Fickle Fad or Smart Investment: Group Buying Promotions

Groupon is ALL over the tech newswire, and has also been getting surprisingly robust coverage from finance journalists in the US and Canada. Why?

It went public yesterday. In the biggest tech IPO since Google’s 2004 entrance on the Nasdaq (Google’s valuation on that IPO was something like $23B, Groupon’s by comparison was $12.7B).

There’s a lot of hoopla about Groupon, and the first day of trading mirrored the volatile press coverage the company has received over the past six months (shares were sitting around $26 in after-hours trading, up $6 from the offering price when the bell rang in the morning). Of course, any investor worth their salt will tell you that the first day of trading is meaningless. So is the second. And the third. It will be months before the market fully prices in the inherent risks and potential rewards of the group buying space- and indeed, the unique things about Groupon’s underlying business. Heck, they tried to use the non-GAAP accounting metric ACSOI in their first SEC prospectus filing. That alone makes me somewhat suspicious about the viability of the company. A friend of mine (@richardburcher) asked earlier today on Twitter what I thought about Groupon’s prospects, so let’s touch on that briefly before we move on to how Group Buying actually works.

Groupon has first-mover advantage in a market segment that they essentially created (LivingSocial may have launched first, but they didn’t adopt the current product-market fit until well after Groupon had conquered Chicago with its current business model). Groupon has a massive direct sales force, servicing 500 markets in 40-something countries. Groupon is now publicly-traded, and tends to annihilate or acquire smaller competitors when it moves into any new, localized market (by smaller, I mean the nondescript players that no one has ever heard of; and there are plenty of them around- a study by Business Insider suggested that there are around 500 firms competing in the group buying space right now).

There are some big threats to Groupon’s continued success though: there’s practically no barrier to entry in this space. Anyone with programming skills can design a group buying system for the web (web-based startups have very low overheads). Consumer fatigue in the deals space is a threat (what’s your threshold for deals that you aren’t interested in? Five irrelevant emails a day? Ten?). Without millions of people subscribed and using the Groupon service, the core value-added component of the company falls apart. Additionally, without retail partners signing on and initiating group buys, there’s nothing of value to offer the consumers who are using the service. Essentially, the entire business model (as currently operating) relies on a huge subscriber base (consumers) to feed a large client base (retailers). Group buying is also a very fractious space (LOTS of players), and some competitors with very deep pockets have or will be launching competing services (Google, Amazon, and AT&T are some examples). Groupon also doesn’t turn a profit. The company has taken an operating loss every year since its launch in 2008 (but their CFO claims the company is very, very close to profitability). For Groupon to be sustainably profitable, their marketing expenses need to shrink substantially while revenues remain constant or grow (which is very difficult to do with this business model- Groupon has to maintain a large marketing budget to attract new subscribers, and to keep existing ones from migrating to competitors).

Personally, I think the biggest threat to Groupon’s future success is retailer fatigue. There isn’t much process support for retailers from Groupon about how to actually run a successful group buying promotion at the store level, and how to make them work for the individual businesses which come aboard. The owner of the small corner bistro who gets slammed with 100 new customers in a single day (and takes a loss on every single one) will never initiate another group buy- and those hundred customers who were most likely pissed off with the wait times/poor service (if the owner didn’t beef up staffing and service capacity) are unlikely to ever return. It’s also likely that a percentage of them took to social media and shared their dissatisfaction, which harmed the brand equity of the bistro (consumers tend to offer public praise very rarely, but are lightning-quick to share criticism and anger).

My bet is that Groupon completely implodes inside of three years, and the creditors pick it over to try and recover some of their losses (which they won’t, because internet firms rarely have significant assets to liquidate in a chapter seven action). Unless their business model evolves significantly, through innovation of their core product and the addition of related revenues streams.

Let’s talk about how group buying actually works in practice.

Do you own or manage a small business in retail goods or services? Yes? You will not make money on a group buy promotion. The group buying company which you partner with will take a commission on the value of the deal in the range of 40-70%. Let’s run through a simple example: your selling price at retail on a widget is $10. You initiate a group buy through a firm that operates in your area, and they charge a 50% commission on the post-deal value. Your promotion is 50% off that widget ($5). So, right away you’re collecting $2.50 (Company X took $2.50 in commission) for an item that normally sells for $10. Here’s the real kicker: for you to break even (before your facility/staffing costs) on that widget, your markup has to be quadruple keystone (400%!).

Knowing this, why would any small business owner initiate a group buy promotion? Are they nuts??!

No. The value proposition of group buying is that it brings a larger-than-normal traffic count into your store, and that many of these people will become new, repeat customers: thus, you have the opportunity to wow these new bodies on service (or whatever else your defensible/unique selling proposition may be). In essence, companies like Groupon and Living Social incent a bunch of new customers to visit your store, and it’s then the job of you and your staff to upsell them on related products or services and (most importantly) convert them into return customers.

Easier said than done when it comes to discounts. Personally, I think that growing a customer base with discounts or deals is a fundamentally flawed strategy. You know your customers: think about who your most profitable repeat ones are. Think about who you enjoy serving. Is it the guy who comes in every so often, asks for your help/advice and then pays the bill… or is it the guy who comes in with a coupon clipped from the weekly flyer AND tries to haggle?

Put simply: do you want deal loyalty or real loyalty?

But if you’re really into the idea of running a group buy promotion for your business, here’s a quick guide for making the experience successful, or at least not a complete write-off:

Assumptions to make before initiating a group buy (be prepared!)

1. You will not make money on the promotion, you will eat a loss.
2. You will have higher-than-normal traffic counts, possibly during non-peak hours.
3. You will be serving customers with psychographic and/or demographic profiles that are unusual for your store.
4. Few of the new customers will convert to repeat customers for your full price offerings.
5. You’re essentially subsidizing advertising with your inventory (but you have little control over the targeting and have no access to the reporting metrics afterwards).

Process changes to support your business during a group buy

1. Control the promotion as much as possible (make the promotion valid only between certain hours and set a short expiry date).
2. Staff for the deal, especially if you’re in food/hospitality (if the deal is valid for the next 30 days between 4pm and 6pm with 600 sold, you need to staff for an extra 20 transactions each day between 4pm and 6pm- and that’s assuming perfectly distributed traffic gains; more than likely the gains will be lower at first and higher near the expiry date).
3. Have extra inventory on hand equal to each confirmed coupon plus 110-120% of your normal inventory for that item and time period (the group buy, plus your normal demand, plus a safety margin to account for extra word-of-mouth buzz floating around or walk-ins who saw the group buy advertised but didn’t purchase a coupon).
4. Be wily about what product you put on a group buy– choose an item that encourages repeat business, ideally a product which requires service/maintenance that you provide or can be enhanced with add-ons that you sell (if you’re in CPG retail) OR a house specialty/signature dish that’s quite unique (if you’re in food/hospitality) OR a high-quality service that you specialize in and that your brand is known for, which has an extremely attractive unique selling proposition (if you’re in services). Don’t initiate a group buy for something that every retailer and their dog carries (like toilet paper).
5. Have a customer relationship management system in place, preferably one that includes a brand loyalty program of some sort. Do your absolute damndest to get every single group buy patron into that system- you need to be able to track the effectiveness of your group buy promotions with some kind of metrics system in order to plan and refine future group buys, and this is the best way to do so.

 

[Disclaimer: I do not own shares in Groupon, nor do I intend to place a short position on its stock; additionally, I do not currently own shares in Amazon, AT&T, or Google]