Ok, not exactly the French Revolution, but they did turn down $6 billion from Google. I can’t help but wonder why. Perhaps my wonder is explained by the Shavian observation about those who can and those who can’t.

Groupon was not the first group buying site. Mobshop, funded, by amongst others, Paul Allen, folded in 2001 (or reincarnated as something else). What is it about Groupon that will ensure its path to glory will lead to other than the grave? I’m tempted to shout Santayana! Stantayana! I won’t, though.

Lets start with Groupon’s offers to users. Pay $x to get a coupon worth $2x from a merchant. If a certain number, say Q, of users sign on, then the coupon is issued, otherwise not. If the target Q is reached, the coupon is issued, the user pays $x, Groupon keeps $0.5x and sends, in installments, $0.5x to the merchant. Notice, by holding back the payment to the merchant, Groupon is able to ensure, to some extent, that the merchant comes through on their promise to discount by $2x.

Now switch to merchants. Why go through Groupon to offer a coupon? There are other outlets, including the traditional ones of coupons in the newspaper, flyers and those sent via the mail. More importantly, why discount in the first place? Let us count the whys (not mutually exclusive but, I hope, exhaustive):

  1. Price discrimination.
  2. To encourage trial, so as to convert to regular business. In effect, advertising.
  3. To attract business during slack periods.
  4. Move inventory that is old or obsolete.
  5.  Incremental volume; coupon may induce an existing buyer to increase the volume they purchase or buy other items they don’t normally buy.
  6. Experiment to determine the demand curve.

Reason (6) may have some merit, but the pool of customers who use the coupon are not an unbiased sample of potential customers. The coupon will attract a disproportionate number of the price conscious (adverse selection!). So, I will focus on reasons (1-5). A common feature of reasons (1-5) is the desire to cut price selectively rather than across the board. Hence, a coupon is effective as a means of selective price cutting as long as those prepared to full price (full payers) are less likely to track and use the coupons. Thus, the important question: what is it about Groupon that allows it to distinguish more effectively between full payers and non-full payers?

Traditional methods (newspapers and bulk mail) impose a slight cost on users with finding the coupon that (potentially) discourages those who would pay full price from coupon hunting. In contrast, Groupon makes it easier to find the coupon by alerting you to the presence of the coupon. On the flip side, to many alerts and sorting through them raises the cost of finding the coupon.

Perhaps Groupon generates higher redemption rates, so that coupons can be sent to fewer people? A merchant can adjust for that by paying different amounts to carry coupons via different channels. For example, suppose channel A generates one redemption for every 10 coupons sent out, while channel B generates one redemption for every 100 coupons sent out. Assuming no adverse selection issues between the two channels, simply pay B a tenth of what one pays A.

No coupon scheme can perfectly screen between the full payer and non-full payer. In some cases the merchant can control for it by limiting when (requiring a reservation) and by whom (new customers) the coupon can be used. So, there will be some mixing. To much mixing, and the coupon becomes an across the board price cut. Groupon’s quantity threshold allows the merchant to limit the downside of mixing. For example, one could assume, in the worst case that only customers who would buy at full price use the coupon. Then compute, for the offered discount, the incremental volume needed to break-even. This break-even volume would be the quantity threshold needed for the offer to go into effect (an aside: it follows that merchants who complain that participating in a Groupon offering lost profits, implies they haven’t done their arithmetic).Traditional coupon delivery methods do not have this capability. However, Groupon clones, can easily replicate this.

So, from my armchair, I cannot tell whether Groupon can distinguish full payers from non-full payers any better than traditional coupon outlets. The merchant is probably in a better position to do this and should be doing so. Thus, why prefer Groupon to any one of its clones. Perhaps its the large installed base of eyeballs? Ok, but what is their cost of switching from Groupon to a clone or going to an aggregator of coupon sites?