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The Groupon Fad – Why rejecting Google’s $6 BILLION offer may have been unwise

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Groupon, the online group-purchasing phenomenon, recently rejected a whopping $6 billion bid from Google. That’s billions, with a “B”. Apparently, its management and investors expect even more dramatic growth than they have experience so far, buoyed by the service’s popularity. But that popularity could signal the beginning of the end, at least for the company’s current business strategy.

Groupon uses heavy discounting to drive new customers to businesses. It usually works like this. A consumer buys a $20 gift card (in the form of a coupon) for a restaurant for $10, to be used in the next six months. Unlike traditional vendors such as restaurants.com, the coupon acts like cash for food and sometimes drinks, without ridiculous conditions like high minimum purchases or the requirement to notify the establishment before using a meal.

Here is the catch, for the restaurant. It pays Groupon up to half of the receipt from the coupon sale. So after giving a half-off discount to the consumer, the business gives another half to Groupon. No wonder it is so profitable! The restaurant, however, has essentially cut its price by 75%, or more.

This is the main reason the practice is unsustainable. Groupon will have a hard time getting its clients, the businesses, to keep coming back with 75% discounts. A select few will accept the sale because of their confidence in bringing in new repeat customers, but by definition, most shops will not succeed in beating the average.

Businesses do not want to be repeat customers of Groupon either, unless they can restrict offers to new customers only, like a gym or spa. They do not want to slash prices on a permanent basis, nor do they want to train current or potential customers to expect such heavy discounts.

Finally, there is little barrier to entry. At least a dozen rival services have sprung up to cash in on the craze. Word-of-mouth is critical, but the magnitude of discounts ensure it is not as difficult as in other online businesses. The success of the likes of BuyWithMe, Eversave, and LivingSocial prove that even without one of the catchiest brand names, scale is not difficult to achieve. At the same time, they offer stiff competition to Groupon as the latter seeks new clientele (ie. retailers).

Recently, the company announced plans to exploit China and other emerging markets. New markets like the world’s most populous countries are perhaps Groupon’s best hope for a sustainable business, but the same problems with pricing, repeat customers, and barrier to entry will ensure the company must stay on the top of its game for any hope of recapturing the $6 billion enterprise value offered by Google. Time will tell whether the gamble was brilliant or overly optimistic.

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Written by Gnostradamus

Thu, 2/24/11 at 1250

Posted in economics

Tagged with , , , ,

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