Why You Should Really Care About Groupon & Living Social?

As an entrepreneur it can be dizzying to watch Groupon and Living Social growing so quickly, raising huge venture rounds at massive valuations while contemplating multiple billion dollar acquisitions and IPOs. While certainly this is something even the most disciplines founders find themselves dreaming about, the experience is such an outlier it’s not something you can build projections from. However, I do think there is one key lesson entrepreneurs should look at – we are moving into a new “default business model” for consumer software that many of the fastest growing startups are applying to their business.

Specifically, while most consumer software over the last few years was commercialized by serving advertisements (and before that was commercialized by charging licensing fees) increasingly I expect consumer technology to be commercialized by enabling purchases and taking a percentage of the transaction over the next few years.

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By “default business model” I don’t mean that there will not be other ways to commercialize technology or that no one has made money using this model before today. For example, eBay certainly has enabled purchases and built a very large business doing this. However, that was certainly the outlier relative to the number of tech companies who focused on online advertising. What I’m trying to emphasize is that increasingly this will be the default approach to commercializing software.

The Last Shift: License Revenue to Advertising

For perspective, it’s helpful to look at why the last shift from licensing fees to advertising happened. Certainly one of the big trends that drove this was the amount of consumer software that became Internet-enabled. This change and connectivity opened up significant opportunities for targeted advertising to be delivered. It also become easier to monitor and more importantly adapt based on user behavior.

Beyond the technology driver, there was also some market implications that drove this. The market dynamics were succinctly observed by looking at the dominant consumer software business Microsoft focus on advertising. As Robert Scoble said when Microsoft launched adCenter (May 4, 2006):

“So, why does Microsoft care so much about the world that Google is the leader in? Well, cause the advertising industry is a lot bigger than the software industry. Translation: the MBA’s here see a lot more growth potential in advertising-backed software than they do in software that you go to Fry’s and buy.”

It’s also worth pointing out that at that point in 2006 Microsoft revenues were $44 billion and Google revenues were $10 billion ; today Microsoft does about $62 billion and Google does about $30 billion annually. In other words, while Microsoft still earns more revenue then Google the MBA’s were correct – today Microsoft does about twice as much revenue as Google as opposed to doing about four times like in 2006.

Trends Enabling this Change

Just like the last shift, there are both technology and business-model changes enabling this shift. From a technology perspective, the increasing percentage of Internet experiences through mobile devices is one key driver. We have documented the increase in mobile broadband well.

However, there also is a similar market dynamic to the last shift. I imagine a lot of MBAs at Google are saying similar things in terms of the shift from online advertising to commerce. (I imagine this is how Google internally reportedly made the case to acquire Groupon and certainly justified the investments made to develop the recently released Google Offers and Wallet.) While Google and Microsoft both have impressive financials, Walmart did $418 billion of revenue at the end of its most recent fiscal year (1/31/2011). Obviously, it has a very different cost structure than either Microsoft or Google but that just shows how big the market really is!

What Should You Do?

As an entrepreneur, ultimately you need to pick the business model that makes sense for you. However, if my thesis is correct that this is increasingly a default model, it’s important to become more conversant in both the enabling technologies trends and economic drivers of commerce. This will allow you to determine if it makes sense to use it as your next business’ revenue model. Specifically, there are three resources I’d recommend you check out to learn more:

A key enabling technology will be near field communications (NFC). Between increasing the speed that devices can synchronize remotely (think bluetooth without the pairing process) to enabling purchases from mobile devices it’s very likely that NFC will become a core enabling technology for this trend. If you haven’t checked out our series on ReadWriteMobile about NFC I’d encourage you to go read every post immediately!
There are a few books in every industry that represent a number of the “first principals” either explicitly or implicitly understood by most of the market. From people I’ve talked to in the retail business, I understand Why We Buy to be one of these books. It’s worth picking up.
Finally, we’re going to have an outstanding panel at our upcoming RWW 2Way Summit: “Mobile Payments, NFC and Your Future Wallet”. If you haven’t registered for the event, do so today with the promo code PAYMENTS and get $200 off your ticket price. If you want to start to understand the payments part of this equation, you can look forward to insight from Qualcomm, Intuit, Mastercard & Rovio.