eBay, Craigslist, dating sites and GroupOn have one thing in common – these are two-sided markets that need two sides (producer-consumer, men-women, stores-deal seekers) to be present to succeed. Buyers flock to such a market like eBay if they believe there is a wider selection of sellers and vice versa. Two sided markets succeed when there is net new value creation that all three (the two sides and the market maker) get to share in it.
When two-sided markets simply redistribute value from one side to other while taking its share we have asymmetry. If you get caught on the wrong side of asymmetry, any advantage you get from participating in the two-sided market is wiped out.
In case of group buying sites it is easy to build the buyer side. These people add no net value but they reap large consumer surpluses.
With a large population of deal seeking customers enabled by social media (like facebook connect) the demand side is almost unlimited. As it has been pointed out by many during the Google-GroupOn acqusition days, the stickiness from social media connections create loyalty to these sites even though the business model can be easily copied.
“Once the first timer experiences your astonishing product and service, they become your lifetime customer”
There is a difference between stating this as one of the possibilities with a level of uncertainty vs. this is the only expected outcome. These are no different than the claims of an adorable cartoon giraffe that, “Madagascar is indeed San Diego because it has white sandy beaches“.
Small businesses must call these rosy projections into question since they are the only ones who is adding value but not getting their fair share. They need to ask,
- What job is the deal seeking customer hiring the group buying site for? For discovery, thrill of getting discount or for maximizing their consumer surplus? Which one of these gives you long term advantage?
- If you were able to lure away someone else’s lifetime customer (who is also likely to have astonishing product and service) with your 50% coupon, what makes you think they will become your lifelong customer?
- What do you get in return to track the lifetime value of these customers?
- Where is data behind the claims of these gurus? Data from Utpal Dholakia point to very minimal if any repeat business or customer margin.
- What is the impact on reference price and value perception due to 50% off? My experiments show customers are likely to assign lesser value a product they bought at a discount than to a comparable product bought at full price.
To repurpose Omar Khayyam, “The deal seeker, having scored the deal moves on to the next deal. (Likely) no amount of astonishing product or service will bring them back to pay the full price”.
If you want to add a new channel to minimize deadweight loss, by all means do it. But do the math behind it and not base it on hope
- Do you have a product with high contribution margin (price less marginal cost)?
- Do you have excess capacity (with sunk costs and no other way to monetize it)?
- Is there a segment of customers with low willingness to pay but reducing the price to include them will deliver less profit than your current profit (even though it is still profitable)?
- Is there a segment of customers with low willingness to pay that you cannot reach through any other way?
- Can you serve these low willingness to pay customers through these group buying site without the full price customers knowing about it (third degree price discrimination)?
If the answer to any of these questions is NO, you have hard math ahead of you (Spreadsheet).