During the height of the dot-com boom, the future looked bright for online group buying services.

Newly launched companies such as Mercata.com, Mobshop and LetsBuyIt.com followed a simple business plan: They created Web sites where online shoppers hunting for the same items could place orders together in hopes of obtaining sizable discounts.

It seemed like a great concept. The sites were free for consumers and made money by charging commissions and fees to the sellers of the products. Support was strong from investors, vendors and media. Within a few years, however, virtually all of the services failed. Traffic on the sites slowed after an initial boom. Most visitors didn’t make purchases, and as the number of buyers went down, prices went up.

Now a similar concept—though with important differences—has arisen and is booming in China. It’s called tuangou, which loosely translated also means group buying.

Tuangou services still start on the Web, where they invite shoppers to register for buying events involving certain manufacturers or retailers. Then they organize bus trips to those stores or outlets where participants who registered—often numbering in the hundreds—negotiate discounts as a team. Another key difference: Tuangou shoppers know their final price before making the purchase, and receive their goods immediately. Earlier group buying sites indicated final prices only after purchasers agreed to buy, and deliveries sometimes took weeks.

Divergent Paths

Such differences matter. Two of the biggest earlier-generation sites, Mercata.com in Bellevue, Wash., and Sweden’s LetsBuyIt.com, filed for bankruptcy protection in 2001. A third, Mobshop, discontinued its consumer service in 2001, though it continued selling software for e-commerce.

Of the more successful tuangou sites, meanwhile, Shanghai-based Liba.com, founded in 2003, says it has 1.6 million members, 300,000 unique visitors per day on its Web site, and some 30,000 transactions a month during team buying events in major Chinese cities such as Beijing, Shanghai and Guangzhou. Teambuy.com.cn, founded in 2006 and based in Guangzhou, says it has more than 100,000 members and arranges team buying events in 48 cities in China. Neither company has released profit or revenue figures. The founder of Liba.com, Zhang Guohua, says his company has no plans for an IPO, but he doesn’t rule it out. A spokesman for Teambuy says the company is considering an IPO. A third tuangou site, taobao.com, is a subsidiary of Alibaba Group, a Chinese Internet company that is 39%-owned by Yahoo Inc.

To be sure, tuangou’s success owes much to China’s culture and still-developing markets, where group haggling is common and transparency in retail prices is not. The tuangou model will have to evolve as Chinese markets mature, and if it is to be exported to the West. A handful of new online services are already attempting this in the U.S. and Europe.

But tuangou represents a significant step in the evolution of online group buying as a whole, and contains insights that may help unlock the commercial potential of perhaps the biggest phenomenon on the Web: social networking. As these networks become the way younger generations interact with each other socially (and maybe even professionally), the potential for buying and selling over these networks in the near future cannot be neglected. Lessons offered by tuangou suggest there are enormous opportunities for online services that are able to position themselves as intermediaries as people increasingly connect in online forums and social networks and demand more value via collective bargaining.

Comparing Models

The key differences between tuangou and earlier group buying sites can best be seen by comparing six standard components of business models.

BASIC STRUCTURES: In its earlier form, online group buying services would initially negotiate with vendors on a range of prices for each item that fluctuated depending on the number of final purchases. Some service providers even owned the inventory, managed the warehouse and shipped the products to individual customers. Such a strategy was risky because the number of customers interested in a certain product was unknown in advance. Unwanted inventory and excess costs resulted.

A tuangou service acts as an intermediary between vendors and shoppers. The service coordinates with the vendors on available goods and schedules for team buying events. The number of service members registered for each event is known in advance and communicated to the seller. Sometimes the seller will announce a discount in advance, based on expected attendance. The tuangou service has no inventory.

SETTING OF PRICES: The earlier services agreed with vendors on a range of discounts linked to the number of buyers by a deadline set usually one to two months in advance. For example, if the retail price of a digital camera was $899, the sale price would be advertised on the site as $689.95 if there were no more than 25 buyers by the deadline; $679.95 for 26 to 200 buyers; $659.95 for 201 to 500 buyers; and so on. A shopper wouldn’t know the final price of an item until the deadline had passed and purchasers were tallied. Discounts of as much as 40% were sometimes possible.

Tuangou services occasionally announce the size of a discount on the site ahead of a scheduled buying event, based on registered participants. But they mostly leave negotiations to the shoppers, who choose leaders from among themselves to conduct the bargaining. Typical discounts are 10% to 30% off the manufacturer’s suggested retail price. Shoppers know the final price before buying, which is essential for a good consumer experience.

