Groupon Is Broken

I have been thinking about Groupon and all the hype surrounding it over the past year, having casual conversations with friends and co-workers.  What I find amazing is that I tend to flip flop on my love/hate opinion about Groupon way too often.  So I'm going to try to create a reasonably objective analysis of what they do, sprinkle it with my own biases and arrive at something concrete. 

Great, let's check out what these guys are doing.  Easy:

• Product - deeply discounted hyper-local offers (goods & services) that "activate" when enough customers sign up, about 500-1000 customers

• Price - low, low, low - 50%+ discount on goods that seem to be in an affordable range for mass - generally under $100

• Distribution - end customer email lists, segmented by geographical location

• Promo - two targets for promotion 1) end customers and 2) local business.  The end consumer promo channels seem to be heavily skewed to Facebook ads as well as viral / word of mouth.  (I'm sure they're experimenting with everything).  Businesses are generally targeted with a combo of direct sales force with other online ads.

Business model 

Groupon will ask the local retailer to discount the product about 50% and then take 50% of the remainder in a rev-share.  In some cases, Groupon will share profits for lead gen or commissions, on the order of 20%.


Groupon

Awesome and simple, right?  Absolutely.  I'm not going to go into the obscene valuation of Groupon itself, it's clearly large.  Rightly so?  Maybe.

Let's look at the LTV (lifetime value of a Groupon customer).  Making some quick assumptions, let's say a paying customer executes on just 1 groupon offer of a 50% discounted $99 offer.  That's $50 split between retailer and Groupon, for top line of $25 for Groupon and maybe less 25% for sales commissions, so call it $20 net revenue per customer.  How many Groupon offers would one customer convert on?  Well, at such a deep discount on local things that aren't that expensive in the first place, probably a lot.  Let's call it 10 times, so LTV of $200.

Wow, holy crap, that's not too shabby, given that your costs of acquiring a user can be relatively well controlled though Facebook ad targeting and Google AdSense.  With respect to customer acquisition ROI, looks pretty solid.

So, on the surface (and a bit deeper), looks great!  Get a customer to come in to a store on a valuable loss-leading product, grab a giant share of that revenue, then try to do it over an over again.  On just one campaign, selling 500 items Groupon makes $10,000. Brilliant! 


Retailer

What about the retailer, what do they get?  Well, here's where things get a little fuzzy.  We're talking brick-and-mortar guys that are trying to bring people into the store. With respect to products, retailers are clearly selling at negative margin (unless they're super high margin products, but in this case they would probably be high-end or niche and be too expensive to qualify for the Groupon model in the first place).  So in most cases, we're talking about a retailer taking a loss on each product sold, receiving roughly 25% of the item's list price (yes, big ouch!)  Add to this - the retailer sells a LOT of this one loss-leading product, anywhere between 500-1000 items.  Quick math - on goods, let's say your gross margins are roughly 50% (being very generous), so you're talking about a $25 loss on each $99 priced item, and that's not even net of your costs yet.  On 500 sales, that's a loss of $12,500 on every Groupon campaign.  Wow, not so great for the retailer.


The score so far - Groupon just made roughly 10k on this campaign, the retailer lost about $12,500.  Why would the retailer do that?  The argument is that the person who'll come in to buy this product will "discover" the retailer for the first time and will become a long-term shopper.  Think of the Groupon campaign as similar to a loss-leading advertizing item on flyers and coupons, like half off 2L bottles of Coke.  Presumably after discovery, the customer will make enough profitable purchases from the retailer to more than make up the difference.  Really?  I mean we're talking about EACH of the people that converted on this campaign has lost the retailer some serious dough.  What percentage would you expect to come back and make a second purchase? 20%?

Are these the right customers?

And now for the kicker.  Groupon brings in extremely price-conscious customers to retailers, asks the store to take a giant loss on the campaign, with the argument that these same cheapskates (no offense, I'm one of them) will then come back and convert on regularly priced items many times over?  I'd say highly unlikely!

The only decent argument I've seen so far from retailers is for highly seasonal businesses, where certain months of the year are just so bad it's not worth keeping the place open - restaurants sometimes fall under this category in the winter months.  In this case, if you could time the Groupon offer to coincide with the down months, you may be able to squeeze a bit of value out of continuity - cover rent, keep employees on, things like that.  There's value, but it's a stretch.

Growth vs Sustainability

And now we're back at valuation.  Groupon is growing like crazy, with month-over-month revenues reportedly growing by double digits.  Valuation is somewhere in the billions (at this point it doesn't really matter how many).  Why?  Groupon has been around for 2 years and is the fastest growing company, like ... EVER.  Where's the growth coming from?  Geographic expansion, taking on more and more retailers.  Groupon has been extremely successful at converting the retailer on the first campaign, because the promise of new customers is just so great.  However, how many times have you seen Groupon convert the same retailer for the second time?  I haven't seen it once yet.  Once the geographic expansion is done (and there's still plenty of that left), Groupon's success will be directly dependent on their ability to bring SUSTAINABLE value to the retailer.  So far, I fail to see it.

Competition

Quick note on competition.  I live in Victoria, Canada - about 500,000 people and I'm being generous.  I'm now getting 3 groupon-like offers every morning, from Groupon, Couvon and ethicalDeal, specifically for Victoria.  What do you think is going to happen to Groupon's margins over time?  Hmm.

Industry or Communication Channel? 

So, my friends and collegues, where does that leave Groupon?  It's a high growth business with a very uncertain future.  Is this a new industry?  No.  Groupon is a new communication channel, that has been very effective at bringing customers into stores, albeit just once.  Like every new channel (that works), it's getting a ton of attention, much like in their time did Newspapers, Radio, Television, Flyers, Coupons, etc.  Every one of these gets saturated over time and returns decline.

Conclusion

Groupon's growth will continue as they take on new retailers in more and more places.  It'll look awesome, they'll have a giant IPO.  Unfortunately, this insane growth hides a weakness in the model - lack of sustainable value to retailers.