Note: This blog post is a section from my full paper on the Groupon business model in which I describe a strategy for Google to compete with Groupon. The strategy rests on a novel economic framework for understanding Groupon, as explained in my previous blog post. The full paper is available at this link - “Undressing Groupon”.
The Equivalence of Advertising and Price Discrimination
Product and price are two sides of the same coin. The worth of a product to a consumer – its utility – is subjective and depends on how much a consumer desires the product. Price, on the other hand, is an objective measure – the cost of the product in the real world.
The two are intimately connected in that they both determine the value of a product – the spread between the subjective worth of a product and the real world price. Value increases not only when a product is desired more but also when the price is lowered. Consider a silver necklace at a bargain price of ten dollars. It is actually more valuable than an identical gold one at a million dollars.
In the same way, advertising and price discrimination are intimately connected. Both have an equivalent objective: increasing a consumer’s perception of value. Advertising does it by raising a consumer’s subjective perception of the utility of the product. Price discrimination does it by lowering the price.
The equivalence of advertising and price discrimination means that Google and Groupon are essentially in the same business – a surprising realization since the business models are so different. Both companies provide a service to influence consumers’ perception of product value – Google via advertising and Groupon via price discrimination. And both aim to deliver customers – one virtually, the other in the physical world.
It begs the question: can Google compete with Groupon? If so, how?
The short answer is that they can. Moreover, they can do it well because they possess all the necessary tools and resources to innovate and create a superior business model.
Two potential scenarios are presented here. The first is an evolved version of the Groupon business model. The second is a more profound integration of price discrimination into the existing Google Adsense and Adwords platforms.
A next generation business model
The Groupon price discrimination degree transformation model has two sides – the merchant facing side and subscriber facing side. The merchant facing side is the “real world” and involves the merchant sales and service functions. The subscriber facing side is “data” oriented and involves the fundamental task of identifying price-sensitivity.
On the “data” side of the equation, Groupon’s two-tier 2nd degree price discrimination function is a relatively crude way of identifying price sensitivity, relying on self-selection and several hurdles. It works in a binary way and cannot measure the magnitude of price-sensitivity.
Google, on the other hand, has access to vast amounts of data, including Gmail user data, search queries, click-through data, and all manner of other information from their vast constellation of services. On top of that, they are experts at computational algorithms. They can easily implement sophisticated analysis to identify price-sensitive users and to measure the magnitude of the price-sensitivity as a quotient assigned to each user. For example, if a user frequents websites with information on how to save money then Google would know that the user is price sensitive. But if a Gmail user receives a reservation confirmation email from a very expensive restaurant then Google would conclude that the user is price insensitive.
The Google system would be much closer to the ideal of 1st degree price discrimination and far superior to Groupon’s two-tier 2nd degree price discrimination function. It would give Google a competitive advantage in their ability to target users and to maximize profits for merchants.
All that would remain is to grow a subscriber base. Google could imitate Groupon by advertising on its own search platform. More effecively, they could get permission from Gmail users to message them - easily done with a prominent “Turn on daily local deals” button in Gmail. A massive subscriber base would instantly spring to life.
On the merchant side of the equation, Google could easily imitate the Groupon model. They possess the financial resources to build their own sales and customer service organization in the same way as Groupon. But they have a much more powerful option: to externalize the merchant facing sales and service functions to independent locally based affiliates.
The “we provide the platform only” model would be superior for two reasons:
First, a distributed collection of local affiliates would hold an information and relational advantage over a centralized army of non-local sales and service employees (i.e. Groupon’s Chicago office). Native folk know their communities better and are more effective in cultivating merchant relationships than outsiders.
Secondly, an externalized model would have a financial and scalability advantage. Internal sales and customer support employees need care and feeding and require a huge amount of working capital to support their operations (look at the funding that Groupon is soaking up). An externalized model would be more capital efficient and therefore more scalable, absent the investment requirements of growing a sales and service organization. External independent local affiliates – properly incentivized with a profit motive – would be far more effective and cost efficient in covering the many small local areas that are currently being ignored by the Groupon model.
To illustrate this, imagine a local newspaper with a restaurant review column. They could become a Google affiliate and begin to offer a deal a day for a featured restaurant. They would handle the sales, customer service, and promotional email design – all the functions performed by the merchant facing side of Groupon. They would then use the Google platform to offer a deal. The platform would take care of all the necessary technology functions, including sending emails, running the website, and payment processing. And because of lower overhead, the affiliate would share in the revenue for much less than the onerous 50% Groupon fee.
This hypothetical Google platform would require considerable thought and design. All the important issues discussed in this paper would have to be addressed. But it could be a game changer. There is tremendous room for innovation. One possibility is the integration of an auction model, in the same way as the current Adwords program. Third-party affiliates would compete for access to the Google platform. The competitive dynamics would ensure that only the best deal affiliates would continue to thrive.
The integration of price discrimination into Adwords and Adsense
A potentially more profound application of the principles of price discrimination is integration into the existing flagship Google Adwords and Adsense platforms.
The entire basis of Google’s advertising business is relevance. Advertisements are primarily targeted on the basis of search and context relevance as well as location, language and other parameters. As described already, Google possesses the resources to algorithmically identify price-sensitivity on an individual basis. Consider if this parameter is added to Google’s advertising platform as a targeting option. In addition to relevance, advertisers would be able to tailor their messages based on the price-sensitivity of the viewer. A price-sensitive user might be shown an advertisement that highlights a discount whereas a price-insensitive user might be targeted with a message that highlights the high-end features of a product. The platform could also be used to distribute daily deals but with even greater flexibility.
If Groupon’s power is derived from the scale of its target audience, one can only marvel at the possibilities with Google in this scenario.