Is Groupon subject to network effects?

As virtually everyone with a computer knows, Groupon turned down Google's acquisition offer, said to total $6 billion, last Friday evening. Parties who claim to have been close to the negotiations say that Groupon didn't want to risk its culture as part of Google, and that the company believes that it's following in the path of Facebook, which turned down several acquisition attempts. (For that matter, it's following in the path of Google, which tried to sell itself to Excite in 1999 for $1 million, without success.)

Critics of the Google/Groupon deal say that it's easy to create a "daily deals" service, and in fact, there are dozens of them in the U.S. alone. The technical barriers to entry are very low. The same was true in the 90s, when eBay became the dominant Internet auction site. There were dozens of other auction sites, some of which focused on vertical niches, and others that took eBay head-on. However, eBay became dominant because it took advantage of network effects, where the value of a product or service increases as the number of people using it increases. (Bob Metcalfe argued that the value is roughly the square of the number of users.)

In eBay's case, as more people used the service and more people posted products for sale, it generated a "virtuous circle" that made it more popular and gave users ever fewer reasons for using other auction sites. Groupon, however, is a different animal. Most Groupon users don't go to the site to find deals; instead, they get daily deals via email. Groupon's value comes in cornering the market for daily deals, and there are simply too many retailers out there for that to happen. Even Groupon realizes that it can't add enough salespeople to grow its business fast enough, so it's implementing a service that enables merchants to post their own deals.

Groupon may get to the point where consumers no longer pay attention to other daily deals and merchants no longer bother to post deals with other services, but it's not there yet and may never get there. That doesn't mean that Groupon won't continue to grow and won't be successful enough to eventually IPO, but it does mean that the "low barriers to entry" argument is credible. It's far too early to say whether Google dodged a bullet or Groupon made a brilliant decision, but either way, Groupon is no eBay.