The shakeup at Groupon, where Andrew Mason was just fired, and two board members have taken over has put the daily deal industry under scrutiny again, raising the question of where the industry is headed next, and indeed, whether it will continue to exist.
As a part of the executive team at JustDeals.com, a startup within the discount space, here’s what I see happening. For the biggest players such as Groupon, LivingSocial, Gilt City and others, consolidation is likely to occur in the market, as competition continues to grow.
Companies with a broad range of available deals and discounts such as LivingSocial might look to combine with a more niche deals provider in order to focus on perhaps a higher margin area. It’s likely that the bigger players will be around in some form for the near-term future, although they might not look like as they do now or offer deals in the same manner.
Although Groupon's revenues were up +24.79% in Q4 2012 over Q3 2012 and up +23.47% over Q4 2011, operating income was substantially down -- down 152% from Q3 2012:
The reason for the drastic drop in operating earnings in Q4 2012 over Q3 2012 and Q4 2011 was higher costs of revenues -- up 54.95% over Q3 2012 and representing 44% of revenues in Q4 201 2 versus 32% in Q3 2012 :
For example, the leading pure-play daily deal company, Groupon (Nasdaq: GRPN), is moving away from strictly relying on the coupon part of the business and becoming more of a localized e-commerce platform. The challenge in such a transition will be to satisfy customers who expect the brand to offer deep discounts and of course competition from massive and entrenched players such as Amazon (Nasdaq: AMZN). For these big companies, trouble is already brewing with Groupon’s recent poor earnings report and stock tumbles and LivingSocial canceling employee bonuses in late February. Both will likely need to shift tactics in order to remain viable.
For service businesses, daily deals certainly have a role in attracting initial interest to a new business, but they do pose drawbacks for established businesses. The margins, of course, can be steep, with many restaurants or nail salons breaking even or perhaps losing money on the typical heavily discounted deal.
A growing drawback for these types of deals is the inability for many businesses to attract long-term customers through daily deal promotions. Many consumers simply “deal hop” to find the current discount, and are only drawn to be a repeat customer if the service provided is truly extraordinary.
Current customers can also be negatively impacted by daily deals. Consider a nail salon that features a steep 70 percent off offer in order to drum up business. If the deal attracts 600 people, that might seem to be a great result, but it could mean the salon is booked for the next four months, and regular full-price customers are effectively pushed out.
The business can of course set controls on the number of offers, although many simply want to pursue the largest possible number. The longer-term ramifications of these arrangements are turning off many establishments from conducting as many daily deals or from offering as aggressive discounts.
Companies that offer a physical inventoried product are likely positioned to fare considerably better than those firms that offer services such as massages, restaurant discounts, and fitness classes. More of these types of companies will look at buying directly from manufacturers and keeping stock of products in order to operate at reasonable margins. They might even make deals with such manufacturers, working with them to produce branded or unique products.
Firms like JustDeals.com and some other product-centric sites offer mainly overstocked items, discontinued merchandise, or products that are simply at the end of their marketable life. There will always be products that fall into these categories, and savvy deal firms can acquire the product at price points that offer quality margins even when they are subsequently heavily discounted. Some of these product-centric deals firms also focus on just a few offered deals at a time, as opposed to many sites that fit into the “Paradox of Choice” model where they simply offer too many products and services and don’t focus the consumer on one particular area. Many of these sites resemble a “pennysaver” type magazine that offers myriad products that don’t go together logically.
Going forward, successful deal companies will need to:
- Mirror the leading players in other categories, which universally excel at service.
- Deal sites need to be transparent, both in providing detail as to the exact nature of the deal.
- Provide adequate customer service access in order to address any problems. More automation will be found in the returns process, allowing companies to reduce costs and more efficiently serve customers.
The longer-term future includes trends such as the convergence of the Internet and cable television and deals, where companies such as Hulu or Netflix (Nasdaq: NFLX) might feed deals directly into the homes of consumers. College students today are abandoning cable and focusing on streaming content, and smart deals companies will find ways to logically integrate their offerings with related video content. It’s another example of the necessary adaptation that these companies will need to perform in order to remain relevant in 2013 and into the future.
Richard Chemel is vice president of JustDeals.com, and is a contributing writer for Daily Deal Media.
COMMENTARY: In spite of Andrew Mason's laidback, free wheeling, and often controversial methods of running things, Groupon went on to become the fastest-growing company of all time, hitting a billion dollars in revenue in just 17 months. Groupon's growth strategy followed co-founder Eric Lefkofsky's playbook to a T:
A hypergrowth company fueled by mountains of investment capital that claimed to be reinventing an old industry — coupons and loyalty cards — with a high-tech approach.
