GroupOn’s ability to survive lies solely in its ingenious appeal to the psychology of the consumer and merchant – its valuation is outrageously irrational; its business model equally flawed from “rational” economic players perspective, yet I will confidently say it has high chances to succeed, as long as the psychological game persists and remains unchallenged. In a series of blogs, I will debunk the valuation of GroupOn and the deal industry, in general.
Since its IPO announcement, a lot of investor mania has surrounded GroupOn. But, is its value of $30 billion justifiable?
The true value of an asset, theoretically, equals how much cash it can generate in the future. Using this simplistic theory, GroupOn’s $30billion valuation assumes that the company soon will grow to at least $15B in revenue (estimate arrived using 10% discount rate, 20% margin and other projections by GroupOn). Given its revenue growth and consumer’s willingness to pay, such projection seems aggressive, but well within the realm of reasonableness. However, the challenge lies on the supply side. $15 billion of GroupOn revenue equates to $45 billion a year that small/local businesses will have to part with and hand it to GroupOn as marketing expense. (GroupOn keeps 1/3rd of the deal)
As all valuation models are based on the assumption that decisions are purely “rational”, a merchant shall accept a deal with GroupOn only if it can generate positive ROI. From the macroeconomic scale, the GroupOn model simply crumbles.
The fundamental question to ask is if GroupOn actually contributes to value creation or redistribution of funds? Are you, as a consumer, spending more of your income or simply allocating your disposable income differently because of GroupOn? The simple answer is the latter. GroupOn has no capacity to create economic value, but it merely redistributes revenue from non-GroupOn merchants to GroupOn merchants. The question that bags itself is: If all merchants participate in a GroupOn offering, then where will the redistribution come from?
Based on data provided by the SBA and Economic Census Bureau, it is estimated that small businesses, at best, in the consumer sector, generate about $1-$2 trillion in annual sales. Assuming 10% profit margin, all consumer small business profits are around $100-$200 billion. For GroupOn to generate the revenue it forecasts, at least, ALL small businesses shall sign a deal with GroupOn and decide to give away $45 billion out of $100 billion profits they make. Wow, that’s a whopping 45%.
If not all merchants participate, the story is even more bleak. The $45 billion will have to come from smaller number of merchants.
Aha, two fallacies in the valuation are exposed. Is it reasonable to assume that ALL small businesses will sign up? And second, will a rational business owner simply give away a quarter, or half, of its net cash receipts to GroupOn, when there is no promise of true revenue growth or positive ROI? Let’s remember that GroupOn’s valuation of $30billion requires that almost all small businesses sign up for a deal with the Company…therefore, no net redistribution of revenue will be possible. Month 1, one merchant will pocket more revenue as a result of its GroupOn deal; however, in months 2-12 it will forgo its revenues to fund the redistribution of industry receipts to its rivals featuring a GroupOn deal.
And of course, let us not forget the copy cats proliferating the market. One might ask if international expansion is their basis for growth…that sounds too optimistic - China alone has already launched over a 100 GroupOn competitors. It’s an industry with zero barriers to entry, and therefore, competition is rampant.
If GroupOn’s valuation appears so optimistic, the entire industry taken together appears highly speculative. I would highly caution any venture capitalist, and investor pouring funds into the industry.
But, where did this all start? The deals industry… The power or bargaining power… The concept of offering a deal to seduce customers… Read “The myth of the deals industry” for more.
I think your argument is very valid. The better question would be what is the value of Groupon alone so we, Sloanies, can short it say in a year.
ReplyDeleteCheers,
Will : )
Sloanie'12
Groupon has plenty of room to grow if it starts to microsegment its markets, offering particular Groupons to various market segments in each of the geographic areas that it serves. I have one of my How does groupon work business. It provide good services.
ReplyDeleteIf you wondered how GROUPON gives large discounts, it is because it is a giant SCAM. Indeed, once you have paid for an item, you are directed to a website: you input the coupon number, the site accepts but does not send any confirmation email. You think that all is well but nothing is delivered. A few weeks later, you complain to Groupon which states that you have not exercised your coupon and that it is lost: you have lost all your cash!!!!!!!!
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