Q&A: How "Group Buying" Sites Will Earn Billions on Deals Made Just for You

The phenomenon of online "group buying" is reaching critical mass, as Time and others are reporting. Just last week, the biggest of the sites, Groupon, raked in 445,000 customers for The Gap (GPS) in a single day, earning $11 million off that day's work.

The burgeoning industry could easy nurture several billion-dollar competitors, two of which may end up being Facebook Place and Google Places (GOOG), which are actively recruiting SMB participation just like Groupon's (only Google is charging). They're less discussed than real-life Web apps like Foursquare or Gowalla, perhaps because the primary "app" in group buying is basic economics. Yet these services amount to ad-hoc local business networks that are every bit as powerful -- and their scale will be massive.
Look no further than the whopping $39 million raised by Groupon's closest competitor, LivingSocial, in two back-to-back venture rounds last spring. LivingSocial's CEO Tim O'Shaughnessy explains how they work, how they'll differentiate themselves, and how these deals will eventually become personalized.

What are SMBs getting out of this? Is it a way to clean out inventory?
It's solving the number-one problem for most SMBs, which is: how do I get more customers through my door? That's what it's best at.

Does this come out of their advertising budget?
Yes, it's a marketing program. Businesses that we work with might have $1500 a month that they spend on marketing, but once they might work with us they can usually cut that budget drastically -- potentially down to zero. It's pretty a big cost savings at the bottom line.

If they're not paying for the service, who is?
We put together a package for them and promote it on the site for 24 hours. People buy, and have six months to use their vouchers. We collect the money through our site and then write a check to the merchant [for approximately the cost of the services]. We actually don't get paid if we don't sell a single thing -- but they still get a lot of branding. We only get paid based on actual sales we take.

How big can this get?
It's certainly getting bigger and it will for a while. This space had a lot of growth opportunity in it. It's based on two truisms: SMBs want more customers through the door, and people like saving money. Those are two phenomenon that will exist for a long time.

Right now, users are presented with a deal a day that they don't choose it. With more competition in the market, will consumers start to see an "inventory" of deals build up across the Web?
I don't think so. That relates to the curation aspect of what we do. We view LivingSocial as helping people explore and find new things to do in your city. There should be an editorial piece in that: we introduce you to new things. That's going to always be a part of what we do, but we might also try to be smarter about it. If you live in the Upper East Side [of New York], you're proably not goon be super interested in a restaurant in Brooklyn -- we should be smart about that kind of thing. You don't want to overwhelm people with a huge digest of options. [Groupon has also been experimenting with similarly personalized offers.]

You're concentrating on the local market. What else can be done there with smartphones?
I think that the convergence of local, mobile and commerce has almost found its exactly right combination. We'd like to find that combination, but we haven't yet. We've cracked a big nut, but thee's a bigger one to crack there.

As the Web goes mobile, how will the chronology of deals change? Are they going to get more time- and place-sensitive?
That's a little bit of a different model. If it's literally that quick -- come in next hour and get free desert -- then it's the difference between "push" and "pull". I think that's complimentary to what we do, but different. But we like the push model and we what to make sure we're driving that home before we get into things that are complimentary, because they're meant to solve a different problem for the merchant.

How will all this change?
The conduit between people and merchants can evolve. Right now the package is a "50% off" type of offer, but there are other ways we can think of to connect people and merchants. I don't know those answers at this time, but when you be a trusted outlet in local markets, you can leverage that in other ways than just a daily-discounted product or service.

What's the bigger picture?
When facebook first opened up their app platform three years ago, we started thinking about what people liked to do: favorite restaurants, favorite movies and so on. Facebook told you where these people lived, approximately, and what they liked to do. We figured we could bridge the online and offline gap.

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