The big Groupon question

By Felix Salmon
June 11, 2011
Observational Epidemiology have come to the end (I think) of a fantastic series of posts about Groupon which get to the heart of the question I was trying to ask here: does Groupon actually work, in practice, in the way it's meant to work, in theory?

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Mark and Joseph over at Observational Epidemiology have come to the end (I think) of a fantastic series of posts about Groupon which get to the heart of the question I was trying to ask here: does Groupon actually work, in practice, in the way it’s meant to work, in theory?

A lot of the recent analysis of Groupon has concentrated on the financials, which have a habit of proving whatever you want them to prove. Yes, Groupon is losing ever-increasing amounts of money — but it’s doing so because it can, and because it’s convinced that all the money it’s spending on customer acquisition today is going to be repaid in spades tomorrow. If Groupon stopped spending money today on customer acquisition and marketing, it would be extremely profitable already, at its present size. It just wants to get even bigger and more profitable still, as fast as possible: a perfectly respectable capitalist goal.

Which brings us to the question of whether size matters, when it comes to Groupon. Insofar as Groupon has a moat — something which protects it from competition — it’s scale. But is scale particularly useful for Groupon? Where are the economies, there?

The simple and obvious answer is that the more customers Groupon has, the better it can get at targeting deals. Groupon is all about local — but if you live in a big city, some restaurant over on the other side of town ain’t local. If, thanks to its scale, Groupon can show you places much closer to home, or otherwise targeted to what you’re interested in buying, it will have a huge advantage over most of its competitors.

And then there’s the “Group” part of “Groupon” — the social aspect of the site, with people turning deals into opportunities to get together with their friends in the real world. Again, as with any network, size is crucial.

Mark started off the thread by pushing back against my assertion — sourced to Groupon itself — that diners spending their Groupon at a restaurant averaged a check 80% greater than the face value of the Groupon. Looking at the offers in his area, he reckoned that diners both could and would spend almost exactly the amount of the Groupon.

Joseph then followed up with more anecdote, buttressed by provocative thinking:

A good mate who owns a restaurant and did one of these deals after said it was outright amazing – many people would come in and spend EXACTLY the amount of the coupon. They didn’t want to go 50c under and heaven forbid they went 50c over and have to pay more at full price

Even worse, you seem to have to more effects. One is a priming effect. New customers assume your $30 entree is worth $15. That is poison.

I’m generally unpersuaded by argument from anecdote, and I don’t think the priming effect is all that strong. But the post was a great one if only because it set off a whole stream of posts from Mark, starting with the smart thesis that people buying Groupon shares are basically buying a lottery ticket. It’s true that if Groupon cracks the targeting nut, then it will be worth many billions of dollars. But there’s no evidence that it knows how to do that, or that it has yet done so, or that it’s going to be able to do so in future.

While it’s true that almost all marketing is targeted to some extent and a few companies have been able to take that targeting to a relatively high level, identifying customers who have a high likelihood (rather than a slightly higher likelihood) of buying something remains an extraordinarily challenging business problem…

Groupon has to worry about non-responders (who are still associated with some costs), and about bargain hunters who use the offer then never come back (who cost Groupon’s partners a substantial amount), and about regulars who use an offer for a visit they would have made anyway (who represent a double loss).

Separating all this chaff from the customers you want would be daunting even with the best of data and you will not have good data. How do I know? Because I’ve been there. I’ve dealt with third party data and I’ve written the hundreds of lines of SAS code needed to produce clean, usable data-sets. And I was only dealing with data from four or five sources, not trying to tease out a badly defined target variable from data collected from thousands of merchants.  (remember, we’re trying to identify customers who made their first visit using a Groupon offer and have since returned on their own dime.)

In a follow-up post, Mark tried to work out how Groupon was targeting its offers, based on the offers he was receiving. Except it was pretty clear, from an offer he got for a 24-Karat-Gold Specialty Facial and Chocolate Foot Scrub (only $125!) that there was really no targeting going on at all. Which impression was buttressed by the fact that Groupon was advertising as “New” its attempts to get its readers to hand over basic information about themselves, such as their sex and zip code.

And Mark’s smart when it comes to noticing the strategy behind Groupon’s messaging, too: the company is signing up subscribers by promising to save them money, rather than help them discover new merchants. Maybe that’s the best way to get new subscribers in the door — but it does hint at a quantity-over-quality mindset which isn’t entirely alien to Groupon’s founders:

The people behind Groupon have proven extraordinarily adept at running up big numbers and generating hype, but they have shown remarkably little interest in setting up a sustainable, profitable company. Their targeting strategies would have been considered somewhat primitive a decade ago. Their attitude toward customer data is nonchalant. They’ve used a carpet bombing approach to advertising (including the inevitable Super Bowl ad) which generates large email lists but seldom produces high quality ones.

All of this makes me wonder if these people are more focused on the stock price in 2012 than in the solvency of the company in 2020.

If there’s a weakness here it’s that Mark is being way too scientific about the fuzzy art of marketing when it comes to small local merchants. Groupon can carve out an impressive business just by being better than a billboard, if enough merchants come back for more. And so far, Groupon’s merchants have shown themselves to be quite willing to be repeat customers. But will that last? I suspect Mark might be right about this:

Merchants keep coming to Groupon despite its mediocre list and the fat slice it takes out of every deal (from Wikipedia):

As of 2010, it is difficult for local merchants to get Groupon interested in agreeing to a particular deal. According to the Wall Street Journal, seven of every eight possible deals suggested by merchants were dismissed by Groupon.

Just to be clear, merchants spend time and effort putting together offers that will probably be rejected and, if they’re not, will probably bring in a lot of customers they don’t want. They do this because Groupon has successfully branded itself as the next big thing.

This is not something the company stumbled into. Groupon has aggressively pursued fast growth, generated ubiquitous buzz and has done its damnedest to portray itself as part of the social media movement. The ‘social’ aspect of Groupon’s business has always been trivial to the point of cosmetic but it plays a large, even dominant role in the public image of the company.

I do worry that Groupon is as famous for being valuable and fast-growing as it is for providing the first-ever scalable solution to the problem of how small local businesses can leverage the marketing power of the internet. It feels like a momentum play, in contrast to say Google, which is a stock I’d happily own on a multi-decade time horizon.

Mark concludes:

In one sense, Groupon’s strategy has worked very well. After all, the people who started the company will almost certainly walk away with a great deal of money. Eventually, though, the company will have to make the transition to former next big thing and since being the current next big thing is an essential part of the company’s model, that transition is not going to be pretty.

I can definitely see Groupon recapitulating the arc of AOL. It will build a solidly profitable core business, which will go into decline, and then will have to work out whether and how to pivot to something else.

At the same time, I can also see Groupon — and especially its nascent Groupon Now business, if it ever takes off — becoming part of life as it’s lived on a daily business, a bit like local cable TV. As Mark says, it’s a lottery ticket. And if you buy it on the first day of trading, after it’s already had its first-day pop, then you’d better be feeling lucky.

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