I was not able to make Tim O’Shaughnessy’s presentation at MIT – I was en route to London at the time of his talk. Coincidentally enough, I arrived to read a really interesting piece in the FT on the Groupon IPO. I felt compelled to write a little something in response, prompted in part, by Tim’s comment that Groupon’s success proves that the “business model” works.
Well, I’m not so sure. What Groupon has proven is its ability to make “daily deal” a part of our everyday vocabulary – a concept that it developed and then exploited starting in November 2008. Just about every organization from Facebook to Foursquare to Google (who tried to buy them) to the thousands of local Groupon-like clones since then have tried to emulate its success. The Internet is literally flooded with daily deals now. There is no doubt in anyone’s mind that Groupon has capitalized on the notion that it is possible to create a powerful advertising machine that taps in the consumer deal/bargain psyche. (Related: Sandwiched Together, Groupon and Quiznos Test New Loyalty Strategy)
Groupon has also proven that it takes a village – and a rather large one at that – to feed the beast. It employs 3,500 sales people who dial for the deals that are served daily to the tens of millions of customers that are on their email list. But that is an increasingly daunting activity. One study by Rice University Professor Utpal Dholakia found that 42 percent of merchants would never do another deal with Groupon. Why? Not every merchant likes Groupon’s terms: discounts of 40 percent or more off and then a commission of up to 50 percent of the face value of the deal. Now, no one goes into these deals with the idea that they are going to make money on that one particular gig. Yet merchants, with fingers crossed, hope that people who buy the deals spend more money than the coupon’s face value and come back for more. But that is not the way that the story usually ends. Groupon, according to Professor Dholakia’s work, appeals to bargain hunters who follow the bargains and not the brand, including existing customers of establishments who take advantage of the discount. The question now is whether merchants will continue to pay that kind of premium for advertising that doesn’t bring in enough new customers willing to spend more while there and then come back a second time.
The implication, therefore, is that Groupon has (and will continue to) have a mighty big and hungry sales nut to crack – every day. If about half of the merchants wont re-up, more money and time and staff has to be poured into finding merchants who are willing to give it a try. That suggests that Groupon’ s cost line will increase, as more staff are needed to find new merchants, expand to new geographies or both. And according to the FT article, that is just what is happening. In Q1 of 2011, administrative and marketing expenses rose from $11m to $387m against revenues of $270m, creating a cumulative deficit of $522m. [Note: there’s also another aspect of their business model that is coming under scrutiny, and that is whether its “voucher” system is really a gift card in disguise and subject to those rules and regulations, including longer redemption periods than what is promoted as part of the deal. More to come here.]
Now, some might say that is the cost of doing business and building a consumer business. We all know that it is costly to build a consumer brand and that there are many years of investment necessary before red ink turns to black. And, I generally hate it when the armchair entrepreneurs who’ve never built or launched anything snipe away at what’s wrong and not what’s right when a new company starts to get traction in the marketplace. But I have thought for awhile that Groupon’s valuation is extraordinary for a company that is essentially a huge email list with an expensive sales operation. It has no network effects, in part because it has not created a network and is valued at orders of magnitude more than companies that actually produce tangible products (or have valuable networks). Groupon is clearly an example of a clever advertising platform that has brought innovation to a whole new sector and brought value to many consumers and merchants along the way. And, that’s worth something. Whether it is worth $3 billion, I’m not so certain. If it turns out that it is, I think it’s another sign that we’re in a big bubble. So, all you entrepreneurs, hurry up and get your piece of the action before it pops.
Karen Webster is the President of Market Platform Dynamics (MPD), a consulting firm that helps companies find, implement and monetize innovation. She serves as an advisor and member of the board for a number of companies operating in the payment, technology and digital media industries. More info here.
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