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UNDRESSINGGROUPONAnAnalysisoftheGrouponBusinessModelAhmadaliArabshahiDecember16,2010

IntroductionGrouponisfascinating.Howcanatwoyearoldstartupemployingsimpletechnologies(e.g.emailandawebsite)generatehundredsofmillionsofdollarsineconomicvalue?Whereisthevaluecomingfrom?Inthisessay,Itrytoprovideanansweranduncoverthebusinessmodelsunderlyingprinciples.Ifind,andthinkthatyouwillagree,thatthemodelhasmanysubtleintricacies.Fromasimpleperspective,Grouponisamediationplatformthatconnectspeopleseekingbargainswithmerchantswhoarewillingtoprovidethem.Fromanotherperspective,itisanonlinecouponingsystem.Butneitherdescriptiondoesthemodeljustice.AbetterwaytogaininsightistothinkofGrouponasamonetizationstrategy.Thecompanyhasaverylargenumberofemailsubscribersandhasfiguredouthowtomonetizetheminaselfreinforcingvirtuouscycle.Theydoitbyprovidingsomethingofvaluetomerchants.Ouranalysisbeginsbyexaminingthissomethingofvalue.Beforethat,wetakeaquicklookatthesubscribers:TheSubscriberBaseGrouponsmassivesubscribersbase40millionaccordingtonewsreportsisanemaildistributionlistsegmentedonthebasisofgeographicalboundariesandakeyfactorinthecompanysabilitytomobilizecustomers.Emailisboththemechanismforreachingsubscribersandthebasisoftheconnectionspersistence.Butmoreimportantly,itischeapsomethingthatcanbeappreciatedbycontrastingitwiththepracticesofadvertisinginnewspapersorslippingflyersunderdoors.Withtraditionalmethods,marginalcostsincreasewithgreatergeographiccoverage.Butwithemail,thecostofsendingapromotionisthesameregardlessoflocation.Becauseofthisproperty,Grouponcantargetthemaximumrelevantgeographicareawhenpromotingalocalmerchant.Eachdealregionusuallyadenselypopulatedurbanbestdescribedasanexpandedlocalislargeenoughtocoveranysubscriberwiththepotentialtoparticipate.TheharvestingofthemaximumgeographicareamaximizesGrouponsabilitytogeneratecustomersformerchants.


ValuetoMerchantsMerchantsbenefitfromaGroupontransactionmostobviouslybecauseofalargeinfluxofcustomersoverashortperiodoftime.Inthelongterm,amerchantcanalsobenefitfromrepeatcustomersandreferrals.Weassumerationalmanagers,soaGroupontransactionpresumablyleadstogreaterimmediateprofit,greaterfutureprofit,orboth(i.e.notsacrificingonefortheother).Inanutshell,Groupondeliverscustomersusingacombinationofapromotionalservice,apricediscriminationserviceandasupportingprepaymentservice.Whatisspecialisthemassivescaleofthebusinessbyvirtueofthelargesubscriberbase,theexpandedlocalsizeofeachregion,andthenumerousmarkets,bothdomesticandinternational.APromotionalServiceApromotionalserviceisanintegralpartofeveryGroupondealintheformofamarketingmessageembeddedinthedealemail.Thecreativeoftenfunnymessagesarepreparedbyexpertwritersandhighlighttheattributesoftheproductorservice.Theproximategoalofthemessagesistodrumupexcitementforthedealandcoaxsubscriberstopullthebuyingtrigger.Itistrialinducementweareprovidingthissuperdiscounttogetyoutotrytheproduct.Butitisalsoanadvertisingmessagethatraisesawarenessofthemerchantoveragreaterexpandedlocalregion.APrepaymentServiceGrouponcollectspaymentforservicesprovidedinthefutureandpaysmerchantsinadvance.Theserviceislikeaprepaidgiftcardandbenefitsmerchantsbecauseofthetimevalueofmoney.Cashnowisbetterthancashlater.AmerchantcantheoreticallybootstrapitselfbydoingaGrouponandusingthecashtostartorexpandoperations.Prepaymentalsobenefitsmerchantsbecauseofnonredemptions.Thelastcomponentofvalueisthemostsignificant:AnEngineforPriceDiscriminationGrouponscorebusinessispricediscriminationfornow,afancywordfordiscounteddeals.ThefuelofGrouponsabilitytodelivercustomersisthemassivescaleofthesubscribersandthenotionoftheharvestingofthemaximumgeographicregiontheexpandedlocalcoveringallpotentialcustomers.Thesparkisthemaximizationofdealacceptance.


