The real problem with Groupon

If you've been reading this blog over the past few days you've probably picked up on the fact that neither if us is a big fan of Groupon as an investment. We've talked about issues with priming and adverse selection, the company's oddly primitive approach to targeting and its curious indifference to customer data. We didn't even get around to the difficulties with running a business based on so many merchant partners.

But as serious as these things might be, they are fixable. A management shake-up, a few smart people in the right places. I've seen business lines with bigger problems turned around and by companies with fewer resources than Groupon.

Problems with business plans are different and when you look at the bare bones core of Groupon's business plan, stripped of all the hype and obfuscation and needless complexity, Groupon is based on bringing together customers and merchants and convincing both to do something they normally hate doing: respectively, paying up front and taking a loss.

A Groupon offer is not a coupon; it's what we would normally think of as a gift card, a really crappy gift card at an exceptionally good price. How crappy? It can be used at only at a specific business (sometimes only at one location). You have to buy it on their schedule. Many if not most have expiration dates. Some even have blackouts on holidays. Finally, it can only be used one-per-visit with any unused balance being sacrificed.

People purchase these terrible cards partly because of the considerable (and non-sustainable) level of advertising and buzz; mainly, though, they buy them because the discount, both nominal and effective, is huge. (Felix Salmon has argued that the effective discount can be much smaller, but based on the offers I've received and reports from other users, it's generally easy to keep a purchase close to the offer amount.)

In other words, Groupon has huge revenue because, even when you take into account breakage, its merchant partners are offering huge discounts and certainly, in some cases, taking a loss.

What do merchants get in exchange for these discounts? The stated reason is to bring in new customers, but if that's your goal, Groupon is a terrible choice. Its customer list is enormous but of poor quality and the company hasn't even bothered to gather the data needed to do the most basic of targeting. There are any number of options using the internet and/or traditional media that will bring in a much higher percentage of the right kind of customers.

But merchants keep coming to Groupon despite its mediocre list and the fat slice it takes out of every deal (from Wikipedia):

As of 2010^[update], it is difficult for local merchants to get Groupon interested in agreeing to a particular deal. According to the Wall Street Journal, seven of every eight possible deals suggested by merchants were dismissed by Groupon.

Just to be clear, merchants spend time and effort putting together offers that will probably be rejected and, if they're not, will probably bring in a lot of customers they don't want. They do this because Groupon has successfully branded itself as the next big thing.

This is not something the company stumbled into. Groupon has aggressively pursued fast growth, generated ubiquitous buzz and has done its damnedest to portray itself as part of the social media movement. The 'social' aspect of Groupon's business has always been trivial to the point of cosmetic but it plays a large, even dominant role in the public image of the company.

In one sense, Groupon's strategy has worked very well. After all, the people who started the company will almost certainly walk away with a great deal of money. Eventually, though, the company will have to make the transition to former next big thing and since being the current next big thing is an essential part of the company's model, that transition is not going to be pretty.