Groupon’s Crummy Business Model Is Finally Dead. Hooray!

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Aug. 14 2012 6:19 PM

Ding Dong, Daily Deals Are Dead

The thrilling demise of Groupon’s crummy business model.

Groupon screenshot.
Are daily deals dead?

A year ago, Rakesh Agrawal, an analyst and journalist who spent many years working in the local advertising business, wrote a series of devastating articles about Groupon. At the time, the digital coupon firm was regarded as one of the most brilliant Internet advertising companies to come along since Google. In fact, Groupon was so hot that Google itself offered $6 billion to buy it—but Groupon decided it didn’t want the search company’s billions and instead prepared to raise many billions more in a stock offering. Now, just before the IPO, Agrawal was calling Groupon’s entire business model into question.

“Groupon is not an Internet marketing business so much as it is the equivalent of a loan sharking business,” Agrawal wrote, and the critique got more scathing from there. To you and me, Groupon seems like an easy way to save money on spas, auto detailers, chiropractors, and lots and lots of people who want to remove hair from your nether regions using wax or lasers. And to many investors, Groupon seemed like a sure thing. In 2008, its first year of operations, the company booked $94,000 in revenue; by 2011, it was collecting $644 million per quarter, leading some to call it the fastest-growing company of all time.

But as Agrawal described it, Groupon was riding high because its most important constituency—the small businesses who slashed their prices to entice Groupon’s customers—was getting ripped off. When Groupon runs a deal with a local business, it demands very unfavorable terms. First, the merchant is asked to substantially reduce his prices. Then he has to agree to give Groupon a huge split—often 50 percent—of the tiny amount that he does make from each Groupon sale. For instance, if my fast-food shack normally sells a burger-and-shake combo for $10, Groupon will want me to offer it for $5, and then take half of the $5 sale—so I’ve just sold $10 of merchandise for $2.50.

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Why would any right-thinking business owner take this lopsided deal? Because, as Agrawal noted, Groupon dangled a very attractive carrot in front of them—it would offer to pay their cut immediately. If 1,000 people purchased that $5 combo deal at my restaurant, Groupon would pay me my share—$2.50 for each customer, or $2,500—in three payments over two months, with the first payment arriving within a week of the deal’s launch. Its sweet-talking sales staff would also promise that I’d get long-term benefits from the deal. All those Groupon customers would likely spend more than their Groupon amount, and if they liked my food, they’d keep coming back even without a deal. Many cash-poor businesses apparently didn’t consider the other possibility—than in exchange for taking a lump sum now, they were signing up to give heavily discounted stuff away to deal-hungry customers who would never step into their stores ever again. If that happened, my $2,500 in immediate Groupon cash might cost me $7,500 in lost revenue over time—“a very, very expensive loan,” as Agrawal put it.

Now, after a spectacular debut on the Nasdaq, Groupon is a public company. On Monday, it reported its second-quarter earnings results. The numbers were dismal. They paint an unmistakable picture of the future of Groupon and other similar sites: The daily deals industry is drying up. Groupon reported that its customer growth slowed substantially over the second quarter; the amount of money that each customer spends on the site tanked; and the company’s “guidance” for the current quarter suggests that things are going to get a lot worse. The spin from Groupon’s executives was not very encouraging. In a conference call with analysts, the firm’s CEO Andrew Mason kept talking up Groupon Goods, a service in which Groupon sells discounted merchandise to customers—in other words, something completely different from the coupons that earned the firm its IPO.

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