Does Group-Shopping Work?

The economics of Mercata and Mobshop. 

This is the third in an occasional series on e-commerce.

One of the latest trends in Web commerce is so-called group-shopping. In short, it’s a way to use the Web to get a volume discount: Groups of consumers will band together to buy a particular good, and manufacturers will be forced to offer wholesale prices to these groups. This notion is considered sufficiently innovative to have sparked a patent squabble between the two leading group-shopping sites, and

But legal wrangling aside, is group-shopping really a good way for consumers to save money? As it turns out, it is a reasonable way to get a discount—but not for the reasons that Mercata and MobShop suggest.

Here’s how group-shopping sites are supposed to work: You visit MobShop and browse its selection of personal electronics, sports equipment, software, and DVDs. Each item lists a price and the number of people who have agreed to buy it at that price. Each item also has a paragraph explaining that if X number of people agree to buy the item at the current price, the price will fall by $Y. Here’s the key: This lower price is applied retroactively to everyone who agreed to pay the higher price. So, for instance, if you agreed to buy “WWF Smackdown for PlayStation” for $50, and another 10 people subsequently agree to buy the game within a certain time period, then you’ll pay only, say, $40. In fact, next week, the same item will probably be offered again, beginning at $50 and falling in price as more people agree to buy it. (Mercata works the same way, except that the site doesn’t specify how much the price will fall as more buyers sign on. On the other hand, it offers a wider array of goods, including jewelry, home-and-garden equipment, and appliances.)

In theory, because they can promise to place a large order, Mercata and MobShop can turn around and negotiate a volume discount from the manufacturers, which they then pass on to their customers. But in fact, a brief Money magazine survey compared group-shopping sites with ordinary Web retailers and found that group-shopping sites sometimes have lower prices and sometimes don’t. According to the survey, group-shopping is likely to save money only on smaller items (like DVD movies) rather than on larger ones (like laser printers).

Why? For one thing, despite the way it sounds, these Web sites actually purchase the goods before they’re offered for sale. It’s not as if they actually walk over to Panasonic and negotiate a special price on DVD players based on the purchase promises of some group of customers. In fact, they tell Panasonic that they intend to buy a large number of DVD players in the hopes of reselling them through a series of group buys. That means that Panasonic may or may not give the Web sites a volume discount.

Moreover, even if they can get goods for wholesale, that’s not necessarily enough for Mercata and MobShop to make good on the promise of offering goods below the retail price. Retailers like Best Buy and Circuit City also get wholesale prices—that’s how they make money. In fact, ordinary retailers—who are supposedly group-shopping’s major competitors—buy goods in far greater volumes than any Web site, and therefore they must be getting far larger volume discounts than Mercata and MobShop. So if Web sites are going to ultimately offer consumers lower prices, it probably isn’t going to be through volume buying.

But there are a couple of ways that they might still offer lower prices. One is lower overhead: Web businesses don’t have to pay for retail space and don’t have to charge sales tax (so far). Even so, this is hardly unique to group-shopping. and even old-school mail-order houses such as J&R Music World also benefit this way. So if MobShop and Mercata offer lower prices because of lower markups, this has everything to do with the economies of the Web and nothing at all to do with the power of volume buying.

But lower markups aren’t necessarily the whole story either. An alternative explanation for Mercata’s and MobShop’s lower prices on inexpensive items like DVDs is that manufacturers are using such sites as part of a price discrimination scheme. It sounds vaguely illegal but isn’t. Here’s how it might work:

Price discrimination means selling the same good at different prices, based upon people’s willingness to pay. A company can make more money off a particular good by selling the same item to big spenders at a high price and to cheapskates at a low price than by only selling either to the big spenders or to the cheapskates. A classic example is airline tickets. Sometimes everyone in a row of airline seats has paid wildly different amounts for the same flight—the businessman paid more than the tourist, etc. The airlines do this because they can make more money this way than if they charged everyone a business fare, since without low fares, some tourists wouldn’t bother to fly. And they make more money than if they charged everyone a tourist fare, since they can squeeze extra money out of businessmen with expense accounts. But it only works if airlines can deny tourist-price tickets to businessmen—that’s why low-priced tickets come with all sorts of restrictions, like advance purchasing and the requirement of a Saturday night stay.

Price discrimination often crops up in all sorts of other places, like supermarket coupons and “outlets” located in Freeport, Maine. The idea is that if it’s a big hassle to get a discounted box of cereal or a cheap Barney’s suit, then only cheapskates will bother to get the discount. And firms don’t lose money by giving a discount to cheapskates, since cheapskates wouldn’t buy at regular price anyway. (In fact, this argument has been used by economists to justify long lines and lots of red tape in order to qualify for welfare benefits. The argument is that if people are willing to run such a gantlet, they must really need the help.)

So, on this theory, manufacturers might be willing to offer discounted goods to Web sites such as MobShop and Mercata—and not to Circuit City and Best Buy—because group-shopping sites attract only those cheapskates who won’t pay full price at an ordinary shop but who are willing to take the time to sign up for a group buy, wait a few days for the price to fall, and then, and only then, get the item. It also explains why cheaper items like DVDs are typically bargains on group-shopping sites, whereas bigger-ticket items (like, say, laser printers) aren’t: Firms know that if they offer Mercata and MobShop discounts on expensive items, then even non-cheapskates will undergo the hassle of waiting a few days to get the discount. This would cut into ordinary sales. In sum, group buying just illustrates a time-honored truth. It’s possible to save time or money—but not both.