Group-Buying Companies Won't Admit They Do Group Buying. What Happened to the Business?

The "O2O" that Nuomi, Dianping and Meituan now talk about constantly looks a lot like another group-buying war.

"The business model is changing, the market environment is changing, and the group-buying model will not exist in the future." Baidu founder Robin Li said this at an industry conference in early December this year, while talking about "innovative models."

Only five months earlier, Li had stood on stage, declared that Baidu had too much money, and promised 20 billion yuan to Nuomi, the group-buying brand Baidu bought from Renren years ago and had done little with since.

Nuomi, now second in group-buying market share, is not the only one talking group buying down.

"We have always believed this model has a fatal flaw. From the day it was born, it has been a miracle that it survived this long." Before Meituan and Dianping merged, Dianping founder Zhang Tao voiced similar doubts: "In another year or two, the concept of group buying may disappear or fade in every industry."

Given how group buying flourished in China in its early years, these remarks smell a little of hindsight. At the model's peak in 2011, China at one point had more than 5,000 group-buying sites. Most were founded with much the same idea as Groupon, the world's largest group-buying company: spend heavily to earn heavily, raise money on the strength of market size, pour that money into the next round of expansion, and keep going until an IPO.

Now, though, even the biggest companies in the market are eager to shed the "group buying" label. So how did this business model end up where it is today?

Where did group buying come from?

The online group-buying model we know today was first brought online by Woot.com, an e-commerce site founded in 2004. Every day the site gave each user one chance to buy something at a discount, and everything it sold was a physical product: electronics, wine, toys, clothes and so on.

Woot.com's group-buying model

A more primitive form of group buying is simply to gather, by whatever means you can, a group of people who want the same thing, and then bargain with a merchant for a discount. Just as wholesale channels get goods more cheaply, this "small margins, high volume" model can last as long as the manufacturer's supply keeps up. The merchant is willing to cut prices because large-scale demand lowers the cost of selling each item (less needs to be spent on advertising, for example).

In the past, the hardest part was finding enough consumers who wanted to buy the same item. That is one reason traditional retail has valued department stores and convenience-store chains that are big enough to reach consumers. They can keep goods in their own warehouses and sell them slowly, or spread the pressure to sell across every outlet.

The internet made this business far easier. Before dedicated trading platforms appeared, online forums for niche interests often carried group-buying threads. A trusted user would broker the deal, negotiate the price or act as guarantor, and ordinary users who wanted the item would reply to join, quickly forming a small group order.

The company that truly turned group buying into a business was Groupon, founded in 2008. At first glance its approach was no different from Woot.com's: one discount a day, one purchase per person, and the deal goes through only once enough buyers sign up.

But what it offered was group buying of local services, whose supply can be many times larger than that of physical goods: restaurant set meals, discounted KTV rooms, cheaper movie tickets and the like.

This was a shrewd change. Group-buying sites no longer had to handle goods or organize logistics; they became advertisers. They only had to use the internet's huge user base to promote the merchants on the site, and they could earn commissions worth 30%-50% of sales. The risks of production, supply and service went back to the merchants.

Without the high barriers of physical-goods group buying, service-based group buying clearly spread much faster. In its early days Groupon drew 2 million users through email and text messages; a year and a half later the number had reached 85 million, and the company was valued at US$1.35 billion. It crossed the US$1 billion mark faster than Facebook had.

Group buying soon became a gateway to offline stores

Groupon's success also spawned a string of competing sites in the US, such as LivingSocial, Townhog and Homerun, which did much the same thing.

LivingSocial's group-buying product page

In Groupon's early days, the merchants that joined the platform were small businesses and service providers who could not afford big print advertising bills and did not want to spend money on online ad platforms. Group buying could bring them a large batch of new customers in one go. And as long as merchants offered rock-bottom prices and high commissions, Groupon did not impose strict rules on what kind of business they were or what credentials they held, because very few could have met such rules anyway.

But the flood of consumers pushed Groupon to drop the "one deal a day" approach and its focus on a handful of cities, and to expand widely. In 2009 Groupon entered 28 American cities; by the spring of 2010 it was already in 45 countries. In these new markets the company's main job was signing up merchants, and it hired large offline sales teams to do it.

Once the Groupon model reached China, thousands of faithful imitators soon appeared, including Lashou, Meituan and Wowo Tuan. Nearly all of them started with restaurants: sales teams on the ground found merchants and negotiated a cheap set meal; at the same time the sites advertised heavily across every channel to get users to order online, and then split the revenue with the merchant as agreed.

Just as striking was how much each company spent on advertising to win users:

• Tuanbao, whose market share was not especially large, was the first to announce that it would spend 550 million yuan on advertising in 2011;
• Lashou put most of a new US$50 million funding round into advertising;
• Nuomi said it would spend 200 million yuan on advertising;
• Meituan launched an advertising tender worth 130 million yuan;
• Manzuo announced that 100 million yuan would go into advertising;
• Dianping said 200 to 300 million yuan of its US$100 million funding would be spent on advertising.

As with O2O today, the most important part of the process was offline. The merchants were offline and had to be signed up by ground sales teams, who would even offer "zero-commission" deals to win volume; the consumers were offline too, and the exposure that advertising bought was key to grabbing market share.

Almost every Chinese group-buying site is dead, and even the pioneer Groupon is struggling

But the group-buying boom in China did not last long. Within a year, a shake-out swept the whole industry.

According to the China Group-Buying Industry Annual Report, published in early 2012 by the China E-Commerce Research Center, 1,968 group-buying sites in China shut down in the six months from July to December 2011, a third of all the companies in the industry.

Meanwhile Groupon, which had successfully listed on Nasdaq, was being grilled by investors over a poor set of results.

