Online — June 19, 2011 3:36 am

Groupon Wants to Change the World

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Cynics will look at the Groupon IPO and see a seminal event in the history of the second tech bubble: the day the bubble floated to Main Street.

Here’s how the story goes: Groupon’s business model isn’t defensible, because anyone can set up an email list with coupons; its business practices aren’t profitable, indeed they’re losing the company so much money that Groupon will literally be bankrupt in two quarters if it doesn’t get another round of financing; and its primary asset — a huge network of customers and merchants — is atrophying over time, yielding less money per user with each passing day.

Its investors understand this dynamic, the story continues. But because their interest is in the value of Groupon stock, and Groupon stock will become more valuable if the company IPOs, Groupon’s backers want the company to IPO. At that point, they can dump their shares onto a gullible public’s lap, and leave with their profits in hand. It’s worth noting here that a full 80% of the last 950 million dollars Groupon raised went to paying off previous investors who wanted to cash out.

So that’s the cynical story. But there’s an alternative one. This sunnier story casts Groupon as a fresh and exciting company that’s making its money by improving the world – by helping merchants get more from their local communities and helping customers live bigger lives. (Get publicity and earn income! Learn to scuba dive and find a new BBQ place!) Groupon here is figured as synecdoche for a whole class of networked, game-dynamic tech companies that together constitute one of the most vital growth sectors of our economy. And here’s the crucial part: Without IPO, the average American can’t get any piece of that. Most Americans simply don’t have the money to buy stock in secondary markets, where private equity players trade Facebook and Zynga stock with venture capitalists; and now that most Americans’ retirement funds have switched from defined-benefit pension funds, which could and did invest in private equity, to defined-contribution 401ks and IRAs, they can’t invest collectively either. (See Felix Salmon for more.) By some estimates, we have more stock traded in secondary markets today than ever before in American history. Which means that the rich get sole dibs on the tech sector. The Groupon IPO, therefore, is a turn away from that trend.

Whether that’s a good thing or a bad thing – which story you believe, in other words – depends on how likely you think Groupon will fail.

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Summing up the company’s financials, David Heinemeier Hansson writes:

At the moment, it’s costing [Groupon] $1.43 to make $1, and it doesn’t look like it’s getting any cheaper. They’re already projected to make close to three billion dollars in revenues this year. If you can’t figure out how to make money on three billion in revenue, when exactly will the profit magic be found? Ten billion? Fifty billion?

In its older markets, Groupon’s appears to be declining over time, on a per user basis:

And finally, on the product level, there are a lot of important questions about how much value Groupon really creates for local businesses:

Only about 1% of Groupon users become regular customers. Groupon represents about 50% of the deals run by our clients. It’s easily the most effective way to get hundreds or even thousands of people through the door of a salon with one day’s advertising. The problem is that the cost of sale doesn’t really add up for the salon owner. Generally a salon only needs to convert about 10% of Groupon buyers into regular clients for it to make financial sense but based on our internal data we’re only seeing conversion rates of about 1%. Think about that for a second. A salon with three staff sells a thousand deals and only ten of these come back again and pay normal prices. That’s over a thousand man hours (at least two months) of loss-making treatments to gain seven new clients.

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These are valid concerns. Groupon is a young business. Facebook is seven years old and still hasn’t IPO’d; Groupon is two years old. Who knows whether it will fail?

But here’s the thing: an obsessive concern with its present financials is unlikely to answer this question. Read the commentators above, and you’d think that investing in Groupon is like grading a term paper — that the criteria for judgment is the past, not the future. The fact is, Groupon can change; its core business, with all its features and flaws, may well be totally different in one year’s time. Indeed, I suspect that Groupon’s shaky financials are a reflection of this very ambition: their willingness to undercut profitability for growth is born out of their belief that product innovation depends on scale. That once their network is large enough — once they’ve built relationships with practically every merchant in the country, and have access to the inbox of nearly every American with discretionary income — they’ll be able to connect both sides of the market in creative ways we haven’t yet imagined. “There are many ways to skin a cat,” it’s been said; likewise, there are many ways to intermediate sellers and buyers, once you’ve got access to both. Maybe next they’ll do an auction, like Ebay? Or do delivery, like Amazon? They’ve already launched Groupon Now, which is hugely ambition and totally different from an email list. In other words, Groupon isn’t a “daily deals” site; it’s a market-maker for the local economy. That’s the big idea. That’s the reason to invest.

Groupon critics often miss this point. But to think otherwise is to misunderstand how tech operates in our economy. When information technology is applied to a given industry, it changes that industry to the core. Entrepreneurs call this “disruption.” The news industry was disrupted; so was the music industry; so was political campaigning, book publishing, and (soon?) banking, gaming, and television. As Chris Dixon writes, “Predicting the future of the Internet is easy: anything it hasn’t yet dramatically transformed, it will.” But of course, the internet has yet to “dramatically transform” our local business economy. It’s helped us search for stores (Yelp, Google Maps); but it hasn’t changed our relationship to them. Thus the promise of Groupon.

With tech, what matters is the “category” you operate in (what industry you’re disrupting), not merely your product or your market. It’s easy to pivot products, it’s possible to leave markets, but you’re always locked into a category. And it must be said, Groupon operates in a huge and undeniably inefficient category, one ripe for disruption. The local economy structures our daily lives and yet hasn’t been altered in dozens of years — a state of affairs reminiscent of friends networks before Facebook or the music industry before iTunes. Thus if Groupon is the company that finally “disrupts” local business, it will be because it invested so heavily in strategic power within this category — because it invested in growth, even at the cost of performance. Groupon isn’t competing in a market with a product; it’s trying to dominate a category. Its ambitions are much larger than any financial statement would reveal: it wants to change the world.

Photo credit: Business Insider

  • http://www.facebook.com/ehendey Eric M. Hendey

    Congrats on the post. I’m glad you chose to examine the interconnections between the abstractions of the information economy (finance and web/tech) and the average, local business.

    Excuse my cynicism, but Groupon may not be able to control its own destiny despite its various innovations in an unexplored “category”. The fear of many is that Groupon will go public in the midst of a second great tech bubble. After LinkedIn’s IPO in May, its share prices rose 171% in the first day (as opposed to an expected 15%); the result is an obviously overvalued stock. “History has resoundingly shown that IPO-related euphoria rarely lasts longer than a few days. Some of the largest IPO gains in history were quickly wiped out in a matter of months,” said Sean Williams. It’s true that LinkedIn has created a revolutionary social networking platform. But it doesn’t merit such extravagant share prices: neither will Groupon after its IPO.

    Such irrational exuberance will only grow if Facebook, Twitter, and/or Groupon also go public. IPO’s of Chinese Internet companies have only proven this further.

  • Me

    Great post

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