Foursquare, Groupon, and the Market-Making Problem
With Groupon’s filing to go public last week, there has been even more debate over the two-sided market strategy of consumers and local merchants. Another business that has focused on this approach is Foursquare. Is the window of opportunity closing for Foursquare to become the breakout success it could be? The answer depends on how much the company is willing to change its DNA to serve both sides of their market — and perhaps take a few lessons on self-serve and average selling price from Groupon.
On one side, you have consumers who enjoy the social benefits of checking in. On the other side, you have local businesses that provide the contextual canvas on which Foursquare builds its game and value to these users. To date, Foursquare has almost exclusively focused on the consumer side of the market.
Yet how many of us have ever derived any real value from the actual businesses we check in to? I’m not talking about getting a free coffee from a barista, but directly from the businesses’ own engagement with Foursquare. I think the answer is pretty close to 0%. There are other benefits of being a user in Foursquare that keep us engaged and deriving value — such as finding your friends from time to time and discovering new places you’ve never heard of. These are likely common use cases for many Foursquare users.
If one side of the market can be built quickly, it’s possible to use this to generate value and reduce friction in building the other side. Groupon has executed this strategy almost flawlessly.
Foursquare has not sat still on this problem. In March, they launched a slew of new features to let local businesses design offers based on various check-in types. This is goodness, unique in its design, and the logical progression and evolution for Foursquare. The question that lurks: does offering features necessarily mean creating the market for businesses?
Most markets inherently have different amounts of friction on either side of them. Tom Eisenmann, a researcher and professor at Harvard, wrote an analysis of the friction involved in two-side markets. This asymmetrical nature is as dangerous as it is powerful. If one side of the market can be built quickly, it’s possible to use this to generate value and reduce friction in building the other side. Groupon has executed this strategy almost flawlessly – they built incredible consumer demand, which drives a leadership position in fulfilling supply (the local businesses that offer coupons). But if the value is not harnessed quickly, the asymmetry in the market starts to erode the interest of the larger side of the market.
Foursquare has almost no friction for the consumer side of the market. Download an app for free, use it for free and interact with your friends for free. The beauty of Foursquare is that they didn’t require the consumer to do something totally new. You were going to that coffee shop anyway. But in the end, the network effect that drives consumer social apps will prove to be much simpler than the linear effort it will take to acquire local businesses as customers.
The other side of Foursquare’s market is about local business engagement. It’s actually extremely hard to do this well and not every model accommodates it. Witness Ben Horowitz’s defensive claim that LivingSocial can never compete with Groupon because of the sales force Groupon has built.
The beauty of Foursquare is that they didn’t require the consumer to do something new. You were going to that coffee shop anyway.
It comes down to this: it takes a vastly different DNA to acquire local businesses than to acquire self-service consumers. Additionally, what drives this engine is the inside sales structure and the time-value of the customer. Foursquare absolutely has time to get this right, but changing the DNA of a fast growing, mostly consumer focused business is not an easy task.
Let’s look at why approaching local businesses is hard:
Local Businesses Don’t Self-Serve (at Scale)
While many types of businesses are self-service, local businesses are rarely sophisticated enough or have enough time to explore their options. This is why the Yellow Pages, radio and local television advertising industries are still massive. It’s an area local businesses don’t have to learn (they use it) and they’ve been doing for a while. While they may not be spending their money profitably on these channels, local businesses are much more comfortable sticking with what they know. Part of the reason why Groupon is so successful is they are pitching a model that all businesses are familiar with: coupons.
Foursquare will have to redesign their own business on the premise that acquiring local businesses cannot be done with a self-service model.
With few exceptions, those who have tried to build local businesses with self-service have ended up retreating, selling to the businesses directly and then at scale restarting their self-service program simply due to brand awareness (e.g. Constant Contact, Service Magic, and now Groupon). Even Google has partially admitted this is true and recently started hiring inside sales teams all over the country to call on local businesses to sell advertising products like AdWords and Google Places.
The ASP (Average Selling Price) of the Local Customer
One of the hardest things about selling to local businesses is that they individually don’t spend that much money on marketing and advertising. One of the most important things that Groupon has been able to do is sell hundreds (sometimes thousands) of coupons at once for each business. This means that the average selling price (ASP) of each sale is quite high. If Groupon sells 200 coupons for $25 and takes 50% cut of the sale, they are making $2,500 from that one business. Furthermore, the local business doesn’t pay them $2,500, they perceive it as getting $2,500 from new customers (granted at a deep margin discount on their product or service). For Groupon, this means they have a huge amount of money to work with when they design their approach to selling.
Let’s assume Foursquare plans to offer coupons tied to check-ins and use a similar revenue split as Groupon. Assuming that 10% of consumers that check-in will use a coupon it means Foursquare has to see 2000 check-ins to sell 200 coupons to make the same amount as Groupon does in one offering. Groupon also benefits from those that don’t redeem coupons and can also create demand by expiring offers. It’s possible that Foursquare could do this as well by offering a “follow” feature for the businesses you care about, with limited-time offers.
I don’t know the actual usage statistics but I’m guessing that few local businesses see 2,000 check-ins per year right now (that’s about 5.5 check-ins per day for those math-inclined readers). I’m sure coffee shops, restaurants and bars see much more than this volume, but what about retailers and service providers who are a large part of Groupon’s customer base? Something Foursquare will have to do is find ways to increase check-ins across their local businesses in order to raise the ASP of their customers. They have this data so likely can target their sales force on the most profit-potential customers (e.g. the ones with the most check-ins).
