Much has been written about the rapid growth and success of GroupOn. Every week seems to bring a new GroupOn copycat. And it is for good reason— No other startup has gone more quickly from launch to $1 billion+ in valuation except YouTube (12 months), which Groupon achieved in 16 months with its  $135 million infusion  in  April 2010. Just as unprecedented is what  followed  this valuation– after turning down an offer from  Google that valued it at $6 billion  last December, the Chicago firm is now eying a  US$25 billion IPO !

Some would explain this with the ready-to-explode bubble in startup valuations, and others say this is the impact of “Social”. While we see some merit in both arguments, we feel all that is written about Groupon has overlooked a key idea embedded in its innovative business model. We feel GroupOn is at least as much an application of renaissance innovation principles for managing risks of demand. Why?

Most businesses struggle with matching their demand with their ability to serve customers. Many businesses invest massively in building fixed resources but these investments are productive only when there is sufficient demand. Consider a high-end restaurant – the real estate and development costs are massive, and you often see such  restaurants  almost empty on non-peak days (Mondays) even though it may be impossible to get a reservation on the weekend. An owner of one of these businesses would love to see some more demand on slow days. This increases the return on the real estate and other such investments. Typical strategies to achieve higher asset utilization are  special promotions (fixed price menus, etc.)  or  deals on slow days. These strategies are effective in generating some non-peak demand and GroupOn deals achieve the same benefits, but they one-up the traditional promotion by managing the inherent risks in a deal better.

Offering a traditional promotions carries an operational  risk for the business owner. While deals often attract customers to non-peak hours, thus rendering the fixed investments productive, they also decrease  margins! In fact, the margins could be so low that unless there is enough of a confirmed jump in volume, it might not recoup the daily costs of keeping the restaurant open, such as staff, lighting, etc. So with a traditional deal, the restaurant owner faces a dilemma– offer the deal, operate the restaurant at the non-peak hour, and be exposed to the risk of  not breaking even because of insufficient and uncertain number of low-margin customers; or not offer the deal at all, shutter the restaurant and earn nothing on the non-peak days.

The GroupOn deal retains the advantages of promotions but manages the downside risk much better. In particular, a GroupOn deal is on if and only if a large enough group buys or commits to using the deal. Now think of the same restaurant owner. With a GroupOn promotion, he is no longer faced with the prospect of offering a deal that may or may not break even – either the deal will not be on, in which case he can just shut down the restaurant or the deal will be totally on,  i.e., there will be a lot of committed demand for the deal. With a GroupOn promotion, the restaurant owner is assured that he will either break-even on the deal or he won’t open the restaurant– thus eliminating the risk of offering a promotion and loosing money on it. From the customers’ point of view, they have incentives to share the deal with their friends to ensure that the deal is genuinely on, getting some free marketing for the promotion.

Thus, like MyFab, another renaissance innovation we blogged about a few weeks back, a  big advantages of group promotions comes from reducing the demand risk.  And the restaurant owners are very happy to share some of the advantages of this reduced risk with the customers, thus offering even better deals! Go Deals!