Grouponspromotionaleffortsareobviouslyimportantinconvincingsubscriberstobuy.Butultimately,mostsubscriberspullthetriggerbecauseofasuperdiscountedprice.PricediscriminationisthereforethesecondkeyfactorinGrouponsabilitytogeneratecustomers.Firstaquickandsimplifiedoverviewofthemicroeconomictheory:Inatypicalmarketwithoneprice,amerchantcanincreasecustomerdemandbyloweringprice.Butthebenefitcomesatacosttheoriginalcustomerswhowerewillingtobuyattheoriginalpricealsoreceivethelowerpriceandconsequentlyprovidelessrevenueasagroup.Theanswer:pricediscriminationthepracticeofdistinguishingandseparatingpotentialcustomersonthebasisofpricesensitivityandofferingadifferentpricetoeachgroup.Therevenuefromtheoriginalcustomersisprotectedbycontinuingtoshowthemtheoriginalprice,whileadditionalrevenueisgeneratedfromnewpricesensitivecustomerswhowouldotherwisestayawaybecauseofthetargetedlowerprice.Themerchantgainsaslongasthelowerpriceishigherthanthemarginalcostofproducingtheirproductorservice.Thechallengeliesinidentifyingpricesensitivepotentialcustomers,commonlyaddressedintwoways:In3rddegreepricediscrimination,anobservablecharacteristicisusedasaproxyforthepricesensitivityofacustomer.Theobservablecharacteristicformsthebasisofsegmentationanddefinesacoherentgroupfortargeting.Oneexampleisthepracticeofofferingstudentdiscounts.Studentsarepresumablynonemployedandconsequentlymorepricesensitiveasaresultofthefinancialconstraint.In2nddegreepricediscrimination,customersarecategorizedbasedonactionsthatrevealtheirpricesensitivity,usedwhenobservablecharacteristicsarelackingorimpracticalasabasisforsegmentation.Customersaretypicallyluredintosignalingtheirpricesensitivitybasedontheirresponsetoasetofchoicescraftedbythebusiness.Couponsareawellknownexampleasuserswhogotothetroubleofcollectingthemaretakinganactionthatsignalstheirpricesensitivity.A3rdDegreePriceDiscriminationServicetoMerchantsTheprimaryGrouponservicetomerchantsisa3rddegreepricediscriminationservice.Fromtheperspectiveofmerchants,Grouponsubscribersareareadilyidentifiablegroup.TheobservablecharacteristicisthattheyareGrouponsubscribers.Theserviceprovidesawaytotargetthemarketsegmentdirectlywithapromotionalmessageandoffer.Allamerchanthastodoistosignacontractfortheservice.Itcanbetemptingtothinkoftheserviceasblockpricingaformof2nddegreepricediscriminationbecauseofthedealactivationthresholdrequirementofaminimumnumberofcustomers.Blockpricing,however,isdesignedtoidentifypricesensitivityattheindividuallevelbypresentingpotentialcustomerswithaquantitybasedchoice.WithGroupon,thejobofidentifyingpricesensitivecustomersisalreadydone.Furthermore,thegroupistargetedwithasingleprice,notaselectiondesignedtoelucidatepricesensitivity.


Onewaytoappreciatetheserviceistocontrastitwithanalternative.AcomparablemethodwouldhavetoincludeadvertisingonagrandscaleperhapsahalfpageadvertisementintheNewYorkTimes.Andtheadvertisementwouldhavetoincludeapricediscriminationcouponingmechanismtofilterconsumersbasedontheinconvenienceofclippingthem.CanyouimaginecouponsintheNYT?Itwouldlookterriblyoddeveniftheeditorsweretoallowit!TwoTiersof2ndDegreePriceDiscriminationGrouponprovidesmerchantswithaccesstoauniquetargetablemarketsegmentofpricesensitiveconsumers.ButhowdoesGrouponidentifypricesensitivityattheindividuallevelinordertobuildthegroupinthefirstplace?Asdiscussedpreviously,2nddegreepricediscriminationisthemethodofidentifyingpricesensitivecustomersonthebasisoftheirchoicesoractions.WhenaconsumersubscribestoGroupon,theyareessentiallymakingachoicethatsignalstheirpricesensitivity.Iftheprocesswereaconversation,itwouldlooklikethis:Groupon:Hey,Ihavesuperduperdeals,butyoumustgivemeyourname.Consumer:Ohyeah!PutmedownbecauseImpricesensitive.Grouponisthereforeaselfselectionmechanismforpricesensitiveconsumerstorevealthemselves.Pricesensitiveconsumerscannotresistthebaititiscatnipforthem.Subscribersprovidetheiremailaddress,whichconvenientlyservesasapipelineforcontinuedmessages.Butthereismore.Thereisalsoasecondtierof2ndDegreePriceDiscrimination!Whensubscribersarepresentedwithadeal,therearestringsattached.First,subscribersmustprepay.Grouponprovidestheplatformtodoso.Secondly,theymustagreetobeboundbythelimitationsofthedeal(e.g.admissionafter7pmonly).Lastly,subscribersmusttakeactionwithintheonedaylimitofthedealoffering.Incombination,theactionsareasetofchoicesthatconstituteanothertierof2nddegreepricediscrimination.Subscribersaresignalingtheirpricesensitivitybyagreeingtothehurdlesplacedinfrontofthem.Sointotality,Grouponisahighlyeffectivetwotier2nddegreepricediscriminationmechanismthatfilterssubscribersinawaythatcrediblydemonstratesapricesensitivegroup.PriceDiscriminationDegreeTransformation/ArbitrageWecannowbegintoappreciatethebeautyoftheGrouponbusinessmodel.Onthemerchantside,Grouponprovidesaconvenient3rddegreepricediscriminationserviceintheformofacoherenttargetablemarketsegment.Onthesubscriberside,Grouponidentifiespricesensitiveconsumerswithatwotier2nddegreepricediscriminationmechanismcomprisedofaselfselectionfilterandasetofhurdlesconsistingofprepayment,acceptanceoflimitations,andrequiredactionwithinthetimelimit.AndGrouponsitsinthemiddle.Thebusinessmodeltransformsthemorepowerfulbutdifficultmethodof2nddegreepricediscriminationtoamoreconvenientandpalatable3rddegreepricediscriminationservice.The