Investors had liked Groupon early on not only because it grew quickly but also because it turned a profit very fast. On every transaction it took 30%-50% of the sale price as commission, and it went from launch to profitability in just 7 months.

In 2011 Groupon filed to list in the US. According to its prospectus, its revenue grew 22-fold year on year in 2010, with a gross margin as high as 40%.

The problem was that the company poured the money it earned back into expansion, especially into building offline teams. From 2008 to 2010, Groupon's operating expenses were US$1.64 million, US$12.01 million and US$700 million, producing huge paper losses. Its headcount jumped from 37 in 2009 to more than 7,000 in 2011, many of them from the local group-buying sites it bought as it expanded overseas.

In China, Gaopeng, the local group-buying site Groupon set up as a joint venture with Tencent

The Chinese imitators fared even worse. To this day, not one company has managed to burn cash all the way to an IPO.

At the end of 2011, Lashou, which had at one point led China's group-buying market, filed to list in the US with results much like Groupon's, high revenue and heavy losses, but withdrew the application in mid-2012.

In the two years before that, Lashou had raised US$166 million across 3 funding rounds, and it put its pre-IPO valuation at US$1.1 billion. The failed IPO burst the bubble: its valuation quickly shrank to around US$600 million, and its market share fell sharply.

The blow hit most of the remaining players as well. According to Analysys International, by the fourth quarter of 2013 five sites, Meituan, Dianping, Nuomi, Wowo and Lashou, held 95% of the market, with Lashou's share under 5%.

Before their merger, Meituan and Dianping approached group buying in very different ways.

Meituan began as a group-buying platform and grew large in both merchant numbers and coverage. But beyond the flow of payments, it struggled to build up long-term data on what its users bought. Later Meituan developed three businesses of its own, food delivery, movies, and hotels and travel, which gave it a better understanding of its users.

Dianping, by contrast, started from information about consumers and merchants and worked backward into group buying. In its online-community days, Dianping built up a huge body of reviews, making it something like a search engine for one sector, but it had little experience with payments. Only in 2014, when it bundled group buying with mobile payment into "Shanhui," a service for paying in store, did things start to improve: by the end of September 2015, Shanhui covered more than 600,000 stores on Dianping, with monthly transactions above 1 billion yuan.

In categories, merchant numbers, payment and even pricing, the Chinese group-buying companies that survived had long since broken the rules Groupon laid down in its early years: one deal a day, ultra-low prices, growth driven by marketing, and frantic fundraising all the way to an IPO. Groupon itself began looking for a new direction right after its IPO, moving into selling its own goods, travel and restaurant reservations, concert tickets and offline payment...

None of them look like pure group-buying companies any more.

The "O2O" that group-buying companies talk about today probably won't escape these problems either

The business that Baidu Nuomi, Dianping, Meituan and the rest now most like to talk about is "O2O" (online to offline). This abbreviation, which took off in China, can mean many things: online booking, mobile payment, online marketing, offline delivery, home services...

Baidu's own "O2O" covers a whole raft of businesses, including group buying, food delivery, Merchant Direct accounts, Baidu Maps, Baidu Wallet and iQiyi. The ones you are most likely to have noticed are the fast-growing food delivery and movie-ticket businesses: after linking up with the company's other markets, Baidu Waimai has been spun off and raised US$250 million; in discount movie tickets, Meituan's Maoyan Movies and Baidu Nuomi are fighting for the top spot in sales.

Dianping's "O2O" is a set of new features inside its app: "food delivery," "queuing," "ordering" and "Shanhui." Together they form a one-stop package for restaurants that makes them run more efficiently and, by combining different kinds of promotion, helps them market to customers.

Meituan's "O2O" means the independent business groups it has set up in three sectors: food delivery, hotels and movies. They run in much the same way as its core group-buying business: they turn the huge traffic on Meituan's platform into large volumes of orders for merchants and take a commission.

What has changed since the group-buying era is that most of the work in a transaction now happens online, not only the transaction itself but many of the steps before and after it. The model these companies now want to copy is no longer Groupon the marketing platform but Uber, which turns technology and service into control.

Uber's global expansion, and the success of Didi, its biggest imitator in China, both come from controlling the business of getting a ride. For drivers, it is already hard to earn a living without going through Didi or Uber; for passengers, the apps' flexible dispatch, online payment and extra services make riding convenient and comfortable.

Technology makes all this possible: route planning, dynamic pricing, the spread of mobile payment. But while drivers and passengers gain convenience, the ride-hailing platforms gain information of more lasting value: travel routes, payment habits, driver ratings, and behind them a real person and the social resources they touch in daily life.

Group buying never had that kind of control. For merchants it was one marketing platform among many; for consumers it was the relatively cheap but heavily restricted way to spend.

After being "upgraded" to "O2O," some of group buying's problems seem to have been solved by products that move more of the process online. One example Dianping founder Zhang Tao likes to cite: in the past, using a group-buying voucher at a restaurant meant writing down an order number while the waiter checked back and forth with the customer; with Shanhui, the discount is applied directly and the money moves as a transfer between businesses.

But just as Alibaba, after more than ten years, has still not come to dominate Chinese consumer spending, traditional offline spending will not soon be fully replaced by these steps moved online. And the boom you see in the industry now has much the same causes as the group-buying boom back then: heavy subsidies and lower commissions.

Without a steady flow of investors' money, this does not look like a model that can keep growing. According to IT Juzi, a startup database, only about a quarter of "O2O" projects raised a Series B round in the first half of 2015; among the O2O startups that have already died, more than 50 had raised over US$10 million, spread across 16 sectors including healthcare, beauty, real estate, cars, education and restaurants.

Two or three years from now, some other executive will probably stand on a stage and talk about how overoptimistic everyone was about offline business over the past few years.