The Groupon Effect in ChinaPublished: January 03, 2012 in Knowledge@Wharton
In January 2011, Groupon, the world's fastest-growing company, launched its online coupon business in China, the world's fastest-growing economy. At that time, more than 2,000 Chinese group-buying clone sites were already competing aggressively in a highly saturated market. While Groupon might have pioneered the group-discount model in the Western world, the concept of group-bargaining already existed in the Chinese culture. What forces helped shape such rapid growth in this industry in China? How are group-buying companies responding to the competitive landscape? And what are the implications for Chinese consumers today?
Group-buying, or tuangou, became popular in China as early as 2005. Chinese consumers formed groups that would bargain for goods ranging from household supplies to automobiles. According to Han Zhen Hua from Beijing Foreign Studies University, a local participant, groups of individuals interested in group-buying auctions would gather in homes or conference rooms to bargain with vendors, purchasing items in large quantities to receive substantial discounts. Han once participated in a tuangou for home construction materials where food and tea were served to all. The crowd cheered whenever negotiations heated up and evolved into yelling matches between the negotiators and suppliers.
Although news of group-buying activities initially spread through word-of-mouth, online forums and blogs soon became the main form of communication. The concept of tuangou took off in China due to both the Chinese culture of bargaining and the burgeoning number of online users.
Group-buying reached the U.S.in 2008 when Groupon launched an online portal promoting coupons with group discounts. The company's rapid growth spurred its international expansion and subsequent entry into China in 2011. Some in the news media have labeled this phenomenon a "boomerang" of group-buying from China to the U.S. and now back to the country of its origin, where a host of online competitors have already put down roots. CNBC's Cris Prystay writes that "[T]here appears to be a huge demand for [an] Americanized version of tuangou." Today, the Chinese group-buying market has ballooned to nearly 5,000 sites, with several U.S.-based companies also looking to take advantage of the growing Chinese consumer appetite for tuangou.
Group-buying in China Today
How does the tuangou model work? Group-buying enables large groups of consumers to purchase vouchers online that offer up to 90% discounts at local vendors, ranging from restaurants to movie theaters to hair salons. Vouchers are also offered for a wide variety of products, such as skincare items or dietary supplements. These vouchers are available for only a limited period of time (the window can be as short as 24 hours), thus creating a sense of urgency to buy. The time limit and the attractive discount often induce impulsive purchases. Vendors also benefit from group-buying, which can attract new customers. In addition, group-buying bridges offline and online commerce by serving as a new type of Internet advertising channel for brick-and-mortar retailers.
In China, consumers are drawn to tuangou not only by the discounts, but also by the unique types of deals available. Chinese sites offer coupons on jewelry, automobiles and even real estate, items that are rarely featured in the U.S. The range of products and services available in the Chinese group-buying arena is constantly expanding. Online raffles and other innovative tactics are also employed to incentivize consumer purchases.
The first of Groupon's Chinese clones came online in March 2010. Since then, the number of tuangou companies has exploded. Estimated to be more than 1,800 at the end of 2010, group-buying websites more than doubled to 4,800 during the first half of 2011, suggesting that, on average, just over nine new sites were established each day.
Group-buying companies in China fall into three main categories. First, there are the third-party independent websites backed by venture investors. Top market players in this genre include Meituan, Lashou, Groupon.cn (a domestic clone site unaffiliated with Groupon.com) and Chicago-based Groupon's JV venture, Gaopeng. The second group comprises tuangou channels that span leading social networking sites, e-commerce and life-services portals. Taobao, Renren, Dianping and 58.com (China's Amazon, Facebook, Yelp and Craigslist, respectively) each operate their own group-buying businesses and enjoy huge market shares, given their large number of existing users. Third, deal aggregators consolidate coupon information from hundreds of group-buying sites.
Although the Chinese group-buying industry has been in existence for only 18 months, it has already attracted millions of dollars from venture capitalists. In 2010, 12 fundraising drives raised more than RMB 637 million (US$100 million). With Groupon, the largest of the global group-buying companies, completing an IPO in November, Chinese rivals have also intensified their chase for cash. Lashou, the leading Chinese deal site by revenue, completed its third funding round of RMB 700 million (US$110 million) in April 2011 and plans to go public in 2012. Meituan, the first coupon site established in China, completed its second round of financing in 2011, raising RMB 318 million (US$50 million) in July and even attracting Alibaba Group, the world's largest B2B platform, as an investor. 55tuan, a major rival of Lashou that expanded into 150 cities during 2011, claims to have collected RMB 1.3 billion (US$200 million) in funding in March 2011.