arrangementisessentiallyanarbitrageplatform.Intheprocess,Grouponextractsapremium.Onewaytovisualizeitisfromtheperspectiveofthefinancialflow.Grouponsellsaproductoraservicetoindividualconsumersatadiscountedpricebuttheneffectivelybuysitfromamerchantatanevenlowerprice.ThedifferenceisrevenuetoGroupon.ThenotionofarbitragestemsfromthefactthatGrouponrisksnothingintermsofhavingtoaccumulateinventoryorassumeanyobligations.Conventionalwisdomstatesthatarbitrageshouldnotpersistinthelongterm.TheincreaseincompetitionfromGrouponclonesmakescompletesensewhenseeninthislight.Grouponsmarginsthearbitragespreadwilllikelyerodeovertime.

ImportantFunctionsTherearesomesubtletiesintheGrouponbusinessmodelthatmightnotappreciatedbyimitators.Anumberofimportantproblemsmustbeaddressed.Whetherbyaccidentordesign,theGrouponbusinessmodeladdressesthem.TheQualitySignalingProblemBusinessesfaceafundamentalproblemindiscounting.Alowerpricecanbeinterpretedasasignalofinferiorquality.Priceandqualityaretwosidesofthesamecoinandreflecteachother.Ifthereisamismatch,consumerscanbecomesuspicious.Itstheoldadageofifthepriceistoogoodtobetrue,thenitprobablyis.Becauseofthis,merchantsmustprovideanassuranceofqualitywhenrunningadiscountprogram.Grouponservesanessentialfunctionbyprovidinganassuranceofqualityfortheirdeals.Themarketingmessagestatesitexplicitly,talkingabouttopratedlocalsdealsandthebestlocalbusinesses.Customersmustbepersuadedthatadealpriceislowbecauseoftheexclusivityoftheofferingratherthanbecauseofaproblemwiththeproduct.Thisisaccomplishedinseveralinterestingways:


ThePromotionalMessageThepromotionalmessagesindealemailsprovideassurancesofqualitybyhighlightingtheattributesoftheproductorservice.Butbeyondthat,amoresubtleconfirmationbiasreinforcesthequality.AnaturalinterpretationofaGroupondiscountisthatamerchantbelievessostronglyinthequalityoftheirproductthattheyareprovidingadeepdiscounttoencouragepeopletotryit,confidentinthebeliefthatbuyerswillbecomerepeatcustomers.Byframingthepromotionalmessageinawaythatconfirmsthisviewpoint,Grouponcantakeadvantageofpeoplesnaturalsusceptibilitytoconfirmationbiastovalidatetheinterpretationandtoreinforcethepremiseofproductquality. TheDealActivationThresholdGrouponclaimsthatthedealactivationthresholdisvaluabletomerchantssinceitguaranteesaminimumnumberofcustomers.Theclaimsoundsplausibleandisintegratedintothedealbuyingexperienceasthenumberofcustomersiscounteddown.Butintruth,theguaranteeofaminimumnumberofcustomersisnotreallyvaluabletomerchants.Withmostdeals,justificationofthediscountedpricerequiresfarfewercustomers.Infact,assumingrationalpricing(i.e.Price>MC),amerchantshouldbewillingtoacceptanynumberofadditionalcustomers.Soeventhoughmerchantsvaluelargenumbersofadditionalcustomers,thereisnogoodreasontovaluetheguaranteeofalargenumberofcustomers.ThenwhydoesGrouponpromotetheclaimsoprominently?Theansweristhattheclaimreassurescustomersbypreemptivelyaddressingthequestionwhatisthemerchantreceivinginreturnforaspecialdiscount?ByprovidingafalseexplanationthatthemerchantisprovidingaspecialdealinexchangeforaguaranteeofaminimumnumberofcustomersGrouponstrengthensthepremiseofthespecialnessofthedealanddisplacespotentialdoubtsastothequality. AOneDayLimitontheAvailabilityofEachDealandLimitedMerchantExposureAcontinuousorconstantlyrecurrentdiscountprogramcansendanegativesignaltopotentialcustomers.Itsuggeststhatthediscountpriceisnotspecial.Perhapstheproductqualityislowandthemerchanthasbeenforcedtodiscountinordertosellit.Toavoidtheproblem,thedurationandfrequencyofdiscountprogramsmustbelimitedinthesamewayasonedayonlysalesintherealworld.Butthereisacostinthatthelimitationalsolimitstheextracustomersfromalongerdiscountprogram.Grouponprovidesasolutionbecauseofitsabilitytogenerateamassivenumberofcustomersfromasingledaypromotion.Amerchantcanreceivethesamenumberofcustomersinonedayaswithperhapsacontinuousmonthlongdiscountprogram.Andthemerchantavoidsthenegativesignalingpitfallsofoverexposurefromalongdurationdiscountingcampaign.


