The industry has exploded with thousands of sites trying to get their piece of the pie. Surely, the emerging market is a gold bonanza as numerous Chinese consumers group together in their hunt for bargains ranging from cosmetics discounts to gym memberships.

Low entry barriers and a simple business model are also part of the reason for the collective buying spree. Web designing software similar to Groupon, a few technicians and marketing employees, and around 2,000 yuan ($312.5)—that's all it takes to start up a group buying website.

By August 28 China had 5,595 group buying websites, skyrocketing from 2,612 in 2010, according to data from Goutuan.net, a group-buying aggregator and an Internet search engine. The sales revenue totaled 6.058 billion yuan ($946.6 million) in the first half of 2011, compared with only 2.4 billion yuan ($375 million) for 2010.

Lashou.com leads the market with a share of 19 percent. It was followed by 17 percent of Meituan.com and 16 percent of Manzuo.com.

Despite a significant market boom, the prospect of the industry is somewhat overshadowed by a series of problems as smaller websites scramble to win customers by fair or foul means.

Common tricks include huge discounts for overpriced products and fabricating the number of consumers involved in a purchase to attract more buyers.

Goutuan.net said it received 911 complaints about group-purchase sites in June, including fake or substandard products, delayed deliveries and price cheating.

Gaopeng.com, for example, admitted to cheating on a prize drawing. On May 4, Gaopeng announced that people who visit its micro blogs and forward its posts will have a chance to win an iPhone 4 through a lucky draw. More than 110,000 people participated in the activity, and the winner was found to be an employee of Gaopeng.

"The market disorder is attributable to a lack of government regulation and supervision," said Xue Shengwen, a senior researcher at the Shenzhen-based think-tank CIConsulting. "The companies should shoulder their social responsibility and put focus on service quality and innovations."

Red flags

The cutthroat competition led to a fierce price war in the overcrowded sector. Many powerful competitors are even throwing tens of millions of dollars into organic expansion, advertising, recruitment and low-priced offers of deals.

Lashou.com plans to spend around 200 million yuan ($31.25 million) on advertising this year, but the marketing campaign has yet to deliver substantial benefits. Sales revenue of the site stood at 681.8 billion yuan ($106.5 billion) in May, down 33.7 percent from June.

"Those without deep pockets have fallen behind in terms of market recognition," said Lin Maodong, CEO of 55tuan.com. "But the big spenders are also struggling with shrinking profits, with many even swimming in red ink."

"Vicious competition and surging operation costs have dragged the sector's average profit margin to 5 percent from 15-18 percent in late 2010," he said. "In striking contrast, the margin for Groupon.com is 35 percent."

Like its Chinese counterparts, Groupon is also vulnerable to competition because its model can be easily copied. But the U.S. company generated $270 million in gross profit in the first quarter of this year.

While Chinese websites only earn less than 10-percent commission, Groupon typically takes 30-50 percent of revenues collected from deals. This was acceptable to merchants because of Groupon's solid customer base and targeted marketing tactics.

Groupon breaks into new markets by identifying successful local businesses by sending in an advance squadron of employees to research the local market. When it finds a business with outstanding reviews, salespeople approach it and explain the model, and use social marketing sites such as Facebook to further promote the idea.

"In China, most of the websites are less able to make deep research of the market and customer behavior, making it difficult for them to build customer loyalty," said Chen Shousong, an analyst with Analysys International Ltd., a Beijing-based consulting firm.

With their financial pressures mounting, the websites are racing to attract venture capital injections to replenish their war chests. Recently, Meituan.com claimed to have raised $50 million from a string of investors, including Alibaba, Northern Light Venture Capital and Sequoia Capital.

"But many websites are finding it hard to access new loans as investors have gradually lost interest in the once-hyped market," said Wu Xuefei, an analyst with the China e-Business Research Center.

"This will definitely rub salt into wounds of smaller firms and accelerate wind-offs in the sector," he said.

Kai-fu Lee, former head of Google China and founder of Chinese Incubator Innovation Works, said his company has decided to give up plans to invest in domestic group-buying websites due to the gloomy prospects of the industry.

Road ahead

Wang Xing, CEO of Meituan.com, said only three to five large sites are able to survive the crisis and most of the small firms will shut down.

"But the reshuffle will help consolidate the highly fragmented industry and restore its health," he said.

Shen Boyang, CEO of Nuomi.com, agreed. "The future market would see the coexistence of a few major websites and some smaller ones that specialize in certain cities or business fields," he said.

For instance, Nvxietuan.com has specialized in offering shoes for women, while Jumei.com has gained a solid foothold in the cosmetics market.

Despite the ongoing gloom, industry insiders still see great growth potential thanks to Chinese people's zeal for bargains and the burgeoning Internet market.

"After enduring the cooling-off period, the market is bound for a resurgence in prosperity, drawing strength from buoyant demand," said Ren Chunlei, CEO of Groupon.cn, which is not related to the U.S.-based company of the same name.

"Moreover, after several years of rapid expansion, websites will become more rational and far-sighted in making development strategies," he said.

Wu Bo, CEO of Lashou.com, said, "The industry has provided a powerful catalyst for the websites to innovate with services and products, as well as improve the customer experience."

"After all, good word of mouth is the key to widen the market reach and generate more repeat customers," he said.

"It is also imperative for the government to put in place effective regulation measures to protect the interests of consumers," said Wu Xuefei.

"In China, the websites claim that they are just platforms linking retailers and shoppers, so they can easily shirk their responsibilities if the products are found to be counterfeit," he said.

In October 2010, China International Electronic Commerce Center granted credit certificates to 29 websites out of more than 300 applicants. This move was designed to rate credibility of the websites and raise the risk awareness for consumers. But it's up to the websites to decide whether they want to take part in the system or not.

"More powerful policies are needed to streamline the fledgling industry, such as setting a minimum registered capital for newly established websites," said Wu.