groupon features many beauty and wellness offerings. How crucial is the makeup of the subscriber base for the success of the business model?
A: If you look at the nature of the customers who are buying from Groupon, they tend to be younger, more white-collar, they may be better educated and may be a similar profile to those who shop at warehouse club chain Costco.
And so, they tend to be relatively savvy shoppers.
Many of the merchants offer these deep discounts, not with the hope of perpetually offering them, but given that they have excess inventory right now, it would be nice to let people sample their product or service with the hope that they are going to like it and subsequently will come back and buy it when it is not being offered on Groupon and is at its full retail price.
Unfortunately, the people Groupon is attracting are those who are referred to as òdeal prone customersó? who are, to put it differently, price-sensitive customers. These customers tend not to be the most loyal of customers. And because you have attracted them with a low price, you are more likely to lose them because somebody else offers a lower price.
Merchants are going to discover that the Groupon customer is not where you build your future business.
(Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original, full version, please visit: http://bit.ly/jmRE8B)
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