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The Problem with Groupon’s Business Model

Published: November 7, 2011

Author: David Rodnitzky

Groupon recently went public with much fanfare. As I write this (on the day of the initial offering), the stock is up 43%, and the company is valued at around $20 billion. Henry Blodget at Business Insider offered a hearty congrats to Groupon in a blog post that noted:
What you’ve accomplished in the last three years is nothing short of remarkable.

  • You’ve invented a whole new industry
  • You’ve built one of the fastest-growing companies in history
  • You’ve created more than 10,000 jobs
  • You’ve generated more $1 billion of annual revenue
  • You’ve helped hundreds of thousands of companies get boatloads of new customers
  • You’ve brought deals to tens of millions of consumers

All of this is indeed quite impressive. The sheer speed of growth alone deserves major praise. But growth, revenue, and inventing a new industry does not a long-term business make. To my mind, there are several major problems with the Groupon model that are troubling for the company’s long-term success prospects.
I’ll explain these shortly, but before I do, it’s important to discuss another seemingly similar but fundamentally different business model than Groupon – the private sale site. PPC Associates has been fortunate over the years to work with several category leaders in the private sale sector, including One Kings Lane and The Clymb. There are several important differences between a private sale site like One Kings Lane and a daily deal site like Groupon, as shown by this comparison chart:

When you review this chart, you quickly see the problem with Groupon: you need a huge sales team to constantly contact thousands of small, unsophisticated merchants, so that you can churn out hundreds of deals every day, with high merchant churn, and low margins for both the merchant and Groupon. The private sale business is the exact opposite in almost every way.
Businesses like manicurists and coffee shops are for the most part commodity services, meaning that most consumers are willing to switch to another vendor if the price is right. Hence, if you offer a manicure for $5 that regularly cost $15, a consumer will buy the Groupon, visit your store, and then buy a Groupon from another manicurist for $5 rather than paying you your regular price on a repeat visit. If it costs you $10 to perform the manicure, you’ve just lost $7.50 (as Groupon takes 50% of the revenue of the purchase) on a customer who will never return to your store.
As more and more merchants get burned by coupon-clippers with no intention of ever returning to pay retail price, it’s easy to understand why some have derided Groupon as a “Grouponzi Scheme.” For Groupon to survive, it needs to find a way to either a) incentivize Groupon users to actually come back and pay retail to merchants; b) charge in a way that makes it consistently profitable for merchants; or c) find a class of merchants who are not in commodity businesses.
That class of non-commodity businesses is largely composed of brands that command higher prices because of their reputation for quality and service. The problem is, I’m not convinced Groupon’s audience is willing to pay even a discounted price for a premium service, nor is it clear that premium brands are willing to widely offer huge discounts (as it devalues the brand). Those brands that are willing to offer a discount are already using private sale sites that emphasize both quality and value, not just value (see One Kings Lane, Gilt Groupe, Lot18, etc). So it’s a bit of a Catch-22 for Groupon – they’ve got the wrong audience to move upstream into premium brands, but their current business model leads to low to negative margins.
So congrats to Groupon on the IPO and the high share prices, but unless I’m missing something here, I’ll stay on the sidelines for this one.
David Rodnitzky, CEO
-Questions? Comments? Email us at blog at ppcassociates dot com.

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