Social commerce gone completely crazy

Social commerce has been regarded as a blue ocean for the Internet and businesses in the sector have made headlines for drawing huge investment. While they are continuing to spend to increase bulk, an increasing number of people are questioning when they will start making money.

Market growing in bulk, not profitability

The idea of social commerce, where products or services are sold at a huge discount when a certain number of consumers gather, has fascinated both businesses and customers. According to the Korea Information Society Development Institute, the local social commerce market is expected to reach 500 billion won in transactions this year from 50 billion won in 2010.

The huge numbers, however, has nothing to do with profitability. None of the big three local players in the industry, Coupang, Ticket Monster and We Make Price, are operating with a net profit.

It seems certain that they are all in deficit. “We expect to turn things around by the end of the year,” Hur Min, head of We Make Price, said at a meeting with the media last week, proving that businesses are still in the red. “I don’t think the other companies are making money,” he added.

Ticket Monster CEO Shin Hyun-sung refused to give its total sales or profit at his latest meeting with the media. “Profit depends on marketing, sometimes we make profit, and sometimes we are in deficit,” he said.

The firms generally see around 15 to 20 percent of transactions as sales commission. On this calculation, their commission income is estimated to be between 3 and 4 billion won a month.

Meanwhile, they are pouring in money into marketing. In May, Ticket Monster spent 907 million won on TV advertising, and Namu Internet, which operates Wemakeprice.com, spent 777.6 million won. On top of running TV advertisements, they have Internet banners, and are putting ads on buses.

“They have moved away from social commerce marketing, the viral marketing through social networks,” said Kim Yoon-hwa, a researcher at KT Research Institute. “Like a prisoner’s dilemma in game theory, the others have to follow if any of them spend on advertisement. Except for the big three or four in the industry, the rest are likely to be acquired or close down,” she said, adding that the vicious circle of the current marketing war would continue even when only three or four remain. “Consumers will be shouldering the marketing expenses, in the end.”

On top of advertising, they are even selling at a loss. They are lowering commission to attract competitive products or services for their deal, and sometimes paying for the chance. “If an item is sold at a 50 percent discount, the manufacturer shoulders 30 percent and the social commerce firm, 20 percent,” Hur of We Make Price said. “I really want to look at the accounting books of these businesses,” he added, saying they are operating at loss.

As social commerce businesses continue pouring money in without reaping fruits, the market is wondering if they intend to sell the businesses off after expanding their size.

There was one rumor that Ticket Monster will be sold to Living Social of the United States, which is planning to advance into the local market, and another rumor that Coupang will be acquired by Groupon. Both of them deny this but the rumors continue.

Replicating Gmarket jackpot?

Unlike Hur, some people in the industry say that they are doing the right thing, that being at the top of the new industry is crucial, and that profit will follow after a few years. They cite the open market as an example. According to open market operators, however, this can be both right and wrong.

“We were in deficit until 2004. From 2005, we started making money,” said a representative for Gmarket, the country’s leading Internet open market. “This industry needs a sizable transaction to enjoy the economy of scale, when considering operating costs, marketing expenses, and commission paid to portals. I think social commerce is similar in this regard. It should build up a sizable number of consumers first to benefit from advertising and sales of an item,” he added.

The investors, Oak Investment and Yahoo, made a lot of money, as Gmarket, whose shares had a face value of 100 won, was listed on the Nasdaq at $15.25. This may be what foreign funds that poured money into local social commerce businesses are expecting.

However, the situation isn’t quite the same for social commerce. First of all, Gmarket had virtually no competitor at that time. “People came to understand that an open market makes money...CJ also opened an open market in 2006 but it closed down after two years. The market had become one where you can’t make money without achieving economies of scale.”

Gmarket was also lucky in all aspects of timing. “It was the time when offline fashion malls were in trouble. We attracted small garment vendors from Dongdaemun...Before then, few people were expected to buy clothes online as they can’t try them on, but the development of the Internet as well as parcel services all coincided to trigger explosive growth in 2005,” he explained.

New business model needed

Kim of KT Research Institute said that social commerce businesses should set up an advanced business model instead of focusing on marketing.

“When Groupon started social commerce, it caught people’s attention with 50-percent discounts, and the commission was high at 20 percent. The social market through Twitter and Facebook helped it cut costs in marketing,” she said.

“As it came to run advertisements like conventional Internet companies, excessive marketing costs were incurred, leading to huge deficits,” she said, adding that local social commerce businesses, which benchmarked Groupon are facing the same problem. Groupon is planning an IPO, but talks of a bubble are continuing due to the deficit.

“The kind of group sale prevalent in the local market is the lowest level in the development stages of social commerce. An evolution to more diverse and “social” commerce that incorporates communities or portals is needed,” Kim said, citing social commerce services overseas that are being linked with mobile applications or location based services.

Local players are preparing similar services, though profit models still aren’t clear. Coupang is planning to launch “Coupang Time,” a location-based service offering coupons in real time, expanding the service to “time deals” from “daily deals.”

We Make Price, meanwhile, is seeking transform into a regional portal. “I still don’t have concrete plans on how to make money...I have confidence that profit will follow when we launch services that people haven’t seen,” Hur said, adding that the regional portal service is aimed at competing with the country’s top portal Naver in the end.

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