The Wall Street Journal reports that `daily deal’ sites like Groupon are dying fast, casualties of the expensive competition for new users. Groupon now spends about $8 to lure one active user.
This looks like a good example of Darwinian competition yielding an inefficient outcome — as we should expect. (See Chapter 8 of my book The Armchair Economist for more on why Darwinian competition is nothing like market competition, and far more likely to yield bad outcomes.) Vast sums are being spent in an arms race with relatively little social value. Surely consumers benefit from all this competition, but it’s highly implausible that they benefit enough to justify such high expenditures. Even after the recent Great Winnowing, about 350 of these sites remain; surely consumers (none of whom have the time to visit 350 sites a day) would be almost equally well served by 50 sites, at about 1/7 the cost.
Most of the time, markets do a spectacular job of allocating resources efficiently. Sometimes they don’t. Often that’s because the market is structured in such a way that one firm (or a very small number of firms) can supply the entire marketplace, which inspires a largely unproductive race to the top. Consumers benefit, but not enough to justify all that resource expenditure.
The market for oranges works well because producers earn rewards commensurate with the social value of the oranges they grow. The market for daily deals seems to work less well (I say “seems” because I might be overlooking something) because Groupon can earn enormous rewards for being just a tiny bit easier to navigate than LivingSocial. This inspires Groupon (and LivingSocial) to invest a lot of resources making minor improvements.
(Sometimes those minor improvements turn into major improvements that are well worth their cost — but that’s not something we can bank on.)
Economists call this the “tournament” problem. It comes up in any market that’s potentially dominated by “superstars”. Athletic competitions, for example, are prone to drain more resources than they’re worth. (See previous blog posts here and here.) Major league baseball is a good thing — it entertains the fans. But if we could randomly eliminate half the players, we’d lower the quality of competition just a little, while freeing up a lot of ex-ballplayers to start businesses, drive cabs, or write sports blogs. The market fails to find that outcome.
The fact that it’s so easy for markets to fail is part of why we should be so astonished, and so thankful, that they typically succeed.