Deriving value from social commerce networks

MANAGERIAL ECONOMIC ANALYSIS OF SOCIAL COMMERCE

Research Paper

Managerial Economic Analysis of the Impact of Social Commerce on E-commerce

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Student

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Professor Thomas C. Makemson

BUSN 6120, Managerial Economics

Spring 1, 20XX

Section: XX

Webster University

March 2, 20xx

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Today, Facebook, Linkedin, Twitter, MySpace are well-known social networking brand names that many of us have grown accustomed to making part of our daily routine, whether it be for staying in touch with friends, networking, or micro-blogging. Social networking tools have the potential to revolutionize e-commerce as we know it today through “social commerce” platforms. A 2011 study by Booz & Co estimates that social commerce is currently a $5 billion market with the potential to grow to $30 billion in five years. Social commerce's transformational power lies in its personalization of the internet experience, connectivity with an individual’s network, and the dynamic customer data collection that can drive current and future marketing and sales efforts. In this paper, the author will introduce the social commerce concept, examine the social commerce market, explore the effect of social commerce on consumer behavior, discuss social commerce pricing strategies and valuation of social commerce networks, evaluate the industry concentration and look at the future of the social commerce.

What is Social Commerce?

Even though today we equate social networking with Facebook and Twitter, social networking itself is not a brand new concept. “Early forms of social networks include the guilds in medieval Europe, trade groups, and unions, which can be traced back to the early 18th century, and more modern venues like the Chamber of Commerce and Rotary Clubs, which have emerged over the last 10 decades as accepted forums for professionals in similar industries and business communities to meet and further commerce, business relationships, and advocate for changes in business practices”. These early systems evolved into the social networks of today and more recently integrated with modern e-commerce capabilities to develop a new marketing and sales channel known as social commerce.

Because it is a nascent field, the term “social commerce” has many definitions depending on consumer and provider viewpoints. However, the author has chosen to use this definition throughout this paper: social commerce is a “subset of electronic commerce that involves using social media, online media that supports social interaction and user contributions, to assist in the online buying and selling of products and services”.

Today, social commerce is a field that allows firms to harness existing social networking platforms to personalize sales and advertising experiences based on reviews, ratings, recommendations, networks, personalized groups, and location. Vendors are able to provide individualized platforms and encounters driven by data provided through external social networking sites or internal data collection.

Groupon is an example of a social commerce firm that uses internal and external data collection to provide users with coupons for businesses local to a user. Groupon allows users to submit gender, biographical data, residence location information, favorite industries (e.g. health and beauty, food and drink, or retail and services stores), educational background, employment status, income range, home ownership, marriage status, and children status. Combined with analysis of past purchases through Groupon, this sociographic data provides the firm with a wealth of knowledge to predict a user’s spending habits. Therefore, this information allows Groupon to present coupons/deals based on predicative analysis, which is analogous to the “Customers Who Bought the Item You Added Also Bought” feature on Amazon. Groupon customers can also easily share coupons by email or social networking sites (i.e. Twitter, Facebook) by clicking on the share feature located on each potential coupon page (See Figure 1).

( The Facebook “Like” button )

Figure 1: Screenshot of Groupon.com based on selection of Baltimore, Maryland as a home location.

Firms like Resource Interactive have developed end-to-end marketing solutions for companies looking to take advantage of social commerce platforms. Through their “Resource Distributed Commerce Platform”, Resource Interactive provides their customers with a vehicle to engage in Facebook Commerce (also known as “F-Commerce”), where firms can sell their merchandise through Facebook status updates and tab stores. Resource Interactive manages over 18 million of their clients’ fans on Facebook and use this data to drive develop fan engagement, brand loyalty, and social commerce strategies. Figure 1 above shows the “Like” button seen on many websites today and with the over half a billion Facebook members worldwide, the market potential of firms that engage in F-commerce is tremendous.

Social Commerce Market Analysis

In this section, we will conduct a social commerce market analysis, specifically decomposing the supply and demand potential for this marketing and sales platform. According to Social Commerce Today, currently, there are more than 2 billion internet users worldwide and this figure presents a tremendous market opportunity as people on average spend 30% of leisure time online.

Many demographic groups also present opportunities to exploit their social networking habits for social commerce revenues. For example, among 11-14 year olds, high-use social networkers (defined as accessing social networking sites three times a day or more) are “50% more likely to be asked for advice by their school friends about toiletries and cosmetics, 40% more likely to be asked about mobile phones or fashion, and 20% more likely to be asked about new music.”