In an interview with Bloomberg before the company went public, Eric Lefkofsky, a co-funder and early investor, claimed Groupon would be "wildly profitable", a statement the SEC later forced him to retract. And while a few journalists raised questions about Lefkofsky's past, most focused instead on the incredible growth and the smiling Andrew Mason, who personified the disruptive youth and innovation of a startup.
Since Groupon went public, the facade of Groupon has come tumbling down. Instead of wild profits, there's been steady losses (see below). And as the red ink has mounted, so have the lawsuits, from investors who said they were misled and from employees who said they weren't paid. The SEC was forced to look into some very fishy accounting which appeared to have been used to prop up Groupon's books. As the bad news piled up, Mason took the brunt of the criticism, with Lefkofsky fading into the background.
With Mason's departure, Lefkofsky will take over as co-CEO, along with vice chairman Ted Leonsis. In some respects that will mean he finally has to face the music. But just like it was with his previous internet ventures, Lefkofsky, a man with a track record of creating hypergrowth companies that have crashed and burned, the health of Groupon's business has less of a material impact on Lefkofsky than many others involved. Lefkofsky and his family actually cashed out to the tune of $382 million before the IPO taking a huge chunk of cash off the table during the last round of venture funding. Insiders cashed out again duringthe IPO, which valued the company at $12.8 billion. And it wasn't long before talk of a secondary offering, which would allow insiders to cash out for a third time, began to swirl.
In the 16 months since Groupon went public, the stock has plummeted more than 80 percent (see below stock price chart). It's now worth $3.09 billion, or roughly half what Google offered to pay for it back in 2010. And its most recent earnings, reported yesterday, paint a grim picture, with the company notching losses of 12 cents a share.
It's very ironic and surprising that Andrew Mason, who did not have a golden parachute, only received a $378 in severance, saw the value of his 7.1 percent stake in Groupon go up by $34 million in the days since he got fired, and stock prices rose. His shares were worth about $228 million yesterday. He made $31 million in private transactions prior to Groupon’s 2011 initial public offering.
Lefkofsky doesn't appear swained by the controversy surrounding Mason's firing or the early payouts by early Groupon investors, told the Chicago Tribune earlier this week that Groupon is "on the edge of greatness," and that he looks forward to hiring a CEO to replace Mason who has experience dealing with the type of issues the company is now dealing with. Currently, he and Ted Leonsis, a veteran of the biggest dot-com boom and bust in history through AOL are co-CEOs. This sort of reminds you of the co-CEO setup over at Research In Motion (RIM), maker of the BlackBerry. And,we all know how well that arrangement turned out for RIM. Lefkofsky better hurry and hire a new CEO.
The fact that Groupon has lost so much money over its four year history and ended Q4 2012 with another loss, can be blamed almost entirely on much higher costs of capturing incremental revenues. This raises continued questions about the sustainability of Groupon's business model:
- Will Groupon's business model ever generate economies of scale?
- Has Groupon's business model reached a point of diminishing returns?
- Has the pressure of meeting investor expectations required a strategy of attaining revenue growth "at any cost"?
- Does Groupon rely entirely too much on the U.S. market to attain revenue targets?
- Has Groupon become a bloated corporate whale without regard to good business fundamentals?
- How will Groupon perform post-Andrew Mason?
If Groupon is losing money on each incremental dollar in revenues it generates, does this mean there is a flaw in the business model, does this signal poor management decision-making, or has has the company simply forgotten how to generate a profit? I have a feeling that it is a combination of all three.
What is most ironic is that Groupon's revenue model is the same one adopted by hundreds of smaller competitors, so you have to wonder about the entire health of the daily deals industry. However, by its dominant size, Groupon sets the cost and profitability standards for the entire daily deals industry. By virtue of its unique status as a publicly-traded daily deals company, with access to capital via the public markets, huge market share and experienced management team, it would not surprise me that part of Groupon's strategy is to outlast its competitors, forcing many of them to go out of business, or be acquired on the cheap by non other than Groupon itself. Could this be what Lefkofsky meant when he said that Groupon was "on the edge of greatness?"
In early November 2012, Groupon reported very disappointing Q3 2012 earnings as its core business stagnated, sending its stock down 30 percent to an all-time low of $2.76. By its own admission, Groupon told investors in mid-2012 that daily deals are beginning to fade. That should've been a warning to competitors as well. Its biggest rival, No 2 Living Social, is piling up losses, had to scaleback expansion and layoff workers, cancelled its IPO (no thanks to Facebook an Zynga), and even cancelled annual bonuses for 2012. Even LivingSocial part-owner Amazon.com earlier this month recorded a quarterly loss after writing down its Living Social investment.