Asanaside,thenatureofthemerchantdetermineshowwellitcancopewiththeadditionalcustomers;therearethreecategories.Thefirstarebusinessesthatcanscaletoaccommodatethemassiveinfluxofcustomersonanimmediatebasis.Afitnessclubwithhugesurpluscapacityisanexample.TheybenefitfromaGroupontransaction.Thesecondarebusinessesthatcannotscalebutareexpectedtoprovideservicenontheless.Asmallcupcakeshopwithlimitedsurplusproductioncapacityandcustomerexpectationofondemandsatisfactionisanexample.TheymightnotbenefitfromaGroupontransactionandinfactmightsuffer.Andthelastarebusinessesthatcannotscaleandarenotexpectedtoprovideondemandservice.Massagetherapistsorotherbusinessesthatrequireappointmentsareexamples.TheybenefitthemostfromaGroupontransaction.Sincethereisnoexpectationofondemandservice,theadditionalcustomersaretimeshiftedviaanappointmentmechanismforexampleandservicedoveralongerduration.TheCredibilityProblemWouldyoutrustacarpetdealershipthathasbeenadvertisingagoingoutofbusinesssaleforoverayear?Sinceadiscountmeansnothingwhenappliedtoaninflatedprice,merchantsfaceacredibilitychallengeandmustassurepotentialcustomersoftheauthenticityoftheirdiscounts.Asanindependentthirdparty,Grouponservesanessentialfunctionbyprovidinganassuranceofdealvalue.Subscribersmustbeconvincedthatthedealsarevaluableandauthentic.ThefirstwayGroupondoesthisisbyensuringthatthedealsareinfactvaluable.Thisisprobablythereasonthedealsareoftensoextremefollowingtheoldsovietadageofwhenindoubt,addmoresteelormorelike,whenitdoubt,shaveanother10%.Theotherwayistomanageperceptions.Intheirmarketing,Groupontalksabouthugediscountsandincrediblylowprices.Butbeyondjustsayingit,theymustensurethatalltheiractivitiesarecongruentwithamessageofdealvalueandauthenticity.Severalelementsstandout: ASingleDealEachDayGrouponrunsasingledealadayineachcity.Whynotseveral?BecauseGrouponneedstopromoteanauraofexclusivityforeachdeal.Theimplicitmessageisthatthedealsaresorareandspecialthattherecanonlybeoneaday.Thisseeminglyinnocuousdetailgovernsthescalingstrategyofthebusinessmodel.Thelimitationofasingledealadaylimitstherevenuepotentialfromeachcity.Sotoscalerevenues,Grouponmustexpandgeographically. TheMythoftheCollectiveBuyingPowerTheGrouponmarketingmessagetalksaboutcollectivebuyingpower.Thecompanyclaimstonegotiateasuperpriceonbehalfoftheirsubscribers.Itmakessubscribersfeelwarmandfuzzyandreinforcesthemessagethatthepriceisspecialbyprovidingaplausiblereasonforit.


