There’s a big difference between internet bubble Mk I and the one brewing in daily deal sites such as Groupon (known locally as Stardeals, Cudo and Scoopon) the owners of which recently received an $80 million investment from a group including James Packer, who is now in the cybersquatting business.
It took eBay about six years before it became profitable. Groupon’s growth and profitability makes that look pitiful. Former Starbucks CEO and eBay board member Howard Schultz says these companies were “standing still compared to Groupon”.
Groupon sold its first deal — to a joint selling half-price pizza at the base of its Chicago office block — in November 2008. Fourteen months later in January 2010 it made sales of $11 million. By December that figure had reached $89 million. Annual revenues were estimated by The Wall Street Journal to be $760 million last year. This year, Business Week estimates revenues will be $3 billion –$4 billion.
The company is growing so quickly it already has 6000 employees, some of whom work in corridors while others hold meetings in local churches because their Chicago offices are too small.
But what’s really impressive and likely to have caught the attention of Packer and Google, which last year tried to buy Groupon for $6 billion, are the margins on those revenues. With Groupon keeping 40%-50% of the revenues on each sale, they’re almost certainly huge. For an internet company not yet three years old, they’re astonishing. Only rapid growth and incredible margins can justify a rumoured $25 billion float and that’s what Groupon appears to have.
Long term though, it’s hard to see how those margins will hold up. Daily deal sites don’t seem to have any discernable competitive advantage.
First, the technology is easily copied. There are more than 100 US competitors to Groupon, including Jewpon — group deals for Jews in New York and Haifa — and gluten-free deals — for people that live, in all likelihood, Portland. Even internet laggard Harvey Norman is getting in on the act with a site so bad it looks like it was designed by one of Gerry’s horses. All are competing on price.
As for distribution, Groupon’s tens of millions of users are a weak defence against them. According to Experian Hitwise, only about 10% of visits to local daily deal sites originate from email. Google Adwords and social media, both of which competitors can easily access, are the major traffic drivers.
Already, Facebook groups are being bought and sold to increase distribution. And the business model encourages a person to rope in friends and colleagues to get a deal activated, making it easier, not harder, for new market entrants. Brand loyalty, to the sites or the retailers making the deals, is almost non-existent. Everyone is motivated by price.
Daily deals may work well for high fixed-cost businesses and those suffering cashflow problems but targeting the tightwad market isn’t a great strategy for retailers competing on service and quality.
So, if Groupon has a competitive advantage, where is it?
In highly competitive markets, companies can prosper simply by doing the same things better than everyone else. That seems to be Groupon’s approach. Retailers speak highly of how well Groupon works to understand what works for them.
Then there’s the pitch itself. According to Business Week Groupon employs improv actors and 70 comedy writers. When a deal hits your inbox or Facebook page, they make it interesting and witty enough to get you to actually open it.
This Groupon office photo tour, replete with beds and toilets, offers a fascinating insight into how this culture works.
If this is Groupon’s real edge, it would be a fascinating development for online businesses, away from a technology-led model towards something far more traditional; where the real value is in how words and phrases are strung together rather than ones and zeros.
I’d wait until the IPO before we start talking about valuation. A lot of unknowns at the moment; how they calculate revenue is yet to be specified (it is likely to be the value of the coupon, rather than their share of the coupon, with the payout to the vendor as COGS). Means their gross margins might be around 40-50% depending on the vendors share of the groupon (or the difference between the coupon value and payout), which is still small in comparison to a company like EBAY or Google (much better companies to invest in). But what is worse is that groupon is extremely employee heavy for an on-line entity so I’d be surprised if their net margin is competitive compared to Ebay or Google.
Sure there is always a premium for growth. But the business model is extremely easy to reproduce. What is to stop google, apple or even facebook itself replicating the model? Profitability can only decline in this sector in the future. I’d be watching google myself….if they wanted to buy Scoopon, it means they want the functionality. They have the talent to build it themselves and the infrastructure to distribute it better than any deal website available at the moment.
Google, which is already a big beneficiary of this industry in ad spend, has already announced they’re getting into daily deals and Facebook is doing so already. As you imply Scott, this is a business with very, very low barriers to entry. The margins are also open to question, although the rumours suggest they are large than one might expect. As for being staff-heavy, one of the points I was trying to communicate was how this might be their only competitive advantage; in the way that they sell. But it’s not something I’d want to put money on. The IPO may well be a flyer but there’s no way I’d want to be a long term holder of this stock.
Unless they can get their IPO away fast, they may come to wish they had accepted Google’s $6B offer. (Then again, I was gobsmacked by the LinkedIn IPO.) Not just because Google and Facebook are more likely to ultimately capture the lion’s share of this business, but I wonder about the whole scheme. It seems to rely on retailers willing to sell their product/service at one quarter of their normal retail price. Seems to me that is a strategy that has two big flaws: 1. it might work well now during one of the worst economic downturns the US has ever seen and 2. it must have distinct growth limits unless there is a quota of coupons (which there doesn’t seem, but of course a quota will in fact limit the growth). I could add 3. that a lot of retailers might like to use it as a loss-leader or maybe on restricted items to generate foot traffic but is that a viable zillion dollar business? Maybe.
Are you sure that Ebay didn’t turn a profit before 2001? I thought it was profitable well before then, even if it’s growth was held back by it’s inability to build servers to carry the traffic it attracted.
Quote: “It took eBay about six years before it became profitable. ”
Ebay was established as AuctionWeb with no fees in 1995. The founder, Pierre Omidyar, introduced fees because the site couldn’t cope with the traffic, and he thought that would curb the use – it didn’t, so he then developed it as a proper business. Ebay was floated as a public company in September 1998.
In 1999 it’s gross profit was US $191.4 million:
http://www.wikinvest.com/stock/EBay_(EBAY)/Data/Gross_Profit/1999
I can’t find earlier profit and loss details for Ebay, and of course gross profit is not net profit, but I will query the accuracy of the quoted statement.