Groupon, the Chicago-based local daily deal company stunned even the most visionary entrepreneurs of the 21st century by raising the highest amount of venture capital money ever collected by a startup: $950 million.
Groupon brings together buyers and sellers in a collaborative environment that offers buyers unbeatable deals and businesses a guaranteed number of sales. Each deal is ‘triggered’ only if a set number of people ‘buy in,’ thereby creating a strong incentive for buyers to share deals with friends and family. Groupon deals are great for businesses too because they can set the parameters for the transaction as they know a minimum for how many offers they will have sold in advance. And then we have Groupon marriages which work on a ‘first come, first serve’ basis; no questions asked.
At TechCrunch Disrupt, Benchmark Capital’s Mark Cohler was asked if he wished he was an investor in Groupon. “That question keeps me up at night,” he says. “Typically, when there are no barriers to entry for competitors or market frictions for customers to switch, profit margins tend to decline over time.”
Previously traditional coupons simply allowed businesses to segment the market through price discrimination. Groupon, building on that concept, has married the concepts of price discrimination and collective bargaining. Previously price discrimination allowed businesses to sell to the market segment that could not afford products at market prices. However, through collective bargaining, businesses are guaranteed a large number of sales which enables them to calculate the feasibility of even steeper discounts without any element of uncertainty.
Groupon’s profitability almost entirely depends on whether or not using Groupon is profitable for businesses in the long run.
One critical factor that determines the feasibility of offering discounted deals on Groupon is the percentage of buyers that will never redeem their coupons. The data for Groupon’s ‘breakage’ is not yet available as customers have an entire year to redeem their coupons. However, owners of Spill the Wine, a Minneapolis-based restaurant that uses Groupon, have estimated that 30 per cent of the coupons they sold will not be redeemed. It seems that forgetful customers play an important role in Groupon’s business success.
Where Groupon fails:
Businesses hope that discounted deals on Groupon will result in brand loyalty and increased likelihood of future sales. However, analysts have recently pointed out that Groupon customers are tight-fisted discount chasers who just follow the next deal, and so it is uncertain whether Groupon sales contribute to any significant customer loyalty or brand recognition for businesses.
Veteran investor Marc Andreessen says, “Groupon has cracked the code on a formula to basically give access to the Internet as a marketing channel for offline merchants.” For restaurants, clubs and bars, discounted deals sold on Groupon can be an expensive marketing investment given that Groupon charges a 50 per cent commission on top of discounted deals, but it is still questionable whether such a marketing strategy yields worthwhile results especially when many customers coming from faraway suburbs and towns are unlikely to return (at least for undiscounted dinners).
It remains unclear whether using Groupon as a marketing channel is effective for small businesses. In other words, do restaurants lose too much money on the free food to offset the marketing costs? Even Groupon’s director of merchant services admits that, “You may barely break even on Groupon customers the first time, but if you bring them back once or twice, you’ll get a terrific return.” Do customers come back?
Mostly they do not. Businesses have two major problems with using Groupon – a vast majority of deal-chasing customers are unlikely to return and employees have to be compensated with additional wages for having to deal with extra busy work hours.
According to research conducted by Rice University, 32 per cent of businesses reported their deals to be unprofitable and 40 per cent indicated they would not run a promotion through Groupon again. According to research conducted by Groupon itself, 22 per cent of the total customers return to the business for another deal; a figure that is likely to be highly inflated and variable for different industries.
How do businesses respond to deal hounding Grouponers? By posting messages on restaurant entrances saying,
If businesses pay the price, so do customers. Fair enough.
Emerging competitors seem to be the most prominent threat to Groupon’s future. With no barriers to entry, and in the absence of a significant network effect, there seems to be nothing to keep new competitors from entering the market. With the rise of more than 100 Groupon-clones in China and the US, Groupon is locked in aggressive race to new markets with its rising international competitors. Groupon’s strategy appears to be quite clear – expand as quickly as possible to achieve scalability which can later serve as a competitive advantage.
Groupon’s prime competitor, LivingSocial, has announced its expectations of generating $500 million in revenue this year after it successfully expanded to 25 international markets across Spain, Italy, Portugal, Argentina and Mexico by acquiring Spain-based Let’s Bonus. It seems like Groupon is facing emerging competition domestically and internationally on various fronts.
However, Groupon’s new competitors may not be as deadly as pre-existing Internet giants like Facebook that are designing features and business strategies for social shopping that would put them in direct competition with Groupon. Groupon recently turned down a $6 billion acquisition offer from Google, which is now launching its own Google Offers that observers predict will charge less than Groupon’s 50 per cent commission. The immense business potential of marrying local advertising with social shopping has been recently realised, and Google seems determined to cash in on that.
The billion-dollar question: Is Groupon here to stay?
With many small businesses finding Groupon to be unprofitable as a marketing channel and consumers rapidly losing interest in the ‘fun factor’ of social shopping, and with rising competition from emerging corporations such as LivingSocial as well as Internet giants such as Facebook and Google, Groupon’s future seems bleak to say the least. It may ‘stick around’ but it won’t become the benchmark for social shopping – unless it overhauls of its business model (which will inevitably involve cutting profits; something the investors may not be comfortable with).
What about the highly experienced venture capitalists that have heavily invested in Groupon? What about all the other accomplished entrepreneurs involved with Groupon? Well, they will have cashed their investment well before Groupon begins to shrink.
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