Friday, June 03, 2011

Value Erosion - Prisoner's Dilemma & Defections

My previous blog did evoke some interesting conversations on pros-cons on the Group Buying models. Mostly the argument for Pro group buying almost always veered towards group buying being a great model for service which has high-fixed cost and excess capacity. The examples almost always ended with Travel (Airline) and Hotel Industry and extrapolating that to SMBs!

To recap: High-Fixed cost services which has excess capacity (after recovering its fixed cost) tends to gain from every $ they earn for the same session (Airplane, Yoga Studio etc..) as the cost of acquisition is not significant there after. The Key here is "post fixed cost recovery" and "same session". This is a very Rational Viewpoint. The flipside is, behavioral economics, human beings and market dynamics are not Rational!

Lets take a Yoga Studio as in one of the examples. If the fixed costs were $2000 (lets say) per month (Lets call this a monthly session) and you have enough students who have already covered your cost. Now every additional student (assuming you have excess capacity) you add to the same session should be profitable for the Yoga instructor correct? Rationally Correct.

The challenge with this debate is exactly what the "all customer defects" scenario as per the Prisoner's dilemma presents. When the initial paying customers gets a wind of what you do to fill the remaining capacity of the Studio, they start defecting to wait for that Deal... and this catches on (is catching on). Airline and similar (Hotel) industry is only very few industry which can afford to operate in this model as people are 'pressed' to fly and cannot always wait for a deal. For everything else (which is not pressing), they will wait for a deal. This is already happening in the SMB markets in volumes as we speak. Regular paying customers are defecting to wait for deals. Also, they would now not mind to switch loyalty off the Merchants if someone else gives a deal.

We must exercise caution while extrapolating such models to SMBs right off. Unlike airline industry, the 'long tail' of similar merchants (Yoga, Cafe, Saloon...) is relatively much voluminous in a given city than a consolidated few flight schedules between two cities across airline players. which means, there will mostly always be a deal for me to defect.

When most customer's defect, then, the prisoner's dilemma feeds on itself to erode value out of the system. Talk to the SMBs to feel their pain and validate this.

A key metric on the current deal-seekers for Merchants now includes in excess of 50% (median) and as high as 90% in some formats of "existing" customers biting the deal! Did you add additional footfalls then? or are you defecting your current paying customers?

When most of them defect, the SMB will now be fully dependent on the likes of Groupon for filling seats to recover their high-fixed cost. Great if you are Groupon, Living Social, Google Offers..., Epic win if you are a Consumer, Sucks if you are a SMB. You know what SMBs will do if this happens right? (and what will be left of the business model.)

Bottom-line: The current avatar of group buying is just not a proven model yet and needs to focus on a whole lot of market dynamics to assure a equilibrium before we can claim that it works.


Sriyansa said...

Really liked your analysis both here and on your previous post

The crucial point is the following: group buying is never positioned as a sale and almost always as customer acquisition. And given that it runs for a specific time period, and as a business a SMB has to maximize the LTV of all footfalls, one is left with a significant conundrum. How does the business know which user is the best? Can I ignore the one coming in through the door now because the one after him has higher LTV?

I recently wrote about some similar thoughts here:

Preetham V V said...

Good thoughts Sriyansa. Its hard for SMBs to know which consumer shall provide a sustainable LTV the first time she walks in. That said, it is important for them to know when they are bleeding :)

Read you blog, very interesting thoughts. Thanks for posting it here.