Butinreality,thecollectivebuyingpowerdoesnotbelongtosubscribers.ItactuallybelongstoGroupon.Powerimplieschoice,andGroupongetstochoosethemerchants.Grouponalsonegotiatesaverysignificantmarginforitselfbyleveragingthecollectivebuyingpower.AcarefulexaminationshowsthatGrouponsinterestsarenotperfectlyalignedwiththatoftheirsubscribers.Whilesubscribersbenefitfromthelowestpricepossible,Grouponhasanincentiveforahigherpricebecauserevenueisapercentageofthetransactionamount.TheconflictofinterestmustbemanagedtoavoidanydamagetoGrouponscredibility. TheGrouponPromiseTheGrouponpromiseisessentiallyaguaranteeofsatisfaction.Thecompanyprovidesarefundoutofitsownpocketifacustomerisnotsatisfied.Theguaranteeisafantasticwaytoreassurecustomersandcostsverylittleinpractice,especiallyinrelationtomargins.TheCustomerQualityProblemOneoftheproblemswithdiscountingisthatitcanattractlowerqualitycustomers.Thetermlowerqualitycustomerisnotmeanttobepejorative.Socialhierarchyisafactoflifeandmerchantsarenaturallysensitivetothekindofclienteletheyattract.Becauseofthecorrelationbetweenincomeandsocialclass,priceisoftenusedasamechanismtoenforcestandards.Thiscreatesaproblemforpricediscrimination.Consideranupscalerestaurant.Supposethattherestauranthasexcesscapacityandwantstoincreasecustomers.Nowimagineifthemerchantindiscriminatelyofferscouponswithsteepdiscounts.Thereisagoodpossibilitythattherestaurantwillattractundesirablecustomerswhowillalienatetheirexistingfullpriceclientele.Grouponprovidesasolutiontothecustomerqualityproblem,albeitincidentallyperhaps.ThedemographicsoftheGrouponsubscriberbasearehighlyfavorable.Aconsumermustpossesssomedegreeofcomputerliteracyinordertosubscribe,somethingthatcorrelatesstronglywitheducation,socialclass,anddiscretionaryincome.EventhoughGrouponsubscribersarepricesensitive,theyarenotpriceconstrained.Subscribersaretypicallyeducated,young,urbanprofessionals.Mostmerchantsaremorethanhappytocatertothem.TheSegmentationProblemTwoconditionsarenecessaryforsuccessfulpricediscrimination.Apricesensitivemarketsegmentmustbeidentified.Butimportantly,thesegmentmustbeisolatedfromtheexistingcustomerbase.Amerchantmustpreventexistingfullpricepayingcustomersfromtakingadvantageofthelowerdealpriceasituationthatlowersrevenueanddefeatsthepurposeofpricediscrimination.Grouponmeetsthischallengeintwoways.First,dealofferingsarenotpublicknowledge.TheyaretargetedemailstoGrouponsubscribersonly.RegularcustomersareexcludedunlesstheyalsohappentobeGrouponsubscribers,whichisunlikelybecauseofthesecondreason:aminimaloverlapbetweenGrouponssubscribersandmerchantsregularcustomersbecauseofanaturalseparationbasedonpricesensitivityandgeography.Grouponsubscribersareprice


sensitiveanddrawnfromalargerexpandedlocalregionalarea.Incontrast,merchantsregularcustomersaremostlypriceinsensitivebecauseofthehigherendnatureofmostmerchantsanddrawnfromthelocalvicinity.TheBigPictureGrouponisasolutiontoahithertounderappreciatedproblem.Qualitymerchantswanttopricediscriminatetoincreaseprofits.Likewise,qualitypricesensitiveconsumerswanttoconsumemoregoodsandservices.Grouponprovidesaplatformtomediatebetweenthetwogroupsandtoincreasetheutilityofboth.Thebusinessmodelisaconstructwhereinformation,incentives,signals,andotherfactorsareallalignedinsuchawayastoachieveabetterequilibrium.AVirtuousGrowthCycleWhenasystemexhibitsexplosivegrowth,apositivefeedbackloopisofteninvolved.Grouponowesitsrapidgrowthtoaselfreinforcingvirtuouscycle:Theprocessisasfollows: TheGrouponbrandsignals:

o Anassuranceofqualityo Anassuranceofdealvalueo Anexcitingwaytodiscovernewexperiences

Themessageresultsinsubscribergrowth


Becauseofthesubscribergrowth,Grouponsabilitytodelivercustomersisenhanced Asaresult,thereisgreatermerchantdemandforGroupon Becauseofthegreatermerchantdemand,Groupongainsleveragein:

o Choosinghigherqualitymerchantso Negotiatinghigherdiscounts

ThehigherqualityanddeeperdiscountsreinforcetheGrouponbrandandreputation ThecyclerepeatsResourcesGrouponhasbeengrowingrapidlyandmaintainingsuperhighmarginsdespitearidiculousnumberofcompetitors.Sowhatgivesthemanedge?Certainly,beingthefirstoutofthegatehasbeenanadvantage.Butwhatisthemanifestationoftheadvantage?Thekeyresourcesbecomeapparentbylookingatthevirtuousgrowthcycle. TheSubscriberBaseGrouponssubscriberbaseislargerthanallitscompetitorsandadistinctcompetitiveadvantage.Asseeninthevirtuouscyclediagram,thesubscriberbaseiscentraltoGrouponsabilitytodelivercustomers.Thevalueofthesubscriberbasecriticallydependsonthepermissionforcontinuedmessages,whichisimplicitlygrantedwhenasubscribersignsup.Theprivilegeofintrudingonapersonsconsciousnessisveryvaluable.Butitisalsoveryfragile.Grouponmustbecarefulnottoabusetheprivilegeascustomerscaneasilyunsubscribe(i.e.Grouponicusemails).HowhasGrouponmanagedtoaccumulatesomanysubscribers?Theansweristhenextkeyresource. BrandandReputationGrouponsmostimportantresourceisitsbrandandreputation.Asseeninthevirtuouscyclediagram,subscribergrowth,whichiscriticalforthesuccessofGrouponbusinessmodel,reliesonassurancesofqualityandcredibility.SubscribersmustbelieveGroupon.Bymanagingsignals,stayingcongruent,anddoingtherightthingsconsistently,Grouponhasaccumulatedbrandequityandcanthereforemakesassurancesasatrustedindependentthirdparty.TheGrouponbrandalsoattractssubscribersbecauseofitsassociationwithdiscoveringfunactivitiesinyourcityandfindingcoolnewexperiencesasdescribedbytheGrouponmarketingmessages.WhoknewyoucouldgetaBrazilianwaxwhiletakingaboattourofNYC?Thefeelingofcoolnessisareflectionofthecultureofthecompanyandcannotbeimitatedeasily,embodiedineverythingfromthewittypromotionalmessagestothefreshcolorschemeofthewebsite. MerchantRelationshipsandExpertise