According to Facebook, more than 250 million people engage with Facebook on external websites every month. Moreover, an average of 10,000 new websites integrate with Facebook every day and more than 2.5 million websites have already integrated with Facebook. Furthermore, the “Like” button feature for websites unveiled by Facebook in 2010 has presented higher website traffic and increased sales after websites installed the tool. This tool lets users signal their affinity for a brand, item or product and broadcast that back to the social networking site. As an example of the power of the Like button tool, a film database website saw its traffic double since it installed the Like button throughout the site. Separately, Facebook is tasking its members to use the Like button in an effort to compile smart search engine using “likes” to determine what is most relevant on the web, which is in direct competition to Google’s algorithm search method.

Social commerce is also attracting additional share of overall marketing budgets. A recent American Marketing Association and Duke University’s Fuqua School of Business survey predicted that social media advertising will account for over 18% of total marketing budgets in the next five years (See Figure 2). In addition, this survey indicated that service companies (See Figure 3) are planning the biggest social media advertising increases, “as both B2B and B2C service companies have a higher percentage of their budgets set aside for social media than their product-focused counterparts” (eMarketer, 2011).

( Figure 3: Source (eMarketer, 2011) ) ( Figure 2: Source: (eMarketer, 2011) )As mentioned previously, a 2011 Booz & Co study indicated that the social commerce market is estimated to grow to $30 billion by 2015 (See Figure 4). The $30 billion estimate scratches the surface for social commerce’s market potential as it only estimates hard goods sold through this platform. The services industry has a great deal of potential in the social commerce space, especially in cases where existing technologies can be integrated as in the case of mobile phone internet and social media advertising. Booz & Company also conducted a separate survey in 2010 focusing on consumers who spend at least one hour a month on social networking sites and who had bought at least one product online in the last year. This survey indicated that 27 percent of respondents said they would be willing to purchase physical goods through social networking sites.

Figure 4: Source is Booz & Co. (2011, Jan 19). Turning “Like” to “Buy” Social Media Emerges as a Commerce Channel.

When compared to Booz & Co’s estimated social commerce current and future market levels, U.S. consumer aggregate spending in 2009 provides an indication as to the growing importance of social commerce across discretionary spending categories. Table 1 illustrates a hypothetical situation where social commerce could have the potential to account for over 35% of the Apparel and Services (Girls, 2 to 15) market today and 1.54% of the entertainment market. Table 1 also shows 2015 estimated social commerce market figures compared to 2009 consumer expenditures to illustrate the growth potential of social commerce based on current consumer expenditures.

Item

U.S. Consumer Aggregate Spending in 2009

U.S. Social Commerce Market as % of 2009 Aggregate Spending (Est. 2011 Levels of the Social Commerce Market)

U.S. Social Commerce Market as % of 2009 Aggregate Spending (Est. 2015 Levels of the Social Commerce Market)

Average annual expenditures

$5,929,795

0.08%

0.24%

Apparel and services Total

$208,496

2.40%

6.71%

Apparel and services (Girls, 2 to 15)

$14,219

35.16%

98.46%

Apparel and services (Boys, 2 to 15)

$9,499

52.64%

147.38%

Entertainment

$325,412

1.54%

4.30%

(Aggregates in millions of dollars)

Table 1: Source: 2009 Consumer Expenditure Survey, BLS.gov

Demographics of social media users also plays an important role for retailers and marketing staff as they aim to harness the power of social commerce. A recent Gallup poll found that both Google and Facebook pages tend to attract young, affluent, and educated Americans disproportionately (See Figure 5). The study found men and women are about equally likely to have a Facebook page. Gallup also highlighted the overlap of new services between Google and Facebook as a source of increased competition for the two internet innovators. Gallup cites Google’s recent announcement that “will more prominently display ‘social search’ results akin to Facebook's ‘like’ and ‘share’ features, and it also has its own social networking feature, Buzz.” Facebook is following suit by including in-site chat and e-mail options to meet Google on its own turf. This survey sheds interesting light on social media users and could be followed up with a study focusing on non-U.S. users of Facebook and other social media sites considering that 70% of Facebook’s users live outside the United States .

