Back in December, Google offered $6 billion to buy Groupon. My response was, “what’s Groupon?” I investigated Groupon and as I did I learned Groupon rejected the buyout offer from Google.

Groupon is a private company, and so not much is known about how much money they make. But the word on the street is Groupon’s sales are growing faster than Facebook’s did. And when you reject an offer from Google in the billions of dollars, you’re sending a clear signal to the world that you intend to be huge. So what is Groupon?

Groupon was started by Andrew Mason after he got some start-up money from a former employer, Eric Lefkofsky. Groupon works with local businesses and uses the power of the internet to promote them. The idea is simple and easily illustrated with an example.

Let’s say I’m an idiot and think that the future is in overpaying for cupcakes. I have a cupcake shop in DC, we’ll call it “Carus Cupcakes” (Latin for overpriced). Business is decent, but I’m really looking for a way to drive in major traffic. One day, a Groupon rep calls me and asks if I’d be interested in doing one of their daily deals. She suggests we offer a deal of $20 of goods for $10. I agree, since either my markup is more than that, or I’m willing to eat a loss to drum up traffic.

Groupon will list the deal on their site, and Groupon users will buy the deal for $10. They can then take their code, or coupon, or whatever down to my store and get $20 worth of overpriced cupcakes for $10.

So where does Groupon get their cut? Well the transaction takes place through Groupon. When someone buys that $10 deal, Groupon might take a dollar and pass $9 onto the business, in this case my budding Carus Cupcakes. The terms are likely a negotiation, and I couldn’t venture to guess how much Groupon takes. But because Groupon is so huge, they are able to get huge interest in local businesses and make money doing it. Quite a brilliant business model that is relatively new, but not brand new.

There are other details to the Groupon deal. Enough people have to sign up for it to be valid. Maybe I want 50 people to sign up for the cupcake deal before it becomes valid. Once it does, the deal is on (so they say). Business owners are happy to embrace Groupon for the promotional aspect. The cost is clearly competitive to traditional advertising and you can measure the direct impact to sales and business because of the customers coming in to cash in on the deals.

But companies can also use Groupon to increase profits, not just foot traffic. For most businesses, they must obtain materials at a specific cost. They can often get those materials an a cheaper basis (per unit) if they buy more. It’s known as a bulk discount and is the same reason you buy lots of stuff from Sams or Costco. A company could use Groupon to generate enough business to make it worth their while to step up the bulk purchasing at a cheaper per unit discount. For Carus Cupcakes, it might be cream, sugar, or flour.

Groupon uses the power of the masses to create deals that benefit the company, the customer, and themselves. They’ve created a middle man that takes a cut and connect customers with businesses at the same time. This business has lots of room to grow, but also has a theoretical cap. It’s not creating a new market, it only supports existing ones. It’s also an easily copyable business model, and there are many competing sites running now. Facebook and Google created new businesses (or copied and dominated new businesses). Groupon will likely not be able to get as large, and would have suggested selling to Google or anyone else interested in buying at the right price.

I wish them the best though, and at least now we know how they work.

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categories: business, technology