Grouponhasinvestedheavilyinsalesandcustomerservicecapabilities.Thefunctionsgeneraterevenuedirectlyandarethereforeveryimportant.Theaccumulationofknowledge,experienceandrelationshipswithmerchantscanbeconsideredaresource. OperationsandExecutionExpertiseThegrowthofGrouponhasbeenphenomenal.Scalingabusinesssoquicklyisnojoke.Itdemonstratesoperationalchopsandmanagementprowess.Butdoesitdemonstrateanabilitytoinnovate?ItcanbearguedthatGrouponstumbledontoitsbusinessmodel.Soperhapsthejuryisstilloutonthequestion.TheCompetitivePictureGrouponfacestwodistinctcompetitivethreats.Thefirstisfrombusinesseswithsimilarbusinessmodels.Therearehundredsofthem,buttheimpacthasbeenminimal.Marginswillprobablysufferinthefuture,buttheyaresohighthatitwilltakealongtimeforanyseriousproblemstoemerge.AfactorinGrouponsfavoristhatthemarketisstillgrowingandfarbeingsaturated.AnotheristhatGrouponsmassivescaleprovidesahugeadvantageintheirabilitytodelivercustomersandwillprotectmarketshareinamorecompetitiveenvironment.Forthetimebeing,Groupondoesnothavetoworryaboutimitators.Therealthreatisfromtheemergenceofasuperiorbusinessmodel.LetusrevisitthefundamentalproblemsolvedbyGroupontheneedtomediatebetweenmerchantswhowishtopricediscriminateandpricesensitiveconsumers.Grouponsbusinessmodelisaversion1.0solutionthereisalotofroomforimprovement.Oneproblemisthemodelchannelsaninordinatenumberofcustomerstoasinglemerchant(sometimestoomany)attheexclusionofallothers.Anotheristhatitisveryexpensive,extractingofaheavy50%shareoftherevenueironicsinceGrouponisinthebusinessofprovidingapricediscriminationservice.Asuperiormodelwouldbemorepluralandlessonerousintermsofprice.Orstateddifferently,itwouldproducehigherquantitiesoftheserviceatalowerprice.Whatwouldsuchamodellooklike?First,alittlegroundwork:TheEquivalenceofAdvertisingandPriceDiscriminationProductandpricearetwosidesofthesamecoin.Theworthofaproducttoaconsumeritsutilityissubjectiveanddependsonhowmuchaconsumerdesirestheproduct.Price,ontheotherhand,isanobjectivemeasurethecostoftheproductintherealworld.


Thetwoareintimatelyconnectedinthattheybothdeterminethevalueofaproductthespreadbetweenthesubjectiveworthofaproductandtherealworldprice.Valueincreasesnotonlywhenaproductisdesiredmorebutalsowhenthepriceislowered.Considerasilvernecklaceatabargainpriceoftendollars.Itisactuallymorevaluablethananidenticalgoldoneatamilliondollars.Inthesameway,advertisingandpricediscriminationareintimatelyconnected.Bothhaveanequivalentobjective:increasingaconsumersperceptionofvalue.Advertisingdoesitbyraisingaconsumerssubjectiveperceptionoftheutilityoftheproduct.Pricediscriminationdoesitbyloweringtheprice.Onethingtonote:pricediscriminationismuchtrickier.Unlikeadvertisingwhichmovesthevalueneedleinonlyonedirection(unlessamarketerreallyscrewsup)pricediscriminationcaneasilylowervalueifdoneincorrectly.Becauseofthecomplexitiesofsignaling,alowerpricecanperverselylowerthesubjectiveworthoftheproduct.Superluxurygoodswherepricesarecompletelydisconnectedfromtheinherentworthoftheproductsaregoodexamplesinthatcustomersactuallyseekahighpriceinordertosignalwealth.TheGoogleTheequivalenceofadvertisingandpricediscriminationmeansthatGoogleandGrouponareessentiallyinthesamebusinessasurprisingrealizationsincethebusinessmodelsaresodifferent.BothcompaniesprovideaservicetoinfluenceconsumersperceptionofproductvalueGoogleviaadvertisingandGrouponviapricediscrimination.Andbothaimtodelivercustomersonevirtually,theotherinthephysicalworld.Itbegsthequestion:canGooglecompetewithGroupon?Ifso,how?Theshortansweristhattheycan.Moreover,theycandoitwellbecausetheypossessallthenecessarytoolsandresourcestoinnovateandcreateasuperiorbusinessmodel.Twopotentialscenariosarepresentedhere.ThefirstisanevolvedversionoftheGrouponbusinessmodel.ThesecondisamoreprofoundintegrationofpricediscriminationintotheexistingGoogleAdsenseandAdwordsplatforms. AnextgenerationbusinessmodelTheGrouponpricediscriminationdegreetransformationmodelhastwosidesthemerchantfacingsideandsubscriberfacingside.Themerchantfacingsideistherealworldandinvolvesthemerchantsalesandservicefunctions.Thesubscriberfacingsideisdataorientedandinvolvesthefundamentaltaskofidentifyingpricesensitivity.Onthedatasideoftheequation,Grouponstwotier2nddegreepricediscriminationfunctionisarelativelycrudewayofidentifyingpricesensitivity,relyingonselfselectionandseveralhurdles.Itworksinabinarywayandcannotmeasurethemagnitudeofpricesensitivity.


