Brendan Coffey
When daily-deal pioneer Groupon spurned a $6 billion acquisition offer from Google in December, the reaction was mostly in the nature of "Are they crazy?" Sales for the Chicago company had exploded from $33 million to $760 million in a year, thanks to a burgeoning list of 50 million subscribers who jumped on daily e-mails offering deep discounts on everything from restaurant meals to lawyer consults.
Since then the company, founded by Andrew Mason three and a half years ago, looks to be suffering the death of a thousand cuts—paper cuts, that is, from class actions around the terms of its deals, state regulator cease-and-desist letters around its marketing of alcohol and the me-too business plans of 425 competitors that have flooded the marketplace. As Groupon preps an initial public offering rumored to value it at $15 billion, the question is: Are these problems just annoyances or signs of a more serious struggle to transform its cult following into a sustainable business for the long run?
Groupon's appeal is its simplicity: It e-mails its subscribers one deal a day with a deep discount, say $50 worth of food and drink for $25 or a $100 spa treatment for $40. Groupon keeps half the revenue, the retailer gets the other half without having spent any money up front, and the consumer gets a deal. Peter Krasilovksy, of research firm BIA/Kelsey, projects the daily-deal segment will grow 49% this year to $1.3 billion.
Groupon has emphasized the use of its discount vouchers toward alcohol at bars, restaurants and retailers. The Groupon Web page for first-time users features an image of two cocktails, and its ad copy often touts that drinks like margaritas, ouzo or beer are included in the deal. State regulators are only just now taking notice: In February Massachusetts sent a letter to Groupon demanding it stop allowing vouchers for alcohol, saying it violates a 1984 happy hour law, and requested details on all its deals. Massachusetts is likely only the first of 25 or more states that will find fault with Groupon's approach, according to Thomas Henry, a Pittsburgh lawyer specializing in alcohol law.
The legal issue is that regulators may decide that Groupon, which takes a cut of sales, has been selling alcohol without a license, fine it and perhaps force the company to get its own liquor license. This may be a problem for Groupon even in states with liberal alcohol laws, like California. Chris Albrecht, deputy director of the California Alcohol Beverage Control, says his department has received some inquiries about the coupons but hasn't decided on the legality.
More likely--and as unappetizing for Groupon--its local business customers could face hefty fines or loss of their licenses. Groupon doesn't appear to be greatly concerned, insisting the laws don't apply to its business. "Chicken and beer for $10, rather than $20, is very different than all-you-can-drink offers for $1. I don't think our kind of coupons are necessarily understood by the law," says Eric Lefkofsky, Groupon's biggest shareholder.
Another problem that has popped up of late involves complications over accounting for sales tax: Who pays it, and on what amount--the face value or the amount that consumers paid? And who collects that 10% federal surcharge on the ubiquitous tanning-parlor deals? Says Lefkofsky, "We can't worry about the noise that the legal system creates, and we just have to keep doing what's right."
Groupon's real problem may be the unbreakable law of competition. In the past year 425 me-too companies have flooded the daily-deal marketplace. That has created deal fatigue--the percentage of deal e-mails that are opened has fallen from an astounding 66% last year to a still very good 40% of late, says analyst Krasilovsky.
The competition could be ravaging revenues. Groupon sales plunged 30% in February and another 32% in March, according to James Moran, cofounder of Yipit.com, which tracks daily-deal companies and aggregates their deals into one e-mail for its own mailing list. In March it appeared Groupon's market share, 70% at the start of the year, slid to that of its closest competitor, Amazon.com-backed LivingSocial. Across the top 20 metro areas that month both Groupon and LivingSocial generated $1 million a day from their deals, says Moran. In February Groupon generated $1.5 million a day from its deals and LivingSocial only $500,000.
A Groupon spokesperson says its market share is 80% and points out that Yipit is a competitor. Lefkofsky says copycats have had "a minimal effect" on market share.
Recent entrants to daily deals include the New York Times Co. and Travelzoo, whose first offer in New York City generated more cash than any Groupon offer in Manhattan ever did. Social media behemoth Facebook is field-testing its Groupon competitor in select cities now. Google, too, is rumored to be planning its own flavor, Circles.
Groupon isn't standing still. It now has 70 million subscribers worldwide, adding about 1 million a week. Two weeks ago it unveiled Groupon Now, a smartphone app that gives immediate, localized deals.
It makes sense for Groupon to move beyond vouchers, given indications that just 20% of customers using Groupons return to a retailer for a second, nondiscounted visit. That's a steep price to pay when selling a service for 75% off or more after commission, according to RetailNet Group, a Waltham, Mass. retail strategy consultancy. And, except for a Gap promotion and some others, national retailers aren't flocking to use Groupon, appearing more inclined to replicate the process than use the company, says Daniel O'Connor, RetailNet's chief.
That leaves mom-and-pop businesses as the addressable market. A good business but one that raises the question of whether Groupon is worth $15 billion at an IPO. "Anybody can build a mailing list, but discounts don't mean loyalty," O'Connor says. "Groupon is more of a business model than a company." A business model that works, for the moment.