It is not hard to see why the group-buying market in China is drawing so much attention. While some research firms put the estimated sales volume in billions of dollars, most of the data suggest that tuangou sites generated somewhere between RMB 955 million and RMB 1.9 billion (US$150 million and US$300 million) in revenue in 2010. According to a Chinese market report by tuan800.com, China's group-buying market size is projected to expand tenfold in 2011, topping RMB 15.9 billion (US$2.5 billion) and rivaling the U.S. market, where industry revenue is expected to increase by 138% to RMB 17.2 billion (US$2.7 billion) in 2011. In addition, the group-buying user base in China has also expanded significantly, surging 125% during the first half of 2011 to reach 42.2 million users, or roughly 10% of all existing Internet users in the country.
A Perfect Storm for Growth
In addition to China's inherent bargaining culture, an improving telecommunication infrastructure and a rapidly changing social environment have formed the foundation for explosive growth in the group-buying industry.
China boasts the world's largest Internet market. In 2006, only 123 million Chinese used the Internet, representing a penetration rate of less than 10%. By 2010, usage had ballooned to 31.8%, equivalent to 420 million users. However, given the country's still relatively low penetration rate, user growth is expected to continue. Current estimates suggest that China is adding approximately 80 million new online users each year.
While many users access the Internet from homes and offices, China has a large number of cafés where patrons can go online for less than US$1 an hour. In fact, about a third of the entire Chinese online population surfs the web at such establishments. College students, most of whom are avid group-buying users, often frequent these cafés.
The proliferation of smartphones and upgrades to China's mobile web network has spurred tuangou activity by enabling consumers to group-buy on their mobile phones. Although China's current smartphone penetration (10%) is relatively low compared to that in the U.S., Germany and Japan, this rate still translates to a sizable 90 million smartphone users. In addition, Chinese mobile vendors offer simple web-enabled phones at attractive prices, and mobile operators provide affordable mobile data plans.
For example, China Mobile provides monthly mobile data services of 200MB for as low as RMB20 (US$3.13). By June 2010, 277 million mobile users were surfing the web using their handsets, and this number is growing rapidly. The availability of affordable phones and data plans allows users to browse online and participate increasingly in group-buying. A popular trend among college students is to microblog about group-buying deals with their mobile devices. Tuangou websites incentivize mobile microblogging by offering additional discounts or free vouchers to consumers who solicit the most comments on their microblogs for a particular deal. "My friends and I like to browse each other's microblogs for the best deals," says Pei-yun, a Shanghai tuangou user.
The increasing spending power of the "Little Emperors" also contributes to the robust online group-buying sector in China. This term describes the generation born under the one-child policy. They have no siblings with whom to compete for parental attention, and they inherit wealth from both parents and four grandparents -- or, in sum, "six pockets." However, the term is somewhat misleading, as this generation is now no longer "little": Most are in their twenties or thirties and generating income of their own.
The approximately 250 million "Little Emperors" have different consumption patterns than those of the previous generations. They are more willing to spend on impulse and use e-commerce for their shopping needs. In 2010, there were approximately 140 million online shoppers in China, which was on par with the U.S. By 2015, this figure is expected to reach 520 million. Online sales generated RMB 4.4 trillion (US$684 billion) in 2010 and are estimated to grow at a compound annual growth rate (CAGR) of 50% through 2015.
In addition, herd mentality is a common characteristic among the "Little Emperors." Cora Han, a young professional who uses tuangou frequently, explains that in "today's fast-paced environment, the quickest way to fall behind in conversations with friends is not doing what everyone else is doing." These behavioral and consumption habits are rapidly shaping the e-commerce market, which, in turn, fosters a solid foundation for online group-buying.
According to industry data, globally the most common group-buyers are college-educated professional women between the ages of 18 and 34. China is no exception. It is common to see young Chinese women at web cafés or in the office surfing the web in search of tuangou deals. Piao Mo, a price-conscious college student, purchased a RMB 75 voucher (US$11.70) for a RMB 150 (US$23.50) skin cream to sample a more expensive product normally beyond her budget.
Chinese men in their twenties and thirties are quickly becoming a core target demographic for group-buying. Kenneth Dai is a middle-class, 25-year-old Chinese professional who browses tuangou websites on a daily basis. He enjoys purchasing restaurant coupons throughpopular sites such as Lashou and Dianping. He recently spent RMB 100 (US$15.70) for a RMB 300 (US$47.10) voucher for a high-end hotpot restaurant in Beijing. The tuangou enables him to dine at restaurants that he would otherwise be unable to afford. Mo, Dai and a growing number of Chinese consumers view tuangou websites as a way to access higher-end goods and services at an affordable cost.