Google,ontheotherhand,hasaccesstovastamountsofdata,includingGmailuserdata,searchqueries,clickthroughdata,andallmannerofotherinformationfromtheirvastconstellationofservices.Ontopofthat,theyareexpertsatcomputationalalgorithms.Theycaneasilyimplementsophisticatedanalysistoidentifypricesensitiveusersandtomeasurethemagnitudeofthepricesensitivityasaquotientassignedtoeachuser.Forexample,ifauserfrequentswebsiteswithinformationonhowtosavemoneythenGooglewouldknowthattheuserispricesensitive.ButifaGmailuserreceivesareservationconfirmationemailfromaveryexpensiverestaurantthenGooglewouldconcludethattheuserispriceinsensitive.TheGooglesystemwouldbemuchclosertotheidealof1stdegreepricediscriminationandfarsuperiortoGrouponstwotier2nddegreepricediscriminationfunction.ItwouldgiveGoogleacompetitiveadvantageintheirabilitytotargetusersandtomaximizeprofitsformerchants.Allthatwouldremainistogrowasubscriberbase.Googlecoulddothatcheaplybyadvertisingonitsownplatforms.Moreeffectively,theycouldgetpermissionfromGmailuserstomessagethemeasilydonewithaprominentTurnondailylocaldealsbuttoninGmail.Amassivesubscriberbasewouldinstantlyspringtolife.Onthemerchantsideoftheequation,GooglecouldeasilyimitatetheGrouponmodel.TheypossessthefinancialresourcestobuildtheirownsalesandcustomerserviceorganizationinthesamewayasGroupon.Buttheyhaveamuchmorepowerfuloption:toexternalizethemerchantfacingsalesandservicefunctionstoindependentlocallybasedaffiliates.Theweprovidetheplatformonlymodelwouldbesuperiorfortworeasons:First,adistributedcollectionoflocalaffiliateswouldholdaninformationandrelationaladvantageoveracentralizedarmyofnonlocalsalesandserviceemployees(i.e.GrouponsChicagooffice).Nativefolkknowtheircommunitiesbetterandaremoreeffectiveincultivatingmerchantrelationshipsthanoutsiders.Secondly,anexternalizedmodelwouldhaveafinancialandscalabilityadvantage.Internalsalesandcustomersupportemployeesneedcareandfeedingandrequireahugeamountofworkingcapitaltosupporttheiroperations(lookatthefundingthatGrouponissoakingup).Anexternalizedmodelwouldbemorecapitalefficientandthereforemorescalable,absenttheinvestmentrequirementsofgrowingasalesandserviceorganization.ExternalindependentlocalaffiliatesproperlyincentivizedwithaprofitmotivewouldbefarmoreeffectiveandcostefficientincoveringthemanysmalllocalareasthatarecurrentlybeingignoredbytheGrouponmodel.Toillustratethis,imaginealocalnewspaperwitharestaurantreviewcolumn.TheycouldbecomeaGoogleaffiliateandbegintoofferadealadayforafeaturedrestaurant.Theywouldhandlethesales,customerservice,andpromotionalemaildesignallthefunctionsperformedbythemerchantfacingsideofGroupon.TheywouldthenusetheGoogleplatformtoofferadeal.Theplatformwouldtakecareofallthenecessarytechnologyfunctions,includingsendingemails,runningthewebsite,andpaymentprocessing.Andbecauseofloweroverhead,theaffiliatewouldshareintherevenueformuchlessthantheonerous50%Grouponfee.


ThishypotheticalGoogleplatformwouldrequireconsiderablethoughtanddesign.Alltheimportantissuesdiscussedinthispaperwouldhavetobeaddressed.Butitcouldbeagamechanger.Thereistremendousroomforinnovation.Onepossibilityistheintegrationofanauctionmodel,inthesamewayasthecurrentAdwordsprogram.ThirdpartyaffiliateswouldcompeteforaccesstotheGoogleplatform.Thecompetitivedynamicswouldensurethatonlythebestdealaffiliateswouldcontinuetothrive.

