HypeBusters: Groupon’s Flawed Model

It’s tough to knock Groupon, the deal-of-the-day web sensation that could be the fastest company in history to reach $1 billion in sales. Groupon is wildly popular today with 35 million registered users, skewing to women with upper incomes. It offers what economists call an assurance contract — a deal that is only good if enough people sign up for it — so businesses know if they play, they’re almost guaranteed a crowd. What’s not to love? Plenty. Let’s take a look.

Groupon’s pricing model is unsustainable. Gouging is an ugly word, but damn, Groupon charges a lot — businesses often pay 50 percent of all revenue associated with their special offer to the service. This is compounded because you have to offer a “discount” as well to build the deal. So if you run a massage spa and want to give consumers a “50 percent off” Groupon offer, you’d cut your normal $100 rubdown price to $50 — and then pay Groupon half the remainder, or $25, for every customer in the door. In effect, you’ve given away 75 percent of your total revenue. Yikes.
There is a disincentive for businesses to repeat offers with Groupon. Companies can give Groupon a shot once if they’re willing to play price-framing games (e.g. mark up your service high to then “discount” it low), perhaps to get a splash in a new market. But no company can stay in business with repeated marketing that gives away 75 percent of its sales. Don’t expect to see annual media plans with Groupon as a recurring line item next to banner advertising and Google search. What happens to Groupon after it cycles through all the interested businesses once in each market?
There are no barriers to competitor entry. Yes, Groupon has a network of millions of consumers it can email offers to. But who else has similar networks? Apple, Facebook, Walmart, and almost every large retail brand has lists of customers it could reach with the same quasi-viral coupon deals. Google Offers, announced in January, is just one of hundreds of Groupon competitors. LivingSocial is backed by online heavyweight Amazon, and we hear Amazon has a pretty sweet product line. Others, such as Dealery and Yipit, aggregate deals from multiple coupon players, just as Kayak and Travelocity give you ticket prices from numerous airlines. Coupons, it seems, are a commodity, and anyone with a network can play.
There are no barriers to customer exit. Consumer loyalty can be built with several strategies — price discounts are one form, but the least effective because low prices are easily matched; points, rewards, game mechanics, customer service, and positive and negative switching costs are stronger ties. Facebook has positive switching costs because once you’ve uploaded your contacts and family photos to its platform, you’d hate to leave that personal investment behind. AT&T uses both positive and negative switching costs to hook you — deals on phones that extend future contracts, and nasty termination fees if you cancel early. Groupon is just a price play.
 A wise observer might look at the past few years of economic malaise, coupled with the novelty of social networking tools, and conclude Groupon is riding a chance wave of interest from businesses desperate for sales and consumers desperate for savings. With hefty fees, business one-offs, keen competitors and customers looking for deals everywhere, you have to wonder how long will Groupon’s billions last.
Ben Kunz is director of strategic planning at Mediassociates, a media planning and Internet strategy firm. Follow him on Twitter @benkunz.

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