How does GroupOn work?

Logo of Groupon (Photo credit: Wikipedia)

In response to a friend's query, it set me off thinking. Which can be a bad thing...

Sites like GroupOn are built around the concept of social networking. It could be called Social Purchasing. It could also be called a marketplace because it is about bringing buyers and sellers together.
A bit of background
Traditionally, sellers reach buyers through advertising. This could be TV ads, ads in magazines, billboards, flyers or even the sign above the store. Buyers reach sellers to buy either physically at a store or via on-line e-commerce sites. But there is a problem. There is too much advertising and buyers are tuning out. There are also too many products. Buyers become confused or don't find what they want to buy. Furthermore, they may not know about products that they may want to buy because there are too many ads to pay attention to them all.
From the seller's perspective, they want to sell more. Sometimes they just want to sell something that couldn't be sold. They need a way to find people who will either buy more or buy the thing that is not selling. Don't get me wrong. I don't automatically think that trying to sell something that did not sold well as something wrong. Maybe the target market was wrong. Maybe the product is good but got drowned out by the competition. Maybe the product is a specialty product that can't be sold for the price that would include the costs of traditional advertising. There are also perishable products that have to be sold according to certain conditions, like at a certain time or can only be sold for a specific period. These products need to be sold by those conditions.
What ever the reason, sellers want to sell more or simply sell.
How does Social Purchasing works?
Before we get too far ahead, let's understand trade at it very basic form. We have a buyer, a seller, the thing that is to be traded and the value of the thing that both the buyer and seller agrees on. Money that changes hands represent the value that both parties agree upon. In barter trading, the value of the other thing being traded for the first thing is agree by both parties to be of equal value. Finally, we have a place where all this takes place.
So the central issue is getting the buyer and seller together to do trade. This used to be limited by physical constraints. Buyers need to be at the market to buy from sellers. Buyers are also limited to what is being sold at that market. Sellers at the market also face constraints. First is competition from other sellers who are selling the same or similar items. Second is how many buyers are interested in buying the seller's product. So a price for a product is haggled between a buyer and a seller within all of those constraints.
Fast forward a milenia or so and those constraints facing the buyer and the seller have changed. The marketplace has become global. What is being sold is no longer just physical or service-based but virtual. Ways at looking at those constraints have also changed. In fact, those constraints have been taken advantage of to sell more products.
Take for example the storage limit. If a product is about to be replenished, more space needs to be made in storage. So why not sell what has been in stock the longest at a cheaper price. It's sitting there doing nothing, probably losing value every day. Why do you think we have 2 for 1 Tuesdays for a shrimp plate?
The Social Purchasing is basically about getting the buyer and seller together. It works in a couple of ways. The theme centers around how a group of buyers must change their buying behavior in order to get a cheaper price or discounts. The most familiar model is what we normally see in traditional purchasing: the discount coupon. The discount coupon imposes a time limit in order to enjoy the discount. It also imposes physical possession of the coupon when purchasing which is limited by how many coupons are printed.
Other models imposes additional conditions. The most common is group purchases. A discount will take effect once a certain number of people commit to purchase or when the purchaser buys a certain number of the product. Services being sold through social purchasing can impose additional conditions like delivery conditions. This determines when the service can be used. A common use of this is selling a service at a discount when it is not popular. Ski lift ride in summer anyone?
The organizer's business model. 
The company that organizes Social Purchasing like GroupOn, can make their money through several ways. Remember, the organizer brings buyers and sellers together. Specifically, they group potential buyers and potential sellers through a website. Therefore the first way the organizer can make money is through traditional web traffic / web ads. Advertisers love to target their ads. Since the Social Purchasing Network have detailed information about their audience (that they collect when you register), they offer web ads on pages to the advertisers who want to target that demographic. For example, if 70% of the social network watches more than 14 movies a month, a movie studio may be more interested to buy ad space to market their latest movie. They may want to market their youth-orientated movies to a network that primarily consists of 18-25 year-olds. An organizer can create channels or mailings that are more targeted. For example, a channel selling products for senior citizens may attract advertisers who sell hearing aids and online pharmacies (where ever legal).
Another way to make money is by taking a cut in the sale price. Social Purchasing organizers process payments for the product being sold. So they can take a cut from the sale price before passing on the money to the seller. This is usually small considering the price of the item but given that the concept is based on volume sales, the total amount can stack up.
A social purchasing organizer can also offer marketing services to companies at a fixed fee. This is usually done by companies to promote a new product or service. The idea is to offer the product at a steep discount for a period or for a fixed amount. The organizer would market this to their social purchasing network, either generally or at a target. The purpose is to introduce an new product alongside a well-known brand (the Social Purchasing network), the brand to raise the profile of the product. Another fixed-cost service social purchasing networks can offer is market research. Given that the organizers have profiles of their members, a targeted campaign can be done to gather information or feedback for a sample without exposing the seller. This shields the seller from embarrassment and negative publicity.
Challenges facing Organizers
Operational issues aside, the biggest challenge facing Social purchasing network organizers is education. First they have to educate the seller. The seller should be guided on how to offer products on the network. The most famous story of this is when a bakery offered cheap cupcakes but did not specify the total number of cupcakes being offered. The number of buyers for the cupcakes ran into the tens of thousands, forcing the bakery to hire more workers and work overtime to fulfill the buyers orders. The organizer should have guided the seller on how to best offer the product and avoid the negative publicity that grew out of this incident.
Second, the organizer have to educate the buyer. The buyer should be made aware of the the limits and constraints of the items or services purchased. This is common in the coupon model where buyers often forget the expiry date of coupons. Similarly, a voucher purchased on-line may have date or service limitations. A cheap hotel room offer may not come with services offered to other guests like access to the spa or laundry services. The buyer should be educated and made aware of these constraints to create a positive buying experience which will hopefully lead to repeat purchases.

Beyond the current Marketplace

If companies that organize Social Purchasing want to compete with other social purchasing organizers, they have to be creative. Here are a few ideas.

1. Instead of herding buyers to sellers, why not flip it. Organize a common, general item to be purchased. Have buyers commit to buying that item buy pre-purchasing coupons. Then announce to sellers the items that your buyers are looking for and the price they are willing to pay and see who bites. Yes, it is herding sellers to buyers.
2. Sites like Kickstarter have a social purchasing side to them. For example, when you invest through them, you are eligible to buy the product made at a discount. Take this to the next step, group common producers / makers / manufacturers and have them pitch products that they can make to the buyers. The product will only be made once a certain number of people purchase them.
3. Traditional outlets can also use social purchasing networks to attract customers. A cash voucher that only works in pairs is an example. That is where two people in a line with the coupon can enjoy the discounts. This means the person will have to shop with a friend. To boost sales further, a minimum purchase amount can also be added. 

I hope this provides a simple insight into the world of Social Purchasing. I am not an expert and what you have read most likely came from my extrapolation of the works of others. Feedback or questions is welcomed.