Boom or Bust? The Uncertain Future of Tuangou
While thousands of Chinese group-buying firms scramble for market share, the top 20 sites account for nearly 90% of all sales volume. In June 2011, the top 10 companies took in 74.8% of the total revenue, up from 69.3% the previous month. As larger and better-funded companies absorb smaller competitors, market consolidation is one factor driving the increasing share among the top players. Nevertheless, there is no consistently dominant player in the fierce group-buying battlefield, with dramatic shifts in power so commonplace. The top Chinese tuangou website, Lashou, dropped to a 5.1% market share and 10th place in June, just after it topped the sales chart (14.4% share) one month earlier, while QQtuan took the lead with a 10.0% market share, up from sixth place.
The heated competition in China has driven down the profit margins of tuangou companies significantly. In the U.S., Groupon generates a 40% to 45% gross margin with a 1:1 revenue share with vendors. In comparison, group-buying companies in China had an average gross margin of 15% to 18% in December 2010. This figure has plummeted to 5% in recent months, according to an industry report.
Despite razor-thin profit margins, companies continue to spend heavily on marketing campaigns. These campaigns are most noticeable during one's commute to work. Advertisements for Chinese group-buying companies appear prominently in subways stations and bus stops. Along one exit in Shanghai's Guoquanlu station, the only advertisements one can see are those for Groupon.cn, Meituan, Lashou and 55tuan. This comes as no surprise, as the five major group-buying companies announced they would spend up to RMB 1.3 billion (US$200 million) in marketing fees in 2011. Groupon.cn is the most aggressive of the five, allocating nearly RMB 573 million (US$90 million). Following close behind are market leader Lashou and third-place Nuomi, which announced that they would spend up to RMB 318 million (US$50 million) and RMB 191 million (US$30 million), respectively. These aggressive marketing tactics, combined with traditional word-of-mouth, continue to encourage group-buying behavior.
Given the intense competition in the saturated tuangou market, industry analysts have a dim view of the future viability of the model in China, as these companies have yet to demonstrate their ability to generate sustainable sales. The month-over-month sales increase was flat in May 2011 and 17.4% in June, a huge drop from the 26.2% figure in April and below the 19.8% monthly growth rate during the first three months of 2011. Revenue growth continued to soften, with total YTD sales at RMB 4.1 billion (US$650 million) by the end of July, significantly short of the RMB 15.9 billion (US$2.5 billion) industry revenue forecast for 2011. According to the most recent industry reports, revenue growth in Q4 is expected to drop further, to 21% from its record high of 65% in Q1.
Renren, the largest Chinese social networking site, which went public in the U.S. in May 2011, operates a group-buying portal that generated RMB 5.7 million (US$900,000) in revenue but recorded operating expenses of RMB 29.3 million (US$4.6 million) and a net loss of RMB 23.6 million (US$3.7 million) during Q1. Renren CEO Joseph Chen said it was not alone and that "at least 20% of the [group-buying] companies are losing money on their businesses." At the other extreme, Nuomi CEO Shen Bo Yang speculates that "right now, everyone is operating at a huge loss. No one can claim to have reached profitability yet. The revenue is not even enough to pay for the marketing costs." The CEO of Meituan, Wang Xing, predicted that 90% of the tuangou companies would shut down by the end of 2011. Li Kai-Fu, a prominent figure in the Chinese Internet sector and ex-president of Google Greater China, also suggested that when the group-buying war comes to an end, only about 10 firms would remain.
The entry of Chicago-based Groupon (Gaopeng) into China was met with great fanfare, as the Chinese media reported Gaopeng's aggressive plan to hire thousands of employees in its first few months of operations in the early part of 2011. However, the company recently announced a broad set of layoffs and plans to shut down unprofitable branch offices. As a former employee at Gaopeng commented, "if group-buying companies are not able to generate sustainable margins, many sites will need to close their doors in China."
Faced with the many unique challenges of the Chinese group-buying market, tuangou companies depend on their fundraising ability to survive. Some have already experienced major setbacks. 55tuan recently abandoned its plan for listing in the U.S. because it was rejected by investment banks such as Merrill Lynch, Credit Suisse and Goldman Sachs. The banks were concerned that lax accounting for the dozens of small regional coupon sites 55tuan had acquired would put its financials in question.
As the group-buying industry in China experiences consolidation and growing pains, the tuangou model will continue to develop and play a major role in the online retail market. "People are getting used to online tuangou as it evolves into one of the many ways consumers can shop, just like going to the supermarket," says Serena Zhang, a recent college graduate in Beijing and an experienced group-buyer. "While tuangou may not be the dominant shopping channel, it is becoming a part of our daily lives."
This article was written by Tae-Hyung Kim, Kevin Lam and Christopher Tsai, members of the Lauder Class of 2013.