Retailers make money by buying large quantities of an item and by selling each unit individually at a higher price. The general principle behind this is that of economies of scale: the more we build of something, the cheaper will be every single unit’s production cost. The difference between the price at which each item is sold and the price at which each item is bought will constitutes the retailer’s profit margin.
However, buying large stocks of a product comes at a price. First, large sums of money are needed to purchase the items. Also, a warehouse where products will be stocked is required for which rent will be paid. Of course, if the warehouse is owned by the retailer, the cost of storing the items is equal to what could be collected by renting the warehouse. The retailer must therefore be very good at correctly forecasting demand for the item. Since forecasting is not an exact science, the retailer will always buy less or more of a good than what the real demand will be. In the case where actual demand is more than what was forecast, the retailer will pay a higher price than it could have if his forecast was equal to the actual demand. In the case where actual demand is less than what was forecast, the retailer will be left with overstock which, if not sold, will contribute to the decrease of profit margin.
This is where group buying comes in. Group buying uses the Internet as a tool for synchronizing consumers who are willing to buy the same product. This can be viewed as an attempt to have a better forecast of demand. The point with group buying is that it acts as a retailer for the account of a group of consumers who are interested in purchasing the same product. In that way, demand is generated for people who would otherwise not be willing to buy that product at a regular retailer price. In other words, where retailers fail in forecasting demand and ultimately fail to offer the optimum price to the consumers, group buying helps in reaching those customers. Ultimately, retailers become irrelevant since demand for all products can be synchronized in one place where all consumers will shop in group.
The problem with group buying
Well, all this is very nice, but the realities of our physical world will soon or later make its presence felt. The first issue with group buying is that of delay. If producers have to wait until the group buying service comes with the right number of actual demand, then consumers will have to wait until production is finished and until shipments arrive. Here, retailers that will be able to predict demand with more or less accuracy will have an edge over group buying services since they have products ready on the counter. Since for most products, consumers are not willing to wait indefinite amount of time before they can enjoy their purchases, group buying services will only be able to generate slightly more demand than that is already forecast by retailers. Consequently, resource savings resulting from such demand will be negligible and eventually unattractive to the final consumer. Moreover, retailers can use the public information provided by group buying services (i.e. information about prices and quantities on demand side) to readjust their own prices and therefore disrupt the expected return from the group buying service
Another issue with group buying is one that is more real and connected with current services. If you take a look at the deals on group buying websites, you will notice that most of them are services such as spas or restaurants. Yet, services are known to be difficult to put a price tag on since the producer and the retailer are the same person. What is the difference between one therapist and another? You can only know if you try both. And again, someone else who tries those same two therapists will have a different opinion than yours. Also, services are not always subject to economies of scale. A therapist will not be cheaper if asked to perform her work on twenty customers rather than one. In fact, in the case of twenty consecutive customers, the last ones will most probably have a less relaxing experience than the first ones. Then, how can we say that demand coming from a group of customers for the same service will lead to a better price for everyone?
Finally, there is an argument for group buying that claims that the service can be used by new businesses to advertise their product or services and gain exposure on the market. Well, this argument would be true only if there was an infinite number of business that were opening every year in every city. But this is rarely the case. How many new restaurants and spas open every year in a city? Not enough to cover a deal for every day of the year. In other words, the deals that will be displayed on group buying service will not always be real deals motivated by the need to gain exposure. Rather, they could be regular prices advertised as money saving deals with the hope of luring consumers.
Group buying in reality
If group buying has so much drawbacks, then how-come they’re making money? One way to answer this question is in the peer pressure and scarcity illusion that it creates. When a site is believed to offer good prices because it aggregates demand from other consumers like us, there is a feeling that what will be bought there will have a better price tag. Moreover, when we go on a website and see that there are 50 people getting a deal and that there are only 20 places left, we get a feeling that we need to act quickly before the deal is over.
The other reason for group buying services to exist is that they can act as advertisers. As I claimed above, the price of services cannot be compared from one retailer to another. Again, group buying will give the illusion of saving through group demand. In reality, the site is a place where people will freely go without thinking that it is only advertising, but by thinking that there could be a good deal.