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.

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.

The fact that even Groupon is no longer banking on Groupons is fantastic news for everyone, especially all of us who are sick of morning email deal spam. But the biggest beneficiaries of Groupon’s problems are the world’s small-business owners, people who will no longer be taken in by its terrible deals. Today, Groupon’s stock is down nearly 30 percent. Its demise may not be imminent, but it seems assured. Let’s all rejoice.

This might sound harsh. After all, even if daily deals are a bad deal for small businesses, owners are signing up for them willingly. Why should we hate Groupon—a firm that is, after all, saving people money—for engineering these deals?

The trouble is—as Agrawal and many small business owners have documented—there’s ample evidence that Groupon’s sales reps never adequately explain the risks, and really exaggerate the rewards, of signing up for a deal. Because they work on commission, and because Groupon and its investors grew addicted to unsustainable growth rates, the firm’s sales team is under enormous pressure to keep signing up more businesses or to make deals that are even more lopsided in Groupon’s favor. They often try to get a huge share of revenue—they even ask for 100 percent of the deal. They don’t give businesses much data on how well similar deals have worked out for other businesses. (For instance, how many new customers did the businesses get? How many people spent more than their coupon amount—and how much more?) And they never explain the most important fact about Groupon users: Most of them are looking for a deal, and they’re unlikely to keep coming back to your business.

This isn’t to say that Groupons are always a terrible deal for businesses. Agrawal says that, among other things, if your business is brand new; if you offer subscriptions that can lock customers in to a long-term deal (say, you run a yoga studio); if you’re selling an event with excess capacity (like a concert); or if you’re going out of business (in which case the Groupon is a Hail Mary pass) then Groupon might be for you. According to Yipit, a company that tracks the daily deals industry, Groupon has been signing up more and more “repeat” merchants over the last year—companies that like their Groupon experience so much that they decide to do it again. Sean Spielberg, a Yipit analyst, told me that in the second quarter, repeat merchants represented the majority of Groupon’s overall gross billings.

Agrawal sees this as evidence that Groupon’s merchant base is narrowing down to just the businesses that can do well with such promotions. That’s certainly good for the small business community, but it isn’t good for Groupon, which sold itself as a company with limitless growth potential. That’s why, now, it’s talking up other products besides coupons.

On Twitter yesterday, Agrawal said that he’s tempted to write a four-word story in response to Groupon’s earnings. What are the four words? “I told you so.

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