Why will GroupOn succeed?

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 bogs, I debunked the valuation of GroupOn and the deal industry in general; however, why do I still believe they will succeed?

The underlying success of GroupOn is pinned in its appeal to the psychology of the consumer and merchant. GroupOn is the first deals based business model that went viral, even though its business model has been around for decades. Since the advent of ecommerce, retailmenot.com, coupons.com among others, preceded GroupOn inviting far larger user base, but far too small valuations. Then, what is the secret sauce of GroupOn? 

The ingenious strategy of “prepaying” for deals & “framing” of savings is where GroupOn innovated. The prepaid nature of GroupOn creates commitment and anticipation which have viral elements.  

• Commitment – Unlike a 10% coupon which you can let expire, when prepaying for a saving, you commit to make the transaction. While a 10% savings offer may be lost in your memory, prepaying keeps it fresh in the mind …you'd better remember that you have already paid for a service that you have not yet consumed… so it’s on top of your mind to buzz about it at parties, among friends…
• Anticipation - Most consumer research shows that the prolonged period between commitment and delivery of experience creates additional excitement. Moreover, anticipation keeps the excitement of the experience fresh, exacerbating its viral component. Remember that anticipated vacation you were telling your friends months in advance?
• Framing – Even when the deal is ordinary, GroupOn can make it sound exciting by framing it in a way that resonates with the customer better. How would you like to receive a $20 for $10 GroupOn for Old Navy instead of 20% off $50? Cialdini spends volumes talking about the psychological pitfalls framing leads us to, but when manipulated smartly by a marketing company, it can attract consumer’s wallet share.
• Addiction - Studies show the happiness factor associated with an experience decreases significantly at the time of payment…hence; we tend to enjoy prepaid vacations more. GroupOn allows you to partially prepay for your experience, thus mitigating the displeasure of payment associated with a service you bought…making you “enjoy” your GroupOn dining experience more than otherwise, and in turn, causing you to come back for more GroupOns.

  

Well, merchants also like the immediate cash flow infusion, giving them immediate gratification over other long-term marketing investments. In addition, it is a great tool to solve for overcapacity and slow moving inventory. But, is the cost justifiable to a small business? Rice university research states over 32% of merchants find GroupOn deal to be a financial disaster.

However, as long as demand for GroupOn remains strong, merchants will learn the price elasticity of the GroupOn psychology and pass on the cost to the consumer in terms of higher list prices or smarter framing of deals. After all, how do you determine the fair price of a hot air balloon ride? Your willingness to pay for the service is the GroupOn adjusted price - but, what makes you confident that the GroupOn adjusted price would not have been the true price had GroupOn never existed?

Although some myths dominate the GroupOn controversy about its lack of targeting …these are easily solvable. With time, GroupOn will possess enough consumer data to allow it to data mine and target offers to consumer preferences. As for GroupOn fatigue, well, that is no different than any form of direct marketing…

Despite all the controversy, GroupOn has the potential to succeed as its innovation appeals to the consumer psychology and merchants will continue to supply it, as long as consumers are willing to buy.

GroupOn’s valuation myth debunked!!! A cautionary tale of the deals industry…

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.