Group(on) Value, Where Art Thou? Is Group Buying A Proven Model Yet?

[Editorial Notes: This is a guest article by Preetham, founder of Quantama, a LBS service. Preetham shares an insight into the group buying model and why it seems to be quite a bit of hot gas, especially after you read Groupon’s IPO fling report.]

There are exciting theories and debates on group buying, thanks to the promised land prescribed by Groupon who made Group buying the current rock-star of the fledgling US markets (post, recent down-turns that is). (Is it adding to inflation or aiding? Hmmm, tangentially different debate.) With today’s S-1 filing, the heat (usually which allows a hot air balloon to raise) seems to be turned on. Don’t get me wrong. Hot air balloons are the greatest invention which allowed mankind to fly. Just that its not a preferred mode of transport since the Heidenburg disaster.

So is Group buying a proven model yet?

Quick recap: Retailers usually break down their sales life cycle largely into Acquisition, Retention and Servicing. The budgets for ATL (Above the line), deep-discounts and loss-leader line of products typically falls in the Acquisition cycles. The loyalty and BTL (Below the line) promotions fall into the Retention bucket. Upgrades and up-sell falls into the Servicing bucket. Smart Retailers do not aggregate a single promotional budget to track their consumer micro-segments. Instead, they spend their research and sampling $$ on new customers, marketing $$ on Silver profiles, retention $$ on Gold profiles and the Service $$ on Platinum profiles. Not all these budgets are equal. Most important of all, The ROI of each of these spends are significantly different for each micro-segment. Also, retailers trade-up during boom cycles and trade-down during bust-cycles (So the budget varies).

Where does group-buying fall into? Clearly the Acquisition bucket (which is NOT a capex spend but a marketing cost). The Acquisition is the big funnel that marketers fill in order to convert the footfalls towards the Retention bucket. One must make sure that they fill quality leads which aids in healthy conversion helping them move the leads to the Retention bucket. What are quality leads? Are consistent deal-seekers quality leads? Are Bargain hunters quality leads? Is the cumulative conversion index per consumption-segment positive? These are some of the questions which a optimized, organized retailer such as GAP, Walmart etc. asks. Are these measures different for a SMB retailer? I would argue that they are even more applicable for a SMB.

When does one deep-discount? typically, when you have end-of-line sale, surplus capacity whose account has gone into sunken cost, poor-utilization rates (Ex: Hotel Rooms), Expiring shelf-life, to clear product line whose GMROII is not positive, Projected increase in policy costs (Taxation changes on holding inventory), or adding large sampling to acquire new customer base for virgin markets or virgin products. (I may have missed few others for sake of brevity). Most of the above is a provisional measure for retailers who are operating in a larger scale of economy. What are the premise for SMBs then? In my umpteen conversions with the SMBs, deep-discounting occurs primarily to add leads to their funnel in the hope that the consumer shall experience the “Unique product offering, Service and Ambiance” which is a differentiation for the SMB to exist. Now this sounds like a virgin offering. So it clearly is for “Sampling” then for the SMBs.

Now, the Cost of Consumer Acquisition (CCA) should be paying off on the long run through two different measures that adds up.
1) NPV or the Net Present Value of the Consumer.
2) LTV or the Life Time Value of the Consumer.

The NPV for virgin footfalls does not exist. Which leaves the LTV. This materializes after the conversion. Remember that the CCA of ‘N’ who are added to the funnel is used in determining the ‘M’ conversions and their LTV. Meaning the CCA cost of adding 100 virgin footfalls must be offset by the LTV of the 5 who gets converted (5% as a example).
The CCA and LTV are very segment specific (Beauty & Massage parlours, Small Eateries & Restaurants, Boutique Hotels, Convenience Stores etc..). The conversions are also segment specific. Not only are they segment specific, the country of operation, the consumer behavioral context, culture and current economy makes a huge difference in any of these measures.

As an example: A country like USA where people leave a tip in the Restaurant on the original price of the meal-offer (Not on the group-discounted price) makes a significantly large difference in the operating cost for the Vendor as against in India where people usually do not like to leave tips or have a standard 5 Rupee coin for whatever the ware maybe.

Also the LTV is a layered value derived based on effective frequency of visit. Meaning, How many of them visited 1 time, 2 times etc… and the relative spend thereafter. Also, there is a break even frequency at the same cost before a positive value can be derived (Here is a simplified calculator)

Not all SMBs are also geared to service a peak footfall that occurs during this group-buying frenzy, which results in diluted service/offering. This hampers the conversions badly. Most of the SMBs are not seeing a conversion above 3% (median) of the footfall. I have been following rants about SMBs saying that they shall never go back for Group-buying again . I have also heard rave reviews about some Up-sale (NOT conversion) during such frenzy, especially in the Beauty Segment (people walk in for 500 RS worth of ware but spend 10K), These guys love the group-buying models… besides, there has been theories that deal-seeking bargain-hunters are never loyal (There are stats to prove this)… All of this has to play out towards a equilibrium in the long run.

The point is: Group-buying in its current avatar (Independent of what ever the top-line suggests for Groupon) is not YET a proven model for SMBs. It cannot address the economy of scale challenges of the big retailers either. So where does it fit as a positive operational model? I am not saying that this will fail. Its just that there is a lot more nuance and context specific treatment that is required to make this a classic. I am sure the markets will figure it out eventually.

For now, how many of you are standing in the line for the Groupon IPO? Make sure you do not sell your house as of yet to invest 🙂

What’s your opinion?

[Reproduced from Preetham’s blog]