1Mby1M Deal Radar 2010: Groupon

By Sramana Mitra and Melanie Blake

Deal Radar ends 2010 with a company that has made as many headlines this year as it has dollars – Groupon. Just a few weeks after turning down a $6 billion offer from Google, Groupon plans to raise $1 billion in private funds. First reported on VC Experts and a big story on TechCrunch today, Groupon has filed to authorize the sale of $950 million Series G preferred stock – 30 million shares at $31.59 a share, and its valuation is now $4.75 million. The company has already raised about $170 million in previous rounds from NEA, Accel Partners, Battery Ventures, and Digital Sky. The New York Times DealBook says that Groupon’s revenue’s may be $1 billion, making it, says Forbes, the “fastest-growing company ever.” TechCrunch called Groupon “the future of commerce,” others characterize it as a “one-trick pony” that’s been overhyped. Numbers, superlatives, and media attention aside, there is no doubt that Groupon is popular. Consumers of varying demographics love it. But will it last?

Groupon, a social commerce company, helps merchants in more than 300 markets run daily promotions that appear on its website and are e-mailed the the company’s subscribers. Many promotions offer a 50% or greater discount on restaurants, sports tickets, salon services, yoga classes, bowling, and many other goods and services. A certain number of people have to buy each deal before it “tips,” or is valid, and the idea is that people will tell their friends and family about deals and encourage them to buy the deal. Deal buyers can then print out their coupons or pull them up on the Groupon mobile app. Groupon takes about a 50% cut from merchants on deals sold.

The high discounts have made the site very successful among young people, families, and older couples at a time when many have less discretionary spending money. But Jay Goltz, author of the New York Times small business blog You’re the Boss, recently pointed out that despite the presence of a few high-profile cases, there hasn’t been much talk online from small business owners about whether they would use Groupon again. On its site, Groupon says that 95% of its merchants would run another Groupon discount.

A study by Rice University professor Utpal Dholakia published in September puts that number much lower, at 58%. In a conversation with Times reporter Darren Dahl, Groupon backer Eric Lefkofsky called the study “flawed” and its sample size “absurdly small.” According to surveys Groupon conducts, he said, merchants are “overwhelmingly happy.” The sample size in the study was small: 150 businesses, or 0.003%, out of the almost 46,000 Groupon had as of April 2010. And a few cases of merchant regret gained a lot of media and Internet attention, perhaps out of proportion considering the number of clients Groupon has. But the comments on series of posts by Goltz suggest that Lefkofsky’s characterization of merchants as overwhelming happy may gloss over questions and reservations small businesses have about Groupon. Of the self-identified small business owners responding to Goltz’s posts, about three-quarters said they would use Groupon again and recommended the service enthusiastically. Others had tried it and would not try it again because it was not profitable or had not had the impact on their business they were hoping for. The rest said they wouldn’t try it because they didn’t want brand erosion, did not need new business, were satisfied with the advertising they were doing, or did not think it would be profitable.

Some business owners believe that Groupon is better for service-oriented businesses such as salons and restaurants. Others, such as restaurant promoter Ellen Malloy of Restaurant Intelligence Agency, argue strongly that with their low margins and high cost of goods sold (COGS), restaurants, especially fine dining, chef-driven restaurants, should think hard before using Groupon or other social coupon services. Malloy did report that her criticism of Groupon spurred the company the meet with her to discuss how to better serve high-end restaurants, more of which have been using Groupon lately.

The consensus, reasonably enough, seems to be that Groupon is not right for every business. Running a Groupon deal is not always profitable, as the Rice study showed, and business owners, especially the small businesses that are the company’s main clientele, need to think carefully about their fixed and variable costs, incremental costs, the volume of clients they can handle, and so on before running a deal. Above all, said many small business owners, they need to remember that Groupon is a marketing tool that should be considered as advertising, not a panacea for a business in trouble or a surefire way for businesses to grow. This is a less exuberant tone than that struck by TechCrunch, with its “future of commerce” post; Lefkofsky, who talks about Groupon in the context of the social graph and its disruptive potential; and indeed Groupon and its many competitors. Here, the idea put forth (and which I agree with) is that Groupon is one of the companies creating an entirely new kind of commerce.

There are other questions to consider. “Haven’t we seen this movie before in the world of direct marketing?” asked Jeff Bussgang of Flybridge Capital Partners. His concern is the sustainability of Groupon’s model, and as he traces the history of CPM and e-mail click-through rates, he points out that rates and prices dropped as much as tenfold on these marketing tools. Although one of Bussgang’s readers questions whether the models should be compared, the point about sustainability is valid.

Further, will social commerce do what enthusiasts say it will for both online and physical stores? Are social coupons even social? In bigger cities, there are so many potential buyers for a particular deal that it may not matter whether subscribers encourage their friends to participate for the deal to tip. This is less so outside of major cities, where Groupon has many smaller competitors. Nevertheless, as small businesses continue to look for ways to harness the social Web to market their products and services, Groupon can become a superbly effective customer acquisition tool. And once businesses have acquired the customer, they can continue to market to that customer outside of Groupon through more traditional e-mail marketing mechanisms. For now, Groupon is set to continue to grow.

Many industry observers expect the company to use the money it raises for more international expansion. Mason himself admits that this is very hard given the difficulty in truly getting to know local markets, but Groupon is following this strategy successfully. It bought Berlin-based Citydeal in May, a move generally regarded as wise, and two copycat sites in Russia and Japan in August. A comprehensive, feet-on-the-street sales channel on the ground in many cities around the world would in itself be an excellent asset to build. It’s an expensive task, as P Morgan Brown points out, and while $950 million is a lot of money, Groupon will need it to go after the small and medium business market. What’s more, Groupon could be the next local ad sales channel after the Yellow Pages.

As John Batelle argues, “has the potential to be a new proxy – one that subsumes the platforms of both the Internet and the telephone, and adds multiple dimensions beyond them.” At the end of the day, I agree with Batelle, Lefkofsky, and Groupon itself – it can be far more than an online coupon company.

Recommended Reading Deal Radar 2010: LivingSocial

This segment is a part in the series : 1Mby1M Deal Radar 2010