Groupon deals: a win-win or a win-lose proposition?

Although less than three years old Groupon, the daily deals internet business, has become the phenomena of recent times, with a staggering growth in revenues and subscribers (although it remains unprofitable). The company’s much vaunted initial public offering (IPO) is almost as eagerly awaited as that of Facebook. After postponing presentations to potential investors early this month because of volatility in stocks, the online coupon giant is now aiming to go public in late October or early November. The firm reported enviable results in its second quarter of 2011, including a 36% gain in net revenue to $878 million. The increase in sales volumes has pushed its valuation ever higher, with some analysts estimating that it could fetch $25 billion to $30 billion when it floats, dwarfing the $6.6 billion advance from Google Groupon reputedly rejected at the start of 2011. Indeed, Groupon co-founder Eric Lefkofsky now ranks among the 400 richest Americans, according to Forbes magazine’s annual listing released last week.

Groupon signs up local merchants to offer daily discount deals for everything from hotels to balloon flights to sky-diving, which it claims offers a win-win proposition. However, the company is facing doubts over its business model and its ability to sign up the new merchants it requires to maintain its growth rate.  The daily deals market space is becoming increasingly crowded and in the US, Groupon’s largest market, 53 deal sites launched in August alone. There are few barriers to entry and discount sites are easy to set up, although difficult to scale without substantial capital and human resource investment. Growth requires the hiring of a huge army of sales staff and account managers to develop relationships with merchants, and this is expensive. Two years ago, Groupon has 30 employees; that figure is now approaching 10,000.

However, despite the flood of new internet deal businesses, Groupon and Living Social dominate the market, with Groupon controlling about half of all sales, approximately double that of Living Social; the next largest player is estimated to represent only 5% of the market. Revenues for other sites like Travelzoo, OpenTable and Google offers declined in August, even though their number of deals increased in number. Research shows that consumers are beginning to feel overwhelmed by the flood of daily e-mails from companies offering ‘bargains’ in one form or another.

A Groupon deal can quickly deliver many more new customers for small businesses than using conventional forms of promotion. However, the price of delivering this increase in customer numbers can be very high. A recent example reported in the press was for a restaurant. The customer who signed up for the deal received $15 of food for only $7. Groupon then took half of the revenues, leaving the restaurant owners only $3.50. Out of this, the retailer had to pay sales tax and credit-card charges and all the staffing and food costs, leaving the business with a loss which grew substantially the more Groupons were sold. It is probable that many small businesses in pursuit of future profits are underestimating the effect on current cash flow. It is clear that some merchants have gone into liquidation as a result of liquidity problems created by the Groupon deal, even though the customers attracted to their business has spiked substantially.

So what drives merchants to sign up? Essentially, merchants are looking for repeat business and greater market exposure and increased future revenue streams. However, to know if the deal makes financial sense as a customer acquisition tool, merchants need to know two key numbers:

  • The proportion of Groupon customers who are already their customers
  • How much repeat business is generated?

Clearly, the higher the first number, the lower the revenue gain; the higher the second, the more successful the deal will be. Groupon apparently is not collecting the data required to allow merchants to make informed choices, and the market is too young for conclusions to be reached by independent research firms. The reality is that the discount deals proposition is not win-win for everyone; it appears that Groupon usually wins and merchants usually lose.

IB Style Questions

1. Define the following terms:

  • market share
  • flotation

2. Explain the difference between revenue, profit and cash flow.

3. Analyse the advantages and disadvantages of a Groupon deal for Groupon, the customer and the merchant offering the deal.

4. Evaluate the relative merits of small versus large organisations, and discuss to what extent the growth of e-commerce has altered that balance.

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