SOURCES OF REVENUE: Group buying sites were free to customers. They generated revenue by charging vendors fees based on the number of clicks on the site, and commissions per transaction. Traffic and purchasing rates thus were critical.

Tuangou sites are also free to customers. Sellers pay the services a nominal fee to register on the sites. The sites also charge for advertising. In some cases, tuangou services provide additional Web page design and postings for fees as well. These value-added services are critical to tuangou’s success in China, where most midsize retailers lack the resources and experience to do professional Web design work themselves.

COST OF ACQUIRING CUSTOMERS: Because online group buying was an untraditional concept, it had to be explained and justified to customers. This made the cost of acquiring each new customer more expensive than in traditional retailing. Mercata.com, for example, offered each new customer a $100 credit to shop on its site.

The tuangou services are also relatively new, making customer-acquisition costs high compared with those for retailers in China. But most tuangou sites try to limit those costs by relying on word-of-mouth and blogs to create awareness—a strategy that was less available to the earlier group buying services because blogs and social networks were still relatively new at the time. Also, the concept of collective haggling requires virtually no explanation in China.

APPEAL TO CUSTOMERS: In group buying, the discounts could grow as more buyers committed.

But choices of products were limited, and delays in delivery detracted from the consumers’ experience. The main sites limited their product choices mostly to consumer electronics. Sites that handled their own inventory further limited their products to reduce the risk of overstocking.

In tuangou, negotiating skills are important. But vendors’ willingness to lower prices is often primarily driven by volume, or number of units being sold. To that end, tuangou services allow friends and family of members to register for some events without becoming members themselves. There is also no obligation to purchase anything.

Providers also offer a much greater variety of products and services to their members, with a heavy focus on more expensive, planned-purchase types of goods, such as home appliances, remodeling materials and cars.

APPEAL TO VENDORS: The earlier services helped sellers increase revenue and lower marketing and inventory costs.

Tuangou basically does the same. In China, where retailing is still a fragmented market and product and pricing information is not easily accessible or comparable, the services also offer a way for retailers to promote goods and services.

Prospects in China and the West

While tuangou services appear likely to continue to prosper in China for the short and medium term, their long-term success is questionable due to the rapidly developing market there for consumer goods.

As retailing becomes less fragmented and advertising expands, there will be more ways for shoppers to compare product and pricing information. This could reduce the appeal of team buying events, which sacrifice some convenience in return for good prices and access to noncounterfeit goods. Collective haggling and assurance of quality products are likely to assume less importance, too, as retailers, superstores and discount clubs strengthen their presence and the Chinese government beefs up consumer-protection laws.

To sustain growth for the long term in China, tuangou sites may need to offer more value-added services, such as independent product reviews and pricing data to help consumers make buying decisions.

To succeed in the U.S. and Europe, meanwhile, will require basic changes that recognize cultural differences and the more advanced consumer marketplace. The value placed on convenience, for example, would seem to exclude team buying events. Also, collective haggling is an alien concept for consumers and vendors.

A handful of new services in Spain, the Netherlands and the U.S. are trying to bridge these gaps, some with sites still under development that promise to negotiate prices on behalf of members and that invite vendors to engage in competitive bidding for customers. Netherlands-based UnitedConsumers.com, launched in 2007, says it negotiates price breaks on insurance, phone service, gasoline and utility bills and has some 40,000 participants a year.

Tuangou and Social Networking

The much bigger prize in the long run may be figuring out how to take lessons learned from tuangou and use them to tap into huge potential customer bases found in social networks.

According to the Web tracking firm comScore Inc., the most popular networking sites, MySpace and Facebook, each had more than 100 million users in January. The behavior of these users could generate innovative business opportunities for group buying and tuangou services in the near future. Businesses can identify groups and subgroups on these networks and use text-analytics software to comb through profiles and posted messages to spot new youth trends. The buying services can use statistical methods to identify groups interested in certain products or services, such as personal computers or car insurance, even students posting messages about spring-break vacations. The buying service can then approach members of these groups with prenegotiated deals tailored to them.

Services also can try to identify “leaders” of subgroups, or people likely to influence decisions of others, and provide incentives for them to recruit new members to the buying service. Positive effects can snowball as more members join, making greater discounts possible, which leads to further recommendations and recruiting both on the network and on personal blogs. As word spreads, it becomes a powerful mechanism for acquiring new customers at no cost. Moreover, the growth potential is exponential.