Misdiagnosing Groupon's problem

The WSJ has an article about "Groupon's Boston Problem: Copycats" (here, paywalled). A better title for this article should be: "Groupon's Boston Problem: Dealseekers".

As I discussed before, Groupon's merchants benefits only if the coupons are targeted to those customers who are new to the business or existing customers who would increase their total spending. Dealseekers are the bane of (most) Groupon merchants but also the fuel for Groupon's growth. As these merchants point out, dealseekers show up and spend the minimum amount to qualify for the Groupon deals. If the coupon offers 50% off if you spend more than $50, then the dealseeker spends exactly $50.

This is a less obvious example of adverse selection in marketing. Credit card companies have long known about this problem - the smart ones don't compete on rates. Whoever offers the lowest rates will attract the worst-quality customers because other banks are not giving cards to them. Same thing with insurers: that's why Warren Buffet always says price to make a profit, not for market share.

In the case of competing offer-deal sites, i.e., the copycats, the winning site is the one that loses the merchant the most money.

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In the same way that "Restaurant Weeks" are here to stay, Groupon will serve some merchants and some customers well. But it's important not to mistaken those for the average merchant or the average customer.

Comments

[Krish]

I am not sure I follow the adverse selection in credit cards marketing statement. That the lowest rates would attract the worst customers because no other bank is willing to offer cards at that rate.

So, let us do a small thought experiment here. Say, credit card companies operate at rates between 15 and 25%. Also, there are exactly two customers in the market-place; one who is desperate for credit and the other who is trying to get the best rate for their balances. (The dealseekers, if you will.) If a competitor drops price to 10%, the one who is desperate for credit will apply but then so will the deal-seeker. If the competition increases price to 30%, the one who is desperate will still apply but the deal-seeker won't. So from a selection standpoint, the company at 30% is actually getting the worst customers as only the ones who are desperate (and therefore likely to default) apply. That is when you get adverse selection. Not when you compete on price. When you lower price, you are getting good selection but you are hurting your margins.

[Kaiser]

Krish: Here's how to think about it. There are two banks in the market, A and B. Bank A is conservative while bank B is a risk-taker. Now enter an individual who has a poor credit score. Let's say bank B is willing to give credit to this customer at a 30% interest rate. However, bank A, the conservative one, has a strict credit score cutoff, meaning it will reject applicants like him. So he will get credit from bank B. The "adverse" part of adverse selection says that bank B has (perhaps inadvertently) selected the lowest slither of customers in the market.

[Free FICO Credit Score]

Groupon doesn't have a problem as far as I can see, they have enough cash flow to keep themselves a float. Worst case scenario they probably have what 10 million emails with a high open rate? Sounds pretty good to me.