## Friday, June 3, 2011

### Salmon/Fung cage match -- Did Salmon use a representative example?

Felix Salmon is one of the sharpest business and finance bloggers out there but I've never quite shared his enthusiasm for the Groupon business model. Disagreeing with Salmon on business matters makes me a little nervous, so I feel a bit better to have Kaiser Fung on my side.

Fung (who shares my high opinion of Salmon's acumen) has a good take-down of Salmon's analysis. You should probably read the whole thing but there's one particular aspect that strikes me as requiring additional attention.

Here's Fung:

At Giorgio's, for instance, diners paid \$15 for their Groupon -- which gave them \$30 of food. But dinner for two at Giorgio's, with some kind of alcohol, can easily run to \$100 or more. So even after knocking \$22.50 off the bill (remember that Giorgio's kept \$7.50 of the proceeds of Groupon), the restaurant would often still make money.

This is a bit complicated. We can trace how the cash flows. For Groupon, diners pay them \$15, and they keep half of that, \$7.50. For the diners, they paid Groupon \$15 (now worth \$30 spending), and so they pay Giorgio's \$70; in other words, they paid \$85 out of pocket for a meal worth \$100 without Groupon. Giorgio's take in \$70 from the diners plus \$7.50 coming from Groupon for a meal worth \$100.

...

So, I don't think the Groupon model is the kind of slam dunk Felix seems to think it is. Only if certain conditions are met will the merchants gain anything from Groupon:

• the value of the coupon has to be a fraction of the total spending at the merchant; in this example, the diners spent more than 3 times the face value of the coupon. What if the diners spend exactly \$30? Then Giorgio’s loses \$22.50 on each regular customer and earns \$7.50 on each new customer, meaning that every 3 new customers pay for each regular’s discount. Not very attractive numbers at all.
Of course, that \$7.50 doesn't take into account the cost to the restaurant of preparing and serving the meal (which would further help Fung's case), but putting that aside, how likely are customers to overshoot by a factor of three?

Looking at the offers currently on Groupon, I see three restaurants, Beto's Grill (\$20 for \$10), Stefano's Pizzeria (\$20 for \$10) and Henry's Hat (\$35 for \$15). Of the three, I'm only familiar with Henry's Hat (a game themed bar that, last time I was there, had Kruzno in its library), but, based on the information online, it would be fairly easy for two people to keep the tab down to close to the amount of the Groupon offer in all three.

Obviously, there are plenty of places in LA where you should plan on paying big money for your dinner, but I haven't noticed those places on Groupon. Instead I've seen a lot of moderately priced spots, and I doubt you've got a lot of couples running up a \$60 dollar tab on three buck a slice pizza.

#### 1 comment:

1. Mark, Felix has a follow-up:

http://blogs.reuters.com/felix-salmon/2011/06/04/how-effectively-does-groupon-leverage-its-size/

Of special note is:

"David Sinsky has some extremely smart Groupon analysis over at the Yipit blog, using numbers from the company’s S-1 to throw into question just how good Groupon is at making ever-increasing amounts of money once it has entered a market.

That is, after all, the explicit rationale behind Groupon’s ever-increasing losses"

I generally worry when I see the phrase "ever-increasing losses" to describe a company with a borderline business plan.