Since its launch in 2008, Groupon has been tremendously successful with introducing its group-buying concept to a wide and relatively loyal audience. They claim billions of dollars saved for their users, some 80 million subscribers. The concept is simple: Using Groupon presents you with attractive offers that will be made available to you once a certain condition has been met. The deal is not available until enough users have pledged to purchase, and Groupon doesn’t charge the vendor unless that condition is met. Everybody wins and the site grows virally as aspiring consumers invite their friends. At least, that’s the idea. As Groupon gears up for its IPO (initial public offering) speculations are running wild on what the company might actually be worth. Optimists note that the market for Groupon is almost unlimited. Any consumer could benefit from getting a discount, and every food lover could appreciate a nudging tip to try out a new restaurant. But can this growth really be sustained? A less promising picture emerges when you look at the game mechanics behind Groupon and you see the incentives that provided the core engine that drove Groupon’s success. The games behind Groupon break down at scale.
Groupon is an interaction-dependent product, in that it depends on user interaction to be able to provide value. Users are encouraged to interact with the product through a set of games that reward the users when they perform value-generating actions. It should be noted here that a “game”, in this theoretical sense of the word, is any system that provides reward for a voluntary action. If the user feels compelled to do something to get a reward, then the user is playing a game. An example of a game could be the Rewards card you use at your local grocery store, your Frequent Flier miles or your summer potluck party.
An ecosystem of rewards
Some of the games in Groupon are of particular interest, because they are internally dependent on each other. The strength of one game lends value to another, and so forth. This set of games provides the engine with what is sometimes called a viral loop: a self-reinforcing social growth mechanism. Products like Facebook can attribute a lot of their success to viral loops, as well, but the Groupon games’ interdependent status makes them vulnerable. If one game weakens, or even breaks, the whole viral loop can become undone and the product must find a new growth engine.
To understand the viral loop of Groupon we must look at three distinct games, played by three separate agents. The first agent is engaged in a classic gambling scenario, where the agent wagers a resource in hope of getting a greater return if a certain condition is met. If the condition is not met, the resource is lost. The agent engaged in the gambling scenario is Groupon itself. The site only offers one deal per day, and if that deal does not meet the victory condition Groupon will irreversibly have lost that resource. This makes it important for Groupon to ensure that they have a high volume of potential bets that they can make, to improve their chances of winning. Should Groupon win the wager they are awarded a percentage of the spoils from vendors, who play a different game.
The vendor is playing a modified gambling scenario where the risk of playing, and therefore the barrier to entry, is very low. Rational vendor agents rarely risk losing anything. They are allowed at the table without paying for their wager, but will still get a reward if their wager meets the victory condition. This low barrier to entry helps Groupon ensure that they get the volume they require to optimize their own game.
If the vendor wins their game, then their reward comes out of the pockets of the players of the final game. The consumer, or user, is offered a daily discount. These dollars saved provide the reward for the users, who are engaging in what is called an assurance contract with the vendor. The user commits to buying a good at a lowered price that will only be offered if enough users make the same commitment. If the reward is appealing enough to the user, then the user will have an incentive to recommend the deal to others and invite them to Groupon. The short life-span of each deal will in some cases provide an even more enticing reward, and Groupon will enjoy organic growth from excited and satisfied users.
By now it will have become apparent to the attentive reader that we have a positive feedback loop between these games. Groupon rewards the user, who rewards the vendor, who in turn rewards Groupon. Although not being the entire story behind Groupon’s success or appeal, this simple and elegant system of games has been a factor in Groupon’s organic growth.
A problem of scale
As Groupon continues to grow, especially in any one particular city, this system of games risks being weakened by scale. Even though Groupon’s user base might continue to grow, the same can’t necessarily be said for the vendor platform. The average restaurant or spa can still only take in so many customers, and anecdotes of vendors getting in trouble over unexpected turnouts have forced Groupon to implement a cap on how many people can buy in to the assurance contract. This might make the game for the users less appealing, as getting there early enough to win the discount is now a victory condition. The exertion to reward ratio will start changing negatively for the users at some point of Groupon’s growth, and this could very well result in lower user retention as users lose interest in a game that is becoming increasingly more difficult to win.
Also, as the user base grows it becomes more and more likely that your average daily deal will meet its victory condition. Although this might seem like splendid news for Groupon at first glance, there is one caveat: If the average deal goes through then there might be less incentive for the users to invite others to the platform. The original viral loop providing organic growth for Groupon becomes increasingly weakened over time, forcing Groupon to rely more and more on traditional means of advertising to sustain its growth in existing markets.
The inevitable decline
This trend has already begun and Groupon is still losing money from expensive marketing campaigns and aggressive expansions. Forrester Research is warning potential investors that this kind of growth is not sustainable, as well they should. The revenue generated from organic growth is a mere fraction of the total revenue, and it can only decline. Taking this into account the Forrester analyst has suggested that the company might be worth somewhere near $2 billion, a far cry from the speculations of Groupon being worth $20 billion or more.
Brett Arends, MarketWatch, also posted an insightful article demonstrating the effects of Groupon’s failing games, highlighting the decreasing profit margins as Groupon scampers to secure its growth, and the arguably unimpressive user retention and conversion rates.
Groupon’s failure to account for the evolution of their games has left them with exorbitant operating costs and an unsustainable growth strategy. Competitors of Groupon, or any other interaction-dependent product, would do well to learn from this mistake and make sure that their games can survive their growth aspirations.
Editor’s Note: On November 4, 2011, Groupon’s first day of active trading on the Nasdaq, Groupon shares rose more than 50 percent to a high of $29.52. However, on November 22, 2011 the stock price fell below its IPO level. On September 3, 2012, Groupon's stock price closed at $4.15 almost 80% below Groupon's IPO price ($20). Since April 12, 2012, Groupon is revising its most recent financial results due to what its auditor has called a material weakness in internal controls for 2011.