TheintegrationofpricediscriminationintoAdwordsandAdsenseApotentiallymoreprofoundapplicationoftheprinciplesofpricediscriminationisintegrationintotheexistingflagshipGoogleAdwordsandAdsenseplatforms.TheentirebasisofGooglesadvertisingbusinessisrelevance.Advertisementsareprimarilytargetedonthebasisofsearchandcontextrelevanceaswellaslocation,languageandotherparameters.Asdescribedalready,Googlepossessestheresourcestoalgorithmicallyidentifypricesensitivityonanindividualbasis.ConsiderifthisparameterisaddedtoGooglesadvertisingplatformasatargetingoption.Inadditiontorelevance,advertiserswouldbeabletotailortheirmessagesbasedonthepricesensitivityoftheviewer.Apricesensitiveusermightbeshownanadvertisementthathighlightsadiscountwhereasapriceinsensitiveusermightbe


targetedwithamessagethathighlightsthehighendfeaturesofaproduct.Theplatformcouldalsobeusedtodistributedailydealsbutwithevengreaterflexibility.IfGrouponspowerisderivedfromthescaleofitstargetaudience,onecanonlymarvelatthepossibilitieswithGoogleinthisscenario.CreditCardCompaniesPerhapsnootherbusinessisinabetterpositiontoidentifypricesensitivitythancreditcardcompanies.Offermatic,anewmarketentrant,usescreditcardtransactioninformationasthebasisofdistributingdailydeals.Butitappearsasthoughtheytargetdealsbasedonrelevance,whichwouldmeanthattheyarecompletelymissingthepoint.Unlessthedealsarecouponsforspecificproducts,thentheservicewillactuallyharmmerchants.Byignoringpricesensitivity,merchantsarechasingtheirowntailsinazerosumgameofstealingcustomersfromeachotherorworst,possiblycannibalizingtheirexistingfullpricepayingcustomerbase.Nonetheless,creditcardcompanieshaveaccesstodatathatcanyieldpricesensitivityquotientsforconsumers.Whethertheycanbuildabusinessmodelarounditisanothermatter.Thefirstchallengeisgettingpermissiontomessageusers.Perhapsitcanbedone,butconsumersaregenerallynotfavorablydisposedtowardcreditcardcompanies.BuildingaBetterModelWecouldplayagameofbuildthebusinessmodel.Ourgoalwouldbetoengineerabusinessmodelthatiscoolerandmoreefficientinconnectingpricediscriminatingvendorswithpricesensitiveconsumers.Thereisalotroomforcreativity.Conceptsandtoolssuchascrowdsourcing,openAPIs,notionsofdisintermediation,mobileplatforms,twitter,theFacebooksocialgraph,andahundredotherresourcescanbemeldedintoabetterplatform.Itjusttakesimagination.LookingtotheFutureIfyouthinkaboutit,thehumanconditionisveryinefficient.LetusconsiderourprivilegedexistenceastypicalAmericancitizens.AsIwasleavingmyapartmenttodaytodrivetothegrocerystoreonaverycoldday,aneighborwasleavingthebuildingonfoot,probablyheadedtothesubwaystation.Thesubwaystationisonthewaytothegrocerystoreanditwouldhavecostmenothingtogivethepersonalift.PerhapshewaswillingtopayseveraldollarsfortherideandperhapsIcouldhaveforwardedthepaymenttosomecharity.Ifonlytherewasaplatformtomakeitpossible.Thereasonformytriptothegrocerystorewastobuymilk.Unknowntome,anotherneighborwasthereatthesametime.Shecouldhaveeasilypickedupanothercartonofmilkanddroppeditoffatmyplace.Iwouldhavebeenmorethanhappytopayasmallfeefortheservice.And


perhapsshewouldhavebeenhappytodoit.Itsurewouldhavesavedsomegas.Ifonlytherewasaplatformtohelpmakeitpossible.AtthegrocerystoreIstartedwonderingwhathappenstofoodoncetheexpirationdatepasses.Googlegavemetheanswer.Itisthrownaway,eventhereallyexpensivefreshcrabmeat.Iwouldhaveboughtitifitwerejustabitcheaper.Ifonlytherewasaplatformtohelpmakeitpossible.Andthesewereobservationsfromjustonemorning.SowhattheheckdoesthishavetodowithGroupon?Withallthetalkofpricediscrimination,socialthis,andFacebookthat,itiseasytolosetrackofwhatisimportant.Onanabstractlevel,Grouponfunctionstopromoteamoreefficientusageofeconomicandhumancapacity.Thereisanincreaseinsocialwelfareasbothmerchantsandconsumersendupwithahigherutility.Thepricepointrightnowmightbealittlehigh,butthatisnormalfortheearlystagesofanyproductorservice.WhatGrouponhasdoneistodemonstratetheeconomicpotentialofleveragingsimpletechnologiestoaddressdeeplyembeddedinefficienciesinlife.Andtheeconomicpotentialishuge!AsGrouponlookstothefuture,itmustfinditspurposeinthegreaterhistoricalcontext.Willthecompanyselloutorwillitembraceagreatermission?Theyseemtobegoingforthelatter.Butdotheyhavetheinnovationchopstosucceed?TheopportunitiesaretheretocreatenextgenerationplatformstoleveragetechnologyandtheInternettomakelifebetterforall.