The Groupon model..what cause the steep drop in share price?

Can deal-a-day Groupon survive a brutal post-Facebook Internet economy?
Written by Assif Shameen Monday, 01October 2012
Source: The Edge

AT first sight, with his shirt untucked and ever ready to play a prank on the next person he meets, Andrew Mason comes across as a slightly less serious version of the intensely focused Facebook founder, Mark Zuckerberg.

He may no longer be worth half as much as Zuckerberg, but Mason is still one of the world’s wealthiest 31-year-olds. What Mason and Zuckerberg, 28, have in common is that both founded and run an Internet company that they took public and whose stock has come crashing down as investors wise up to tall stories of future rivers of profits.

Mason is founder and CEO of Chicago-based Groupon, the once-high-flying Internet coupon firm that is fast learning to tackle more earthly things such as revenue growth, profitability and a sound business model.

While Facebook stock’s 50% slump has made more headlines in recent months, Groupon stock’s 85% dive from its peak last year has hurt more investors. Indeed, Facebook’s detractors are known to compare the social networking service’s woes with Groupon’s problems, as evidenced in headlines such as “Is Facebook the Next Groupon?”

Essentially, Groupon, a word derived from “group” and “coupon” is a deal-a-day website that features discounted gift certificates. Using US$1 million in seed money from his former boss, an Internet investor, Mason launched the firm in late 2008 on a US$13 deal of two large pizzas for the price of one at a Chicago motel bar.

The deal raked in US$325 in revenues and, within months, Groupon’s group deal coupons were a worldwide phenomenon. Within 18 months of its launch, Mason was proclaiming that his firm was on its way to raking in US$1 billion (RM3.11 billion) in sales, “faster than any other business, ever”.

Within three years of its launch, Mason had taken the company public, and its valuation soared to US$19 billion in the first few weeks of listing. Going from US$1 million in seed money to a US$19 billion market valuation in less than three years was faster than anything the Internet had ever seen — from to Facebook.

Groupon stock is now hovering at US$4.30 a share, from its IPO price of US$20 late last year and a high of US$31.14 post-listing. Despite tall promises, analysts expect it will post revenues of just over US$2 billion this year and a net loss. Worried that the company could be on a slippery slope, high-profile early investors such as Netscape founder Marc Andreessen have in recent weeks sold their shares in Groupon.

How it works At the heart of Groupon is the concept of collective buying power. Individuals buying a single pizza or hamburger have no leverage over the restaurant selling it. But, if the restaurant knew that 100 people would definitely show up for dinner demanding the same kind of pizza with similar toppings, it would be happy to make a nice deal.

Here’s how Groupon works. It negotiates with a merchant for a sizeable discount — from 40% to 70% — of a product or service. Groupon then aggressively promotes the deal and the merchant’s product or service on its website for customers to purchase its coupons.

Why would any merchant give a discount of up to 70% on its goods or services for a start-up website? Here’s the thing: Most deals are valid for just 24 hours. Moreover, they work or are confirmed only after a tipping point or minimum number of purchases is reached. If the minimum number is not met, the deal is called off.

The customers do not get the deal and the merchants do not sell anything. The following day, Groupon tries to sell another product with another deal. Because the service is now in thousands of different locals markets around the world, including Singapore and Malaysia, offering deals on a variety of products and promoting each one of them aggressively on the Internet, most times, the tipping point, a fairly low bar, is reached, making money for both Groupon as well as retailer or merchant.

The model initially worked because it helps retailers and merchants clear their inventories, promote their businesses and, indeed, woo customers whom it might not otherwise reach. Clearly, retailers or merchants will pay a small price to pull in customers who might not have eaten a pizza or cake or bought a pair of shoes or a handbag if there wasn’t a 50% to 70% discount on it. Groupon was offering small and medium-sized businesses a vehicle with which to do some budget-price, risk-free guerilla marketing. Mason has said Groupon’s group coupon deals took off because of its “win-win strategy”. Essentially, everybody wins with group coupons, he says — retailers, customers and, of course, Groupon itself.

Not as promised Groupon was far less than what it made itself out to be, though. It was merely using emails to conduct what was essentially a coupon-clipper business. There really wasn’t much value-add and there is nothing really proprietary. Anyone who was web-savvy could do locally what Groupon was planning to do in 1,000 markets globally. Indeed, some detractors feel Groupon is not really a tech company, but one that uses technology such as email and social media to get its message out.

One of Groupon’s earliest detractors was Sucharita Mulpuru, an analyst with tech research firm Forrester Research, who gave the firm and its backers their first reality check just weeks before it listed late last year. Mulpuru reasoned that there was “no rational mathematics that could possibly get anyone to the valuation Groupon thinks it deserves”. Groupon’s IPO game, he said, was not “about finding value; it’s about finding a greater fool who actually believes the valuation is true”. For investors who were going ahead and buying into the IPO, Mulpuru had one memorable line: “Trust me, you will be the fool.”

Groupon may have grown from a mere start-up to a 12,500-employee company with 36 million customers in 50 countries on double quick time, but its growth is already starting to slow. In early August, it reported second-quarter revenue of US$568.3 million, compared with US$392.6 million a year earlier, below Wall Street analysts’ expectations of US$573 million and the lowest range of its own previous guidance.

That triggered a freefall of its stock. Moreover, it tried to manage expectations for coming quarters further downwards, which only confirmed fears that its business model was faulty and its growth potential was overhyped. Groupon blamed the European recession and a weaker global economy for its slower growth.

Groupon’s big initial success led to similar copycat group coupon websites around the world, including Asia. Instead of suing these copycats, it used the money that venture capitalists were throwing at it as well as money it later raised from the IPO on Nasdaq to buy up successful group coupon websites around the world, quickly rebranding them as local Groupon sites.

In Europe, it bought MyCityDeal in May 2010, followed by ClanDescuento in Brazil, in Japan and in Russia. In India, it bought deal-of-the-day website early last year, which has since been rebranded “Crazeal by Groupon Inc”. It also bought uBuyiBuy in Hong Kong, Atlaspost in Taiwan and in Malaysia.

Two Singapore brothers, Karl and Christopher Chong, who started their copycat group coupon website Beeconomic more than a year after Groupon was launched, were quick to sell their startup to Groupon for a cool US$24 million just 11 months later. The brothers now spearhead Groupon’s Singapore operations.

Groupon’s investors are hoping, now that Mason is CEO of a listed company, he will shun the fun and games and start acting like the CEO of a billion-dollar firm. For one thing, the company needs to tweak its business model, because “deal-a-day” isn’t going to make money.

It needs to use the remaining IPO cash and other resources to find new sources of revenues fast. In recent months, Groupon has been selling discounted consumer goods. He also needs to focus on delivering some profits instead of telling investors to give him more time, just as they gave Amazon’s CEO Jeff Bezos years to turn a profit. Amazon had a scalable business model that was seen to be working. Groupon does not. — The Edge Singapore

This story appeared in The Edge Singapore on Sept 3, 2012.

Posted by Alex Wong CPA Australia Melbourne University, Australia

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