Figure 5: Source: Gallup.com; “Google and Facebook Users Skew Young, Affluent, and Educated” (Morales, 2011).

Effect of Social Commerce on Consumer Behavior

Consumers operate in a world with imperfect information and must make purchase decisions based on that imperfect information. As such, these transactions involve risk on the part of the consumer, especially for new products. Attitudes toward risk vary among consumers with some consumers acting as risk loving, risk neutral, or risk averse. Most individuals are risk averse in situations with nontrivial outcomes. Therefore, the author will consider that most consumers in the U.S. are risk averse as they consider most of their nontrivial purchases of discretionary and non-discretionary goods.

Given the risk averse nature of U.S. consumers, social commerce provides a mechanism to reduce consumer uncertainty by exploiting their social networks as they consider factors like product quality. As an example of the power of networks on purchasing decision, a 2010 study was conducted by Varsity and published by eMarketer.com (See Figure 6). It showed that when purchasing clothing or footwear, 81 percent of girls, ages 13 to 18, use their friends and peers as a source of trend information and 45 percent list this group as “very influential”. Therefore, the girls surveyed appear to relying on their social networks to lower their uncertainty prior to making purchases.

Figure 6: Source: How to Influence Teen Girls Online; www.eMarketer.com

Social buying sites like Kaboodle, take advantage of these risk averse and imperfect information considerations that consumers face. Kaboodle is a social shopping site where networks can recommend, share products, discover new products from people with a similar style. Members of Kaboodle also “create and join groups, share advice, feedback and product suggestions and personalize their profiles with polls and other widgets”. As of February 2011, Kaboodle had over 14 million monthly visitors and had over 900,000 registered users that have added 10 million products to the site.

Another retailer, Wet Seal, harnessed the power of social commerce by developing a social buying experience through a “virtual runway where site visitors can put together outfits to share with their friends or to present to the community to be voted on. A pair of friends shopping at Wet Seal can use a service powered by Sesh.com to view the same product pages, chat in real time, and use a drawing tool to notate or highlight products they are considering”.

In summary, social commerce sites can help minimize consumer perceived risk and lower consumer search costs. Going beyond traditional price comparison sites, social buying sites can further reduce the reservation price for consumers, who can now also take their friend’s advice on searching for a particular good when deciding whether to purchase from a particular store at a certain price or continuing to searching for a lower price.

Pricing Strategies used by E-commerce and Social Commerce Firms

Amazon, one of the major pioneers of e-commerce, has continued to innovate the online retail space through the integration of social commerce into its sales and marketing mix. Amazon recently invested $175 million in and partnered with the social commerce firm, LivingSocial to draw customers to the Amazon.com site. LivingSocial is similar to Groupon in that they provide users with coupons based on their location. Unlike Groupon, LivingSocial does not offer users to provide deeper demographic information as part of their customer intelligence system. Instead, LivingSocial provides one deal in a user’s area per day. The site encourages users to share the deal to their contacts by offering users the “deal of the day” for free if three additional contacts purchase the deal through a unique link that a user shares with them. To generate buzz, in late January 2011, LivingSocial partnered with Amazon to provide shoppers with a $20 Amazon.com gift card for just $10. LivingSocial sold 1.3 million Amazon gift cards in this promotion.

Social commerce firms are still in their infancy even compared to the e-commerce giants that arose following the internet evolution in the mid-1990s. However, by joining forces with existing e-commerce sites, social networking/commerce firms have developed pricing strategies that indicate that they have market power. Social commerce companies are also able to use that market power to charge higher and vary markups among groups through mechanism such as price-discrimination.

A 2006 study looked at the price-discrimination question as it relates to the e-commerce sites and specifically, choices that Amazon makes in an effort to “empirically assess the optimality of their [price-discrimination] choices” (Ghose & Sundararajan, 2006). To conduct the price discrimination evaluation, the team converted the “sales ranks” reported by Amazon.com into actual demand levels by estimating how the variation in prices was associated with variation in demand. They then took random “samples” of data by checking prices at random times over a set time period. They specifically looked at software packages for sale on Amazon. One of the examples presented in the paper was their study of the sale of the Microsoft Office suites (Professional and Standard suites). The study found that that the sign of the own-price elasticity of the difference suites were positive while the signs of the cross-price elasticities were negative. The study also found that the sales of products decrease over time. The group discovered that the “cross-price elasticity of the Professional version of Microsoft Office with respect to the low-quality [Standard] version (p-standard), was actually higher than the own-price elasticity” (Ghose & Sundararajan, 2006). This result highlighted that in the Amazon case, Microsoft Office Professional was very sensitive to the price of Microsoft Office Standard. Furthermore, to demonstrate their test model for the optimality of pricing, the team used estimates for own- and cross-price elasticities derived for both the Professional and Standard versions of Microsoft Office. The estimated derivative of profits of each version were negative, which suggested that they were both overpriced, “since they are priced at a point where the slope of the

