Top: The group-buying company LaShou Group spends a lot of money in promoting its website. Above: The rising popularity of group buying in China has attracted more and more start-ups to the market. Photos Provided to China Daily

Group-buying companies find the going is getting tough

Group-buying websites in China, after a year of unbridled growth, are now feeling the pressures of expansion and dwindling financing opportunities. The pressure on the sector has been intense in the last few months. Several small players have shut operations and others have scrambled to avoid disaster by forming alliances with bigger players. So what exactly went wrong for a sector that had so much to offer in a huge and untapped market like China?

Industry experts say most group-buying websites spent huge amounts on new branches, more employees and advertising. However, the increased spending failed to have any impact on profit.

Last year, the group-buying industry took off with a bang in China as websites offered mind-boggling deals among others on holidays, hotels, restaurants, food and theatrical performances.

According to data provided by tuan800.com, an Internet portal and classification website for group-buying companies, there were 1,726 group-buying companies in China by the end of last year, with about 4.7 new entrants springing up every day. By August this year, the number of group-buying companies in China had risen to 5,039.

iResearch, a local consulting company, says that during the first half of this year total sales of the group-buying industry were 6.2 billion yuan ($974.4 million, 719.6 million euros), an increase of 15.2 percent over the corresponding period last year. The sales figures for the full year are expected to reach 16 billion yuan, it says.

Like many other e-commerce models such as location-based service (LBS) and social networking services (SNS), group buying also came to China from the United States.

Group buying began in 2008 when Groupon, a Chicago-based company, came up with special coupons or vouchers every day for a certain number of people signing up (and pre-paying) for the deal. But the business model of Chinese group-buying companies was different from the model in the Western world.

In the US the common business model is the one followed by Groupon wherein the company plays the role of the middleman and shares 50 percent of the merchants' profit if the vouchers are redeemed.

But in China the model has been changed to the "buy low and sell high" strategy. Companies buy services and products at lower prices from the merchants and then sell them to consumers at comparatively higher rates.

"In the US, group-buying sites such as Groupon only serve as platforms. However, Chinese group-buying sites are more involved in the whole industry chain, from contacting merchants, product pricing, to the logistics and after-sales services," says Jin Lin, an industry observer with iResearch.

He Xi, an observer with Analysys International, says many of the problems for the industry were a result of the different motivations and development paths followed by companies.

"Domestic start-ups were often keen on quick returns. Instead of thinking how to sustain long-term operations and generating profit, they spent most of their venture capital on brand building so that they could reap returns when the company lists its shares."

Data from China's e-Business Research Center shows that group-buying sites spent about 80 percent of their investment on marketing activities last year.

Zhang Yanan, senior analyst with Zero2IPO, a leading service provider for venture capital and private equity industry in China, says that most of the companies want to list their shares as they desperately need money.

"Chinese companies need capital to enlarge their product lines and improve service quality. But these companies have not made satisfactory returns so have not found too much of favor with venture capital and private equity funds. Most of them are being forced to seek funding from the capital market."

Daily-deal website operator LaShou Group Inc has been one of the companies that was unsuccessful in raising funds from the capital market. The company had to defer its $80 million share float on the Nasdaq for unexplained reasons.

According to its IPO prospectus, LaShou's revenue last year amounted to 10.49 million yuan, while the net loss was 53.5 million yuan.

Wang Huiwen, vice-president of Meituan, another group-buying website in China, says his company incurred losses of more than 10 million yuan in recent months despite a 20 percent quarterly sales growth.

The big picture for the industry is that none of the companies have managed to break-even and most of them are in the red. Besides LaShou, 55tuan, Nuomi, and Meituan have also expressed interest in floating shares to augment capital resources.

On Nov 4, Groupon, the US group-buying company, successfully raised $700 million on its trading debut on the Nasdaq. Zhang says that the good response to Groupon will encourage more Chinese companies to look at listing their shares.

Apart from the market floats, there have also been several instances of fund-raising by group-buying companies. LaShou raised $166 million from three previous rounds of funding, while Meituan and 55tuan attracted $60 million and $200 million respectively from private placements.

But most of the capital raised by these companies went on advertising and expansion. Last year LaShou spent a lot of its money on television and subway advertising.

LaShou's IPO prospectus shows that last year its sales and marketing expenses were 40 million yuan, accounting for more than 67 percent of total expenses. In the first half of this year, the loss was 391 million yuan, while marketing expenses were around 326 million yuan.

"The high operating expenses result in low average gross margins of between 10 to 20 percent. Sometimes it dips below 10 percent when the market competition gets fiercer," says Wang Tingting, an analyst with iResearch.

Such high costs have forced several small group-buying sites to close. Some of the bigger players had to lay off staff, shut down local offices and trim marketing budgets to stay afloat.

In September 419 group-buying companies closed, bringing the total number of closures this year to more than 1,027, accounting for 18 percent of the industry in China, according to information provided by lingtuan.com.

Since June, Gaopeng, the joint venture of Groupon and Chinese Internet giant Tencent Holdings Ltd, has reportedly dismissed 2,000 employees, accounting for 70 percent of the workforce, and closed more than 10 offices.

Based on Groupon's filings to the US Securities and Exchange Commission, E-Commerce King, Gaopeng's parent company in China, has reported a net loss of $46.45 million for the first nine months of 2011, with total sales of $18.44 million.

Pony Ma, founder of Tencent, says the main reason for Gaopeng's setback is that it expanded too fast and lack of necessary market preparation.

LaShou has also been trimming its operations and has laid off nearly 2,400 employees. 55tuan axed 500 people from its 35 offices since the beginning of October.

"The industry expanded irrationally at the very beginning (in 2010), now it is natural to go through this fluctuation," says He Xi, an observer with Analysys. "But an IPO is not the magic cure for the industry."

"Unlike 360buy or Taobao Mall, which have a complete e-commerce industry chain, group-buying companies have to win over offline merchants, invest in marketing and rely on third parties for online payment and delivery."

He warns that most group-buying sites will shut as they are fast running out of money and need to make drastic changes for survival.

But amid all the gloom what is noticeable are the steps top group-buying websites are taking to hedge against upcoming risks.

LaShou, for instance, is putting all its marbles on micro-innovation. The company has changed its original "one deal per day" tagline to multiple deals every day and opened more branches in China to provide specialized services in different cities.

Instead of innovation of business models, Meituan is working on improving its service quality and team efficiency. Wang of Meituan says that the company will stick to Groupon's model and try to be the largest service group-buying site.

Alibaba Group, the Chinese e-commerce giant, has hived off its group-buying platform Juhuasuan to enhance its market influence. Instead of competing with professional group-buying sites, merchants can have their own group-buying campaigns on Juhuasuan's platform.

Yan Limin, general manager of Juhuasuan, says that Juhuasuan will help bring about order and generate profits for the industry.

"Platform is the definite direction for domestic group buying companies, because it is in the upper stream of the industry chain and can save companies' time and effort on maintaining their own industry chain. It is a more cost-efficient business model," says iResearch's Jin.