BLOG STARTUPS, VENTURE AND THE TECH BUSINESS

June 10 2011
by Thanasis Delistathis

GroupOn: Amazing biz model or “ponzi scheme”?

Does GroupOn have a sustainable business model?  Not a day goes by when I don’t have that debate with another VC or entrepreneur.  They went from $0 to $2.5BN annual revenue run rate in less than 4 years.  Arguably the fastest growing company in history.  It almost sounds too good to be true.  Can it keep growing?

The company contracts with local merchants to offer their products and services to GroupOn email subscribers at a substantial discount (usually 50%).  Consumers pay GroupOn to buy the goods.  GroupOn then pays the merchant 50% of what it receives from the consumer.  So costs $100 at retail ends up costing the consumer $50, netting out $25 to the merchant and $25 to GroupOn.  Usually GroupOn offers one daily deal per city.

Why would the merchant offer such deep discounts to its service/product?  To get customers in the door.  In one of the smartest business model innovations of all time GroupOn has allowed merchants to convert their marketing dollars into discounts in an attempt to get new customers in the door.  Instead of spending money on print ads or radio ads or yellow page ads, local merchants offer deep discounts to a list of interested customers.  Of course coupons are nothing new; prepaying for the service though is.  The merchants get buyers.  What they hope is to convert the GroupOn buyers into regular customers. (I want to note here that we have a pony in this race with an investment in a company in Atlanta called ScoutMob, that has a slightly different model than GroupOn).

Is it possible that merchants can give away that much and still make money?  A timely post by a guest writer on TechCrunch today provides an interesting perspective.  The answer is that it depends on the type of business.  A spa that is not operating at full capacity might have variable margins of close to 90%, because most of their costs are fixed.  Restaurants would have lower margins and product retailers even lower, closer to 50%.  Is this model sustainable in the long term?

Arguing against:

  • Too much competition.  Many copycats showed up.  Merchants get called every day to try another service.  Over time competition will drive margins down or force a flat fee for each new customer.
  • No loyalty.  GroupOn attracts discount seekers, coupon clippers: consumers that are only trying the service for the deal and are unlikely to try again on their own.
  • Bad customer service.  Consumers who get the deals complain about the experience with merchants that are not able to handle the huge influx of business (can’t book appointments or service is not good).
  • Other substitutes.  As merchants become more adept at using social media channels (facebook, twitter) they find better/cheaper ways to attract new customers.

Arguing for:

  • First/Early mover advantage.  As of the end of March GroupOn had 83 million subscribers.  Consumers have limited mindshare for similar services so they will not sign up to many others.  This gives GroupOn an advantage b/c they can still drive lost of buyers.
  • Issues can be addressed.  Logistics, scheduling and efficient tracking will be figured out over time, so that consumers and merchants have a seamless experience.
  • Huge market – Small penetration.  There are more than 365 merchants that are in any given city, so nowhere near saturation.
  • It works for some. Many classes of businesses find this offer attractive b/c of the high margins in their business.

This is a bold new experiment at a new marketplace.  I think the model will surely evolve.  I also think that other models that offer discounts but don’t force the customers to prepay, like our portfolio company Scoutmob, have an opportunity to carve part of this market.  I also think that the most interesting problem to solve for local merchants (which I am sure GroupOn and LivingSocial are thinking about) is how to entice repeat buying.  It is not addressed yet.  GroupOn brings customers in the door.  The one that figures out how to retain them will make a lot of money.   Any ideas out there from startups?  Give me a call!

For those of you interested in learning more about GroupOn, here is a link to their initial filing of their S-1.  Also another interesting article on the fight between Google and LivingSocial in Fast Company on some data from Comscore.

 

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