Discount dilemma: Groupon fights for life as daily deals fade

Groupon and its compatriots in the much-hyped daily deals business were supposed to change the very nature of small-business advertising. Instead, it is the daily deal vendors that are racing to change as evidence mounts that their business model is fundamentally flawed.

Groupon last week reported another quarter of disappointing earnings as its core business stagnated, sending its stock down 30 percent to an all-time low of $2.76. Its biggest rival, Living Social, is piling up losses, and part-owner Amazon.com earlier this month recorded a quarterly loss after writing down its Living Social investment.

Both companies 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.

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[caption id=“attachment_522816” align=“alignleft” width=“380”]  The discounts offered through the Groupon coupons have turned out to be costly. Reuters[/caption]

“It’s clear that they need to have other models besides the email daily deals business,” said Aaron Kessler, an analyst at Raymond James. “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 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 are uncertain.

“A lot of people made the mistake of overlooking the price-promotion part of this model,” said Utpal Dholakia, Professor of Management in Rice University’s Jones Graduate School of Business. “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.

“I’ve always maintained that this is a hype driven business built on an unsustainable business model both for the merchants and for Groupon,” said Rakesh Agrawal, principal analyst at reDesign mobile, a San Francisco consulting firm.

Existing customers interested in signing up for daily deals has waned-Groupon reported last week 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 $1.8 billion, down from nearly $13 billion when it went public. Groupon has also been dogged by controversy over its accounting methods, though it said last week that it had $1.2 billion in cash and cash-equivalents with no long-term debt.

BEYOND THE DAILY DEAL

Groupon cites an array of new services and features that it hopes will make the company a crucial partner for many types of merchants over the long run.

Groupon Goods, a more traditional discount online retail operation, already accounts for much of the company’s revenue growth.

“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,” said Kal Raman, Groupon’s senior vice president of international operations, in an email.

“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.

“I don’t think the industry it is completely going away, though it will settle,” said Arvind Bhatia, analyst with Sterne, Agee & Leach. “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 last week, 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.

“It’s a business that scales with bodies, with humans,” said Karim Faris of Google Ventures, which invests in online coupon company WhaleShark Media. “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.

“Groupon is working with small retailers to give big discounts, irregularly,” said WhaleShark Chief Executive Cotter Cunningham. “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.

“The heyday for the daily deals are behind us,” said Bhatia.

Reuters