Business and Value: Groupon?

For fourteen years, I ran a store in Brooklyn, NY called Shakespeare's Sister. In the back, at first, we had a cafe. Later, I turned it into an art gallery and retreat... and eventually into additional sales space for the gift store which occupied the rest of the space. Naturally, I learned a great deal about retail. Now a teacher, I still keep an eye on what is happening in the world I left.

The other day, I came across a blog post, "Groupon is a Straight-Up Ponzi Scheme."  Though I think it's a little more complicated than that, I think the author may be right.

Let me explain.

Normally, a retail merchant uses what is known as a keystone mark-up for goods sold.  That is, the retail price is generally twice the wholesale price, the difference going for rent, utilities, salaries, advertising, upkeep, and profit (if any).  Any mark-up below keystone is considered a discount (hence the name "discount store" for those that try to make up in volume and reduced service for a lower mark-up).  Sometimes, for promotional purposes, goods will be offered at a reduced price, but this is for a limited time: the store cannot afford reductions on a permanent basis.  The purpose of having a sale is actually two-fold: First, it allows the merchant to clear out goods and, second, it brings in new customers--who will, one hopes, return.

Groupon, and those businesses like it, attempt to aid merchants by providing aggregated and directed promotions, generally huge discounts offered over the Internet.  Two-for-one and half-off, huge discounts, are the standard.  Merchants are attracted by not having to pay up front for the advertising, but only if someone actually takes up the coupon from the Web.

Problem is, the businesses end up having to pay quite a bit if someone does use the coupon.  The payment goes through Groupon, which takes half.  Therefore, the merchant is only receiving 25% of the normal retail price.  That is, the merchant is actually selling the goods at below cost--not even counting all of those other expenses the mark-up is normally expected to cover.

Obviously, this is not sustainable for the merchant, but is only useful as a 'loss leader,' getting people into the store for the first time.  Also, the merchant doesn't want it to be too successful--the more people who use the coupons, the more it costs them.  So there's a balance that has to be found, and a limit.  Few stores will want to use Groupon continually.

And that's the problem.  For Groupon to succeed, it needs a continual flow of offers, so it has to always be growing, moving to new merchants as old ones bow out or reduce the frequency of their offers.  This is where it is something like a Ponzi scheme: to work, it needs continual growth.  When its business doesn't expand, its profit disappears.

As there are not unlimited businesses that will be willing to use Groupon or its competitors, it seems likely that the Groupon business model will be of limited utility only.  In a few years, it will have to change its plan or will go bust.

Rumor has it that, in the aftermath of the LinkedIn success with its IPO, Groupon may be next.  Would I invest in it?  Probably not.  It may be that it can make money in the short term, but it will have to change a great deal, is it to prove sustainable.

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and tasty material for those who will recognize that the herd is running with another one after it goes public with an IPO.

"I hope we shall crush in its birth the aristocracy of our moneyed corporations which dare already to challenge our government in a trial of strength, and bid defiance to the laws of our country." - Thomas Jefferson

will buy them. :)