The Groupon effect - using social networks to address collective action problems

In recent months, the electronic coupon company, Groupon, has revolutionized the way the internet can be harnessed to minimize search and co-ordination costs (the collective action problem) in retailing. Its electronic discount coupons get activated (discount sales happen) only if a certain number of fellow citizens agree to buy the same thing on the same day. The retailer makes up his loss due to lower price with larger number of customers, who not only bring in larger immediate sales but more importantly brings in future patronage.

Groupon subscribers receive notifications of one deal a day, tailored to their location and profile. The local business gets customers, and Groupon takes a share of the coupon proceeds. The average Groupon deal offers 50 to 90 percent off retail goods and services, from restaurant certificates to skydiving lessons. Once the tipping point in registrations is reached, all buyers are locked in, and their investment becomes irrevocable. If the point is not reached, the deal is automatically aborted.

Groupon's spectacular success (it has been described the fastest growing internet company ever and has already crossed 50 million subscribers) since its founding in 2008 by Andrew Mason has naturally generated considerable commercial interest. Attempts by all the major web-service providers, including Yahoo and Google, to take-over Groupon have been rebuffed. The company recently raised a record $950 million from big investors and is considering a $15 bn IPO soon.

For its part, Groupon harnesses the power of psychology to attract customers and retailers. It seeks to leverage the inherent attractiveness of a shopping plan where customers are forced to wait for sometime to find out whether they can win the deal. The one-deal a day strategy also means that the attention bandwidth of customers can be more easily captured.

This psychological attraction of getting deep discounts also means that Groupon like websites are likely to become extremely popular in price-snesitive markets like India. In order to overcome the challenge posed by the limited reach of computers and internet, it may be more effective to use the now ubiquituous mobile phones to deliver such shopping deals in these countries. Further, mobile phones offers the possibility of much greater interactivity, potential for behavioural nudges, and the achievement of more overall efficient outcomes.

A recent article in NYT, in the context of the recent wave of street protests that have swept Middle East and North Africa, speculates on the possibility of solving the collective action problem with street protests. It writes, "Even if we all watch television coverage of demonstrations together and express our enthusiasm for the movement online, we have no guarantee our neighbors will take the physical risk of going out in the streets until they actually do so".

Technology will make it much easier for frustrated societies to express their collective anger. However, I am inclined to believe that translating this collective angst into tangible action on the field will remain beyond the reach of technology (apart from increasing the likelihood of participation) and as much a challenge as ever.

Update 1 (20/4/2011)

Excellent infographic on the rise of Groupon.

Update 2 (5/5/2011)

Felix Salmon identifies the USP of Groupon - the idea that coupons only become activated once a certain minimum number of people have signed up for them. He writes,

"This is essentially a guarantee for the merchant that the needle will be moved, that their effort won’t be wasted. With traditional advertising or even with old-fashioned coupons, a merchant never has any guarantee that they will be noticed or make any difference. But with a Groupon, you know that hundreds of people will be so enticed by your offer that they’re willing to pay real money to access it. That kind of guaranteed engagement is hugely valuable, and more or less unprecedented in the world of marketing and advertising."

Update 3 (5/11/2011)

Groupon debuted in the equity markets 31% higher than its offer price in its first trading day, bringing the online coupon-seller’s valuation to more than $16bn and reflecting a surge of excitement for one of the fastest-growing and most controversial companies to list in recent years. Shares in the company were set at $20 late on Thursday, then jumped as high as $31.14 in the first few minutes of trading before closing at $26.11. Groupon raised $700m in its highly anticipated initial public offering, in a deal which valued the company at $12.6bn, higher than the anticipated cap of $11bn but below the $20bn the company had sought earlier this year.

The company’s co-founders, who own about a third of the company’s shares, became billionaires. Andrew Mason, chief executive, has a stake worth about $1.2bn. Groupon’s buyers included many funds that intended to “flip” the shares to take advantage of their first-day jump. By the close, 49m shares had changed hands, nearly the entire float, making it the second most traded US stock on the day.