Tuesday, April 5, 2011

The Economics of Group-Buying Websites

There still are a lot of people that don't get the flash sale model and exactly how much merchants give up for the sake of incremental business and new leads.

Buying a $100 voucher at a high-end steakhouse for $50 seems simple enough. However, many buyers think the chophouse is collecting $0.50 on the dollar for the sake of a new sale. It's not. Groupon and LivingSocial charge as much as 50% of the deal's price to the advertiser. In other words, the chophouse is getting just $25 for $100 worth of menu priced food and drinks.

No one's shedding a tear for the local business. Not even an aggressive site sales rep will twist a merchant's arm. It's also quite possible that the eatery can turn a profit on the deal. The diners can order a lot of drinks (which carry a higher margin than food). They can come in a large group, spending far more than the $100 value of the offer. In a perfect world, they'll be so smitten that they'll continue to patronize the eatery at retail price (even if -- in reality -- they'll just hop over to the next Groupon/LivingSocial deal).

The economics behind the practice of offering a dollar's worth of value for a quarter isn't easy. It's why you find more spa and sightseeing service-related offers than boutiques with hard goods to offer. However, merchants get paid -- typically over three months -- even if many of the vouchers expire worthless several months later.

Obviously the group-buying sites wouldn't be this popular if we weren't talking about a win-win-win scenario. Buyers get a great deal. Sellers get more business. The facilitating flash-sale site gets a meaty piece of the action. However, it's important to understand the economics of the model -- just so you're ready when the restaurant owner grimaces after you've run up your tab to exactly $100.23 in costly steaks.

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