Groupon – Will Weak Network Effects Be Its Downfall?

Groupon is a multi-sided platform without the means of leveraging its network effects for market dominance, which in the end could kill their business.

In 2011, Groupon was believed to be “the next e-bay superstar“ and shortly after, its IPO had a market capitalization close to $16 billion¹. In early 2015 it fell to $ 4.49 billion² – the short term success flamed out quickly.

The hype four years ago was a strong belief in the network effects Groupon could capture through which it would become a monopoly in an attractive market. This was a misconception that is reflected in the new, much lower evaluation today. But why are the network effects not keeping up to its promises?

Business model

Groupon is a multi-sided platform connecting merchants with consumers. Merchants such as restaurants can offer special deals (e.g. 50% prize reduction) on Groupon´s website which consumers can then purchase. The value creation for the consumer is that they save money and might try out deals which they would not have consumed otherwise, whereas the merchants get advertisement. This might generate regular customers (being loyal without the deals) and make a little money off the customer as well. The money the merchants make is arguably very low as Groupon captures between 60-100% of the merchant´s deal.

Indirect network effects without barriers to entry

Groupon has important indirect network effects: The more users that sign up to receive daily offers, the more attractive it becomes for merchants to offer their deals through it and vice versa. Groupon’s biggest problem is that the cost of multi-homing (offering the deals on several platforms or purchasing deals at competitors´ platforms such as LivingSocial) are – for both sides – almost non-existent. This leads to extremely low barriers to entry into the market and competitors can easily contest for customer and business loyalty (in 2011, there were 33 different daily deal companies to choose from in the Boston area alone³).

Absence of direct network effects

For instance, unlike Facebook, Groupon has arguably no direct network effects: The group character of most daily deals might help you acquire new customers. Nevertheless, the increase of other people buying the daily deals does not lead to a direct increase of value to the customer. You could even argue that is has a negative effect as the deals become more competitive and it is harder to schedule your deal after purchasing from your merchant. It is similar for supply-side of the market, which makes it difficult for Groupon to scale their business as they often have to cold-call their merchants individually.

Overall,

Groupon has no strong network effects whatsoever. Yet, it had increasing revenues over the past several years (being profitable) and was much more successful than its second competitor, LivingSocial. This case shows that while it might be easy to implement similar business strategies, it is very hard to scale successfully as Groupon has done. So it is just a matter of time until Facebook or Google begin competing for market share and Groupon will have difficulty holding up against their resources and capabilities.

 

¹http://dealbook.nytimes.com/2011/11/04/groupon-shares-spike-40-to-open-at-28/

²http://fortune.com/2015/01/26/lets-stop-laughing-at-groupon/

³S. Raice and S. Woo, “Groupon’s Boston Problem: Copycats,” Wall Street Journal, July 8, 2011.

 

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Student comments on Groupon – Will Weak Network Effects Be Its Downfall?

  1. Great post! Groupon has struggled to create a virtuous cycle of network effects because of the negative effects from new users increasing competition for the deals and a lack of scalability on the deals supply side because vendors are difficult to access and individual vendors have a capacity limit for the number of deals they can offer. Moreover, many vendors are not savvy enough to evaluate the benefits that accrue to them from a specific deal. In response to this, Groupon acquired Breadcrumb, which is a POS system for restaurants (one of Groupon’s main vendor segments). This system has seamless integration with Groupon and allows vendors to accept and evaluate coupons and campaigns effectively. Additionally, this provides a new sales channel for Groupon, allowing them to sell to POS only customers and prevents easy integration of the POS with other deal sites.

  2. We recently covered Groupon in Digital Marketing Strategy so cool to see it pop up in your post. I agree that the influx of copycats made life tougher for Groupon but what about the fundamental business model? In many cases, you have small / medium businesses giving away $100 coupons and only seeing $25 (after Groupon took its $25). This led to price sensitive customers looting them in droves and then never returning (once prices went back up). I wonder if Groupon could have done anything to enhance the direct network effects and help out those merchants.

  3. Thank you for your answers. Jon, interestingly in the beginning Groupon made use of direct network effects on the consumer side: Before a special deal was “active”, 500 customers had to purchase it. This lead people to share this deal with others to get the deal over its “tipping point” – in some way more users increased the customer´s value. I am wondering if they should have sticked to this “deal tipping mechanism”. Nevertheless, I agree that Groupon‘s business model has additional flaws as you’ve mentioned which add to my doubts about its sustainability.

  4. Hi HF – interesting post (and response to Jon’s comments)! Like Jon, I too am interested in whether Groupon could have adjusted their business model to enable network effects to work positively in their favor. I still like the idea of Groupon, in theory, but like you and many others am not sold on their execution or sustainability.

    One other question that comes to mind is: who are the users of Groupon? That is to say, what type of store, restaurant etc. is willing to give away 50, 60, even 70% of their margin to attract new users. More often than not, it is organizations that were already struggling and were “trying to turn things around” by gaining volume. In my opinion, that’s not a great starting point for one side of your platform. Consumers win by saving, but may not have always received the product or service they were expecting.

    Great post! You raise a lot of interesting issues. Can’t wait to read your next one.

  5. HF, I’m not sure if it would have helped them. A lot of times Groupon gets used for things like laser hair removal, or dental cleanings, etc. That’s not necessarily the sort of thing I’m excitedly sharing with all of my friends and coworkers. I think if they stuck with people needing to be more public about what they were buying, they’d have to change the types of deals they were offering. And even then, even if people were only buying massages and vacations, I’m not sure they’d want to tell everyone what they were doing with their money.

    The way they’re going now may not be working great, but I think their old model would have been way worse.

  6. #1 National Cranberry Fan, to my understanding, you don’t need to publicize your purchases, you just need to have enough people (complete strangers) to also purchase the deal in order for it to become valid. These people don’t come from your personal network, and you won’t know who they are, but they are consumers that are attracted to the deal because of the low prices.

    I agree to Drew O.’s point that Groupon has a poor way of insuring the quality, which is an experience that I had personally. The restaurants and salons that were offering discounts usually don’t live up to the product description on the site. This is especially important given that network effects depends on quality content, which is why I think eventually as they scale, they would gradually run into reverse network effects as seen today.

  7. Great discussion! Two thoughts:

    1) Groupon also captured some value through network effects by offering additional discounts if a user purchased the same item through your referral link, which incentivizes users to share their purchases with friends or purchase in bulk together. Additionally, Groupon created some network effect value when a user “grouped” 3 or 4 friends together and bought the same item, as they then were given the value of one of the purchases for free. Arguably, the merchants may not be capturing as much of this value, but I think Groupon does have some network effects through their deal structure.

    2) Agree with Drew that it doesn’s bode well for your business if you’re offering a Groupon – consumers now take that to mean your business is struggling and may not be around for very long, so they may not consider coming back for repeat business. This reduces any possible value from network effects the merchant can capture. Also, merchant exploitation seems to be pretty widespread, so Groupon isn’t making a terribly popular name for itself. They’ll have to figure that out to continue to operate successfully in the future.

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