profit function is negative” (Ghose & Sundararajan, 2006). This study shows that it is possible to analyze price discrimination and price elasticity models for e-commerce sites and should be followed up with further research on the effects of social networking/commerce firms on price discrimination and price elasticity of e-retailing. This could help firms develop better pricing models and increase revenues.

Because they have market power, e-commerce firms like Amazon can partner with social commerce companies to introduce additional third-degree price discrimination strategies into their sales mix. For example, some social commerce sites use a “group buying” technique where a specific set of consumers must “buy-in” to a particular deal to get a particular discount and occasionally, the higher amounts of deal-takers result in higher discounts. Through the use of “group” buying, social commerce firms are able to give discounts to users that have ready-made networks of contacts that can be exploited to generate additional revenue. For example, it is less economical for a retailer to discount a product by 10% (thereby reducing profit margins by 10%) to just one consumer, but the same firm could benefit from economies of scale if the one consumer resulted in bringing in an additional 50 buyers, all with a 10% discount. While profit margins have shrunk on individual sales in this scenario, the increase volume from “group” sales to 50 buyers can more than make up for the decreased margins.

Moreover, e-commerce sites can “reward” social commerce users with deals based on how much detailed information they provide as part of their customer profile, the amount of “Likes” used on Facebook, and through mobile internet positioning. In summary, price discrimination is a powerful tool that can be used to increase revenues for both product and service companies that partner with social commerce firms.

Deriving value from Social Commerce Networks

A mid-2010 study in the Journal of Marketing Research (JMR) examined the question of how firms can derive value from social commerce networks. The study considered the following questions: Does allowing sellers to connect to each other create economic value (i.e., increase sales)? What are the mechanisms through which this value is created? How is this value distributed across sellers in the network, and how does the position of a seller in the network (e.g., centrality) influence how much the seller benefits or suffers from the network?

The study found that by allowing sellers to connect generates considerable economic value and that the value primarily is linked to making stores more accessible to customers browsing the marketplace (i.e. a “virtual shopping mall”). Interestingly, the study also found that “sellers that benefit the most from the network are not necessarily those that are central to the network but rather those whose accessibility is most enhanced by the network”.

Social commerce industry concentration and possible vertical and horizontal integration possible scenarios

Two of the top three social networking sites, Facebook and Twitter, have received a great deal of attention lately as buzz increase about possible IPO scenarios. Concerns with possible horizontal or vertical mergers could follow closely behind as these sites enhance their current monetization efforts. These monetization strategies become more important as the number of social network users continues to grow in leaps in bounds.

In early 2011, Goldman Sachs and Russian investment firm Digital Sky Technologies invested $450 million and $50 million, respectively. Digital Sky Technologies previously invested $500 million in Facebook and places an overall $50 billion value on Facebook. Facebook has estimated revenues of $2 billion annually.

A separate valuation of Facebook by Seeking Alpha contributor, Albert Babayev, states that “Goldman Sachs [is] paying 25x-28x revenues for [Facebook], while Google and Apple are getting 4-8x revenue [for their own companies]” (See Figure 7). Babayev projects that Facebook’s current stock value of $25 will grow to $111 by 2014. Babayev bases this valuation on membership growth rates (expected to hit ~1 billion users by 2014), revenues (from advertising, gifts, credits, etc), operating margins, tax structures, and earnings. Babayev states that “Facebook did something no other company has ever done. They somehow managed to take control of 600 million users, placing just about every corporation and organization at Facebook’s behest. A minimal fee structure for the corporations to reach these customers, increases valuations by hundreds of millions”. Furthermore, with a current estimated 2 billion internet users in the world, Facebook would account for roughly 30% of all internet users today.

