A report in the New York Times recently revealed that Groupon, the social buying site, is looking at generating $15bn in a prospective IPO.
We’re surely back in internet bubble days with valuations like that! If Facebook’s valuation of $50bn is questionable, then it’s surely not even remotely credible that a business built around coupons is worth $15bn.
So why is there so much news and hyper surrounding Groupon? Their business model is built around offering daily discounts to their subscribers. The discounts are normally very healthy, and the basis of the model is that the special offer will drive footfall (or web-clicks) to the business in question. Customers will do repeat business, and like any loss-leader or promotion, initial losses will more than be made up for in the long term.
But, as this very good piece at the Columbia Journalism Review points out, there are some serious flaws in the long term viability of the model.
- The losses sustained by your offer are considerable. In the CJR piece linked above, Groupon takes 50% of the discounted price. That means that if you offer 50% off, you only get 25% of the price. If you run your own promotion, you’re at least limited in your “losses”.
- You need a significant local sales force. While some offers can be “sold” (or perhaps “negotiated”) at a national level, making them relevant to subscribers everywhere, the major product categories that Groupon deals with are smaller local businesses or groups. So I might be able to do a deal with a London based chain of restaurants, but I need to do further deals in Manchester and Glasgow. That means people on the ground in those locations. Other media are much better placed since they already have local sales forces.
- It’s not a unique business. When Google failed to acquire Groupon, CJR says they set about building their own version. We’ll have to see. In the meantime, there are already competitors out there such as LivingSocial.
- Repeat business. Most sales teams spend most of their time going back to their regular customers. Yes, there are new clients to bring on board, but mostly you’re serving your existing clients. Groupon has to effectively develop a new client every day in every area it works. If I’m a local restaurant chain, I might do a deal with them once, but I’m not likely to want to work again with them the following week. Even if I do repeat business, it’s a law of diminishing returns.
- The business opportunity seems finite. Restaurants and spa treatments – which are the mainstay of businesses like Groupon – have relatively “nebulous” values. What I mean by that is that the difference between raw materials costs and purchase price is quite high. If I spend £20 on a meal, I know that the actual cost to the restaurant in raw ingredients is probably less than £5. I’m paying for the premises, the people, the ambiance and so on. Similarly, if I have spa treatment, the only real costs are the premises, the people, and perhaps some cosmetics (which have their own ridiculous mark-ups). What that means is that there’s a lot of leeway in my pricing model before I actually lose money on each transaction ignoring for a moment, fixed costs. Beyond those areas, there are few services or products that have such room to manoeuvre.
- The coupon culture damages businesses in the long term. We’ve always had coupons, although in the UK they’ve not really attained the levels that they have somewhere like the US. Indeed until relatively recently, I’d suggest that there was actually an unwillingness to use coupons. But that has changed. Businesses like Pizza Express and Gap have gone so far in the other direction that I now feel like I’m being ripped off if I’m not using a coupon. In some circumstances I’m sure that new customers have been generated by offers through Groupon, but I tend to believe that many will treat them as one-off visits. Because don’t forget, Groupon is going to email you another offer tomorrow.
Is Groupon a sustainable business? I’m sure it is. There’s more growth to be achieved in locations that it operates, and the number of subscribers it has. And like any coupons or gift-card business, the levels of coupons that remain unredeemed add to the business’s profitability. That’s not always for the right reasons of course. A couple of colleagues of mine redeemed a coupon for a lunchtime meal recently and the queue was so long, they didn’t actually return to the office within the lunch hour. As a result, even though they still have further coupons to redeem, they’ve yet to return to the outlet.
One way or another this is a business area that’s only going to get tougher – a lot tougher. That’s why putting ridiculous valuations on the business when it’s still very young just seems utterly mad.