The LTV (Life Time Value) of the Customer
Another important factor in acquiring local businesses customers is the life-time value of the customer. Will the customer buy once, multiple times a year or is the service an annuity model? Foursquare has a strong play here with a coupon service that could run every day to perpetuity. This potentially creates great customer LTV for them. Yet there is a major downside to this due to the working capital required to fund the customer acquisition cost (more on this in a second). What matters is that the ASP of the customer and the LTV of the customer must combine to make a robust enough earning potential that the company can afford to acquire the local business.
Working Capital Investment of Acquisition Versus Time Frame of Payback
This means how much money do you have to spend to acquire the customer versus how quickly do you earn that money back from them. If it costs $1,000 to acquire a local customer but the customer only generates $100 of revenue a month, it will require you to fund that customer’s acquisition cost for 10 months before they are profitable. In the model I proposed, Foursquare will have to fund the upfront costs of acquiring customers while waiting for their payoff.
This changes the nature of how fast a company can scale their sales. As Foursquare, you have two choices: sell more slowly (reduce maximum working capital needs), or capitalize the business massively to fund the earn-back period. While Foursquare can easily access capital, it’s easy to run some basic numbers and see that they need a large reserve to cover their earn-back period in this model. Let’s say a SMB customer costs $1,000 to acquire and earns them $100 dollars a month. A simple example:
- $1,000 to acquire customer
- $100 revenue per month
- 500 new customers per month
- 10% churn rate per month (local customers churn heavily)
If you started in January, by October you still would still be in the red by $700,000. You’d be making money by December but your customers would start to come to the end of their contracts and have to be renewed for an additional cost. While this model at scale ends up being quite profitable as the product has almost 0 technology and inventory cost like Groupon, scaling the model fast requires more capital and incredible attention to churn rate. None of us doubt that Foursquare can raise money for this model, the question is how much and how fast?
Part of what makes Groupon such a great model is that they make their acquisition investment back instantly when they launch the customer. This allows them to constantly reinvest in their own marketing and sales force to build both sides of their market. Sales produce more marketing dollars that produces more sales and more buyers. Furthermore, at scale their acquisition costs go down because of brand awareness that simply spins the flywheel faster (everyone wants a Groupon deal, right?)
Local businesses are high-churn customers in terms of purchasing advertising and marketing services. Their cash flow is usually inconsistent, they are often seasonal, and they go out of business frequently. Often local businesses only start advertising when their business is already in trouble and they are trying last grasp methods to succeed. Again, one of the beauties of Groupon’s model is that there is basically no churn on the first sale in their model.
The Structure of Your Sales Force
Basically, all high-scale businesses that sell to local businesses build massive inside (telesales) forces to target these customers: hence, Groupon hiring 2,000 employees in two years. Some models (like ReachLocal) even have feet on the street walking strip malls and handing out business cards physically to local businesses. There are three things that matter in this model:
- The cost of your sales force (there are highly varied costs of telemarketing versus telesales and what each body costs the business)
- The close rate (how many leads turn into actual customers)
- The sales cycle (is this a one-call close or does it take 15 conversations with the customer)
You multiply all these variables together to figure out the expected cost of acquiring a customer. There isn’t an exact model that is the best but you clearly want the following:
- A less costly sales person who can close the deal (cheaper headcount)
- A product that applies to a broad audience and thus has a high-close rate (high density of prospects in your target lists)
- A product that is easy to sell so you can hire less costly sales people and reduce the number of touches you need to make with the prospect
I think the biggest challenge for Foursquare is my last point. The check-in coupon is a completely new model for most local businesses. Everyone understands coupons but a check-in tied to a coupon? As technology-centric consumers, we may all think this is easy to understand but don’t underestimate how hard this could be to sell quickly. I’m not at all saying local business owners are dense, it’s just that this is a new model they have to digest which slows the sales cycle down.
To go all the way back to be beginning, Foursquare (and Gowalla and SCVNGR) have invented a really novel and interesting way for users to engage with local businesses. The check-in coupon model is a potentially massive model to build on top of it. But to succeed and scale this model it takes a very different approach than those businesses have taken so far to build the consumer side of their markets. Foursquare has to accept this is the way it’s going to work or slowly they will lose the consumer side of the market that was easy to build non-linearly as there is diminishing or competing value for them there. To make this even harder, Foursquare’s user base is so distributed (globally even) that they have to get a large density of businesses in any one region to really create perceived value on both sides of the market.
As a side note, SCVNGR is trying to innovate very quickly with this model and their new LevelUp product line. They are starting in just a few locations and I’ve heard they have some innovative approaches to working with distribution partners to build local business awareness of their offerings. I’ve also learned in the last five years there is never only one way to do something so I’ll caveat this whole article with that massive escape-hatch statement.
I hope Foursquare can turn the corner in front of them as personally I’d love to keep engaging with the businesses I care about and I’m already used to the Foursquare model of doing so. I expect with smart investors like Fred Wilson and Ben Horowitz involved they are well aware of this shift they need to make and are working on it. The first step was launching the business-side features (which they have), the next step will be educating the local business world about them one phone call at a time.
Niel Robertson is CEO of crowdsourced PPC services company Trada.