( Figure 7: Source: How Much Is Facebook Really Worth? (Babaye, 2011 ) . )http://static.seekingalpha.com/uploads/2011/1/7/801945-129441080228704-Albert-Babayev_origin.png

As another example of the growing potential value of social networking sites, Twitter was recently valued at $4 billion by J.P. Morgan Chase, who is currently in talks with Twitter Inc. to take a minority stake in that firm. Twitter is still working on monetizing its business and is estimated to generate about $150 million in revenue in 2011, versus Facebook’s revenue projections of $4 billion. Twitter boasts 200 million users, but some estimates place active accounts within the U.S. at only 16 million. According to a recent WSJ article, the “best hope for J.P. Morgan's fund may be if Twitter is acquired. Google and Facebook may be interested. Facebook's popular status updates are threatened by Twitter. And Google trails badly in social media”.

A possible horizontal merger between Facebook and Twitter could present interesting HHI implications as Facebook is the king of social networking sites and Twitter rules the microblogging subspace in that market. Based on estimated user counts, a combined Facebook-Twitter firm could potentially reach 40% of all internet users (a 33% increase over Facebook on its own). Moreover, as discussed previously, Booz & Co’s study on the social commerce market estimates it at $5 billion worldwide. With Facebook’s projected revenues for 2011 heading toward $4 billion, the HHI in this industry is very high. If we consider Facebook and Twitter revenues in the HHI equation (i.e. 10000*(4/5)^2+(.2/5)^2), the HHI value is 6416. As such, horizontal merger activity by Facebook would likely bring on attention from Federal Trade Commission anti-trust regulators.

Figure 8 provides another example of Facebook’s reach and market size, which demonstrates how any major horizontal merger activity would likely draw regulator attention. Developed by a Facebook intern in late 2010, the map provides a visualization of users and connectivity around the world.

Figure 8: Source: Visualizing Friendships, Facebook.com (Butler, 2010)

A possible vertical merger (or conglomerate depending on how the combined firm was to be structured) could exist between Facebook and a major smartphone (e.g. Blackberry) or wireless cell phone provider. By combining a smartphone’s wireless internet and geolocation capabilities and Facebook’s growing social commerce business, a company could develop some very interesting and potentially lucrative synergies of effort in the social commerce space.

Mobile internet: The future of social commerce

Recently, AT&T announced the creation of a location-based marketing service where local companies can send text messages to cell phone users who choose to receive special offers. This program is called ShopAlerts and relies on a location system called a “geo-fence”. In this geo-fence, marketers can develop ads based on user location and aim to increase interest based on proximity. Estimates peg spending on US mobile ads approximately $743.1 million in 2010 and are expected to grow 48% in 2011 to $1.1 billion.

Figure 9: (Reese, 2011).

Social networking and social commerce have also integrated their services with mobile internet capabilities. Foursquare, one of the leading social networking/commerce, is a location-based mobile internet application that allows friends to “check in” to a location and share that location with friends. Once “checked in”, users can see what friends are in the local area and can be approached with deals by merchants in their vicinity. Users also can receive “badges” and other discounts to award them for return visits to business locations. As of February 2011, foursquare had over 6.5 million users (Foursquare, 2011).

The integration of wireless internet technology and social networking/commerce platforms provides the consumer with a completely customized shopping experience. Advertisements can be tailored to not only an individual’s location, but to their patterns around town. The delivery of these proximity “deals” offers a new stage to attract a growing “mobile” population. As indicated in JMR study on valuation of social networks discussed previously, sellers that benefit the most from the network are those whose accessibility is most enhanced by the network. The customized and targeted vehicle that social commerce platforms like foursquare offer, serve to enhance that accessibility. These systems also have the potential to drive significant additional revenue for retailers and social commerce vendors.

Conclusion

This paper provided an introduction to social commerce concept covering an analysis of the market, the effects of social commerce on consumer behavior, pricing strategies industry concentration and look at the future of the social commerce as mobile internet technologies are further integrated. Social commerce is a nascent and evolving field with a great deal of room to grow across all markets. Furthermore, as mobile internet and e-commerce services penetrate deeper into emerging markets, the growth prospects for social commerce increase dramatically. Seventy percent of Facebook’s users based outside of the U.S. and many developing economies have developed regional/language-specific social networking sites. Integrating these non-U.S. social networking sites into effective social commerce platforms could drive unprecedented future e-commerce sales growth in these largely unchartered waters.

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