Both Groupon and LivingSocial are racing to diversify, venturing into more generic ecommerce areas like off-price sales through ventures such as Groupon Goods and LivingSocial's Shop. Meanwhile, upstarts are developing new variations on the discount coupon theme.
Aaron Kessler, an analyst at Raymond James said.
"It's clear that they need to have other models besides the email daily deals business. The problem is that a lot of these newer businesses have lower margins."
Critics say the torrid growth that enabled Groupon to go public at $20 a share just over a year ago was fueled by merchants buying into a new type of marketing that they didn't fully understand. The discounts offered through the Groupon coupons have turned out to be costly, and the repeat business they generate uncertain.
Utpal Dholakia, Professor of Management in Rice University's Jones Graduate School of Business said.
"A lot of people made the mistake of overlooking the price-promotion part of this model. Normal advertising, yellow pages advertising, it really doesn't have a price promotion, it doesn't have discounting component. That's what makes this difficult to do again and again."
A Raymond James survey of roughly 115 merchants that used daily deals services during the fall found that 39 percent of merchants said they were not likely to run another Groupon promotion over the next couple of years. The top reasons cited were high commission rate and low rate of repeat customers gained through offering a promotion.
The survey also found that 32 percent of the merchants reported losing money on the promotions, and nearly 40 percent said the Groupon offer was less effective than other types of marketing.
Rakesh Agrawal, principal analyst at reDesign mobile, a San Francisco consulting firm said.
"I've always maintained that this is a hype driven business built on an unsustainable business model both for the merchants and for Groupon."
Existing customers interested in signing up for daily deals has waned - Groupon reported in early November 2012 that the average revenue per active customer (defined as an account that has purchased a deal from the site in the previous 12 months) fell to $63.96 in the 12 months to September 30 from $76.49 a year earlier.
The company has also suffered a string of high-level executive departures as its market value has shriveled to just $3.61 billion, down from nearly $13 billion when it went public. Groupon has also been dogged by controversy over its accounting methods, though its financials show that it had $1.2 billion in cash and cash-equivalents with no long-term debt at the end of December 2012.
Groupon Goods, a more traditional discount online retail operation, already accounts for much of the company's revenue growth.
Kal Raman, Groupon's senior vice president of international operations, said in an email.
"We're investing in the development of products and technology that help our merchants run their businesses more effectively, from payments and POS services to our evolving suite of marketing services including the daily deal. By this combination we become a true merchant partner, serving the yin and the yang, both the operational and marketing pieces of each business."
A key part of that is the massive sales force that Groupon has built to market its daily deals to small businesses. The relationships it has built with merchants and a retail subscriber base that recently hit 200 million could help it beat back competition in daily deals and broaden its offerings, some analysts say.
Groupon controls about 50 percent of the daily deals market share in North America, according to Yipit, a New York City-based daily deal industry tracking firm.
Arvind Bhatia, analyst with Sterne, Agee & Leach said.
"I don't think the industry it is completely going away, though it will settle. There may be some market share shift to the benefit of Groupon."
The margin pressure, though, could be here to stay. Groupon laid off 80 employees in early November 2012, mostly in sales, as it seeks to bring more automation to the sale process and control costs. But a big sales force is central to the company's strategy.
Karim Faris of Google Ventures, which invests in online coupon company WhaleShark Media said.
"It's a business that scales with bodies, with humans. I'm a technology investor, and I like businesses that scale with technology."
WhaleShark and other competitors such as Coupons.com have focused on bringing traditional coupons into the digital era. Such companies typically get a small percentage of revenue for each sale generated by their coupons.
WhaleShark Chief Executive Cotter Cunningham said.
"Groupon is working with small retailers to give big discounts, irregularly. We work with big retailers, to give small discounts, every day."
Dholakia of Rice University said executives at new startups have told him they plan to make daily deals more attractive to merchants by offering them a bigger cut. He also cites interest in new models around "perishable inventory," such as restaurants and spa services, for which big discounts might make more sense for the merchants.
As such competition builds even as the original deals business flattens, there are no easy answers for Groupon.
Courtesy of an article dated March 6, 2013 appearing in Upstart Business Journal and an article dated February 27, 2013 appearing in VentureBeat, an article dated March 1, 2013 appearing in The Verge, and an article dated March 5, 2013 appearing in Upstart Business Journal, an article dated August 15, 2012 appearing in Bloomberg, an article dated November 12, 2012 appearing in Reuters