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December 20, 2010

Depressing Thoughts About Groupon’s Model

A great deal has been written about Groupon’s rejection of a supposed $6 billion offer from Google.  Most of the reports breathlessly describe the explosive revenue and customer growth the company has achieved in two short years and what a breakthrough the model represents (an example can be found in John Battelle's hagiographic blog post).  With over 40 million email subscribers, Groupon’s success is based on consumers responding to their daily deal emails, and sourcing high-quality offers that compel readers to respond. The story CEO and founder Andrew Mason told in his interview with Charlie Rose last week was that when they offered helicopter flying lessons in one of their daily email blasts, they sold 2,500 in one day. This compares to a business that had acquired only 5,000 customers in its 25 year history.

But haven’t we seen this movie before in the world of direct marketing? History has shown nearly every major new direct marketing paradigm sees impressive initial response rates, but depressing response rates over time. For example, when display advertising was innovative in the late-1990s (imagine websites without ads?), publishers saw click through rates in the 1-2% range, allowing advertisers to be charged a high cost per thousand impression (CPM) in the range of $35-40. Today, iMarketer and MediaMind report that display advertising click-through rates are 0.10 - 0.20% and CPMs of $2-3 – less than one tenth what they were ten years ago.  Email has shown a similar sharp decline over time. Average click through rates for the early years of email campaigns in the 1990s were as high as 30-40 percent. Today, they range from three to five percent, again, a 10x drop.

Groupon conversion rates, supposedly, are now in the three to four percent range. What will those same response rates to the same consumers look like in five years? Will daily deals follow a fundamentally different model than every other new direct marketing medium? The benefit of being only two years old is that you don’t have a lot of vintage data to analyze.

What has impressed me about e-commerce stalwarts like Amazon.com and Netflix is that they have stood the test of time and have grown ARPU (average revenue per user) over time.  Consumers continue to have an appetite for books and movies, year-in and year-out, and the volume of new content changes rapidly. In contrast, the merchants in my community and the ones I regularly do business with do not change all that rapidly.
 
That said, Groupon is building a huge consumer database, a massive set of merchant relationships and a super-talented management team. Just as Amazon and Netflix have innovated beyond their initial model, Groupon has the capacity to replicate these results. But if it the company is going to step into the multi-billion dollar winner’s circle, it will need to find a model that stands the test of time, and the reality of depressing response rates over time.

Frankly, I hope they figure it out. Now if you'll excuse me, I have to sneak in a trip to the local indoor skydiving place before the holidays...

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agree with your doubts about groupon, jeff. as with almost any social network not named facebook, i'm just not convinced these are sustainable headcounts/models.

related to discount space, solutions like this have been around forever. groupon has done a great job to date, but i just don't know that they can keep it up. the space is getting further crowded by the day, and the fad will wear off at some point. for one, my entire family has already distanced itself from groupon when models like scoutmob require no money down.

with all that said, i wouldn't be surprised at all to see them with an IPO in Q2-Q3 of 2011 to take advantage of their current stature. think that's a real possibility?

Search is the ultimate direct response vehicle, and click-rates on search ads have gone up over the years. Postal direct response is roughly flat.

The key difference vis a vis display and email is that search & cataloging enforce scarcity of inventory. Display and email have created incentive to find ways to generate an additional impression, so it has been the race to the bottom you've described.

I think the key question for Groupon is whether they can maintain - and potentially increase - the scarcity of their inventory. If so, not at all clear to me that response rates will decline and suffer the problems you foresee.

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Good points, but I would suggest that
search is an ever-changing landscape – people are always looking for something
new and new things are always created.  It’s not clear to me the same breadth
of content/merchant turnover will exist in this one area.  How many new merchant
relationships can a consumer absorb every year?
 

If Groupon is taking 50% of the overall revenue (per Battelle) and there's a deep discount to start with, the merchant is getting on a small fraction (25-40%?) of the nominal price. This seems to be tenable only for business with huge markups or who are willing to pay out the nose for customer acquisition. Perhaps there will always be enough of the latter to fuel "50%/month" growth, but it seems unlikely. If the former, you'd think consumers would be suspicious by now of the "deals!" they're getting from certain high-markup merchants... but perhaps not.

There's plenty more room for Groupon to expand domestically and internationally with just a deal recommendation system via email. However, I agree that overtime their conversion rates will suffer (especially as large competitors enter the space like Yelp, OpenTable, TravelZoo, DailyCandy and others).

I agree that, for them to have true long term success, they will need to innovate beyond the email recommendation system and it seems like Groupon Stores is their early attempt to do so. I also wouldn't be surprised to see a Groupon credit card come out.

The indoor skydiving was totally worth it.

I agree with your view on Groupon. Can you comment on what is role of investors("VC") in coming to a decision? Are they also responsible for helping management to hedge their bets?

There are sustainable flash retail models out there, but I am not convinced that Groupon has one.

I cofounded a successful, niche-focused, offer-a-day retailer, that has seen only growth - since our inception more than 4 years ago. I have seen other niche flash retailers find great success, as well.

If I am Groupon profile customer, though, I can't see that they can continue to flourish. Their offers have become increasingly dull, and participating retailers that I have spoken with are not seeing the sort of ROI that has been promised. Customer acquisition seems to be losing out to bargain-hunters that are seeking the next fun restaurant or merchant to visit. In order for Groupon to succeed, past this exciting honeymoon phase, they need to create far more value for retailers and consumers.

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I’m a huge fan! J
 

I have the feeling that the Groupon management might have already seen the "deal fatigue" thing coming. In recent months, every several weeks, Groupon would offer a mega national deal, such the GAP deal and the Nordstrom GC deal, which created lots of new excitement among existing and new users. Just like how many ppl keep their marriage fresh :)

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They are smart managers and investors
there, for sure.  I don’t know how much direct marketing experience they have,
but they’ll probably figure out another act.
 
 

Groupon's 50% cut of all sales is an issue worth an entire blog post of its own. These deep discounts are often intended to get the word out about a local business, offering an introductory deal at a loss in the hope that the customers will come back for more at the full price. Some businesses hope for 1-200 takers, and are flooded with 2,500. How many of those 2,500 would-be helicopter pilots bought the deal because it was novel and 60+% off, and will never come back for full-priced lessons?

Agreed - I think the Groupon concept is still so new and exciting that businesses (and consumers) are willing to try it. Consumers may stick around (what's not to love about 70% off a nice dinner for two?), but retailers may not (what's there to like about providing your service to a large group of cheapskates for 15% of the revenue?). I'm just not sure that the model will become a staple in local businesses' advertising and media planning budgets.

Exactly. Loyalty and everyday spend are the missing pieces for the model to work.

It seems true that there is some correlation between Groupon's utilization of email and the way some direct marketers utilize this technology. I agree that it will be interesting to see where they are at in five years.

Thanks for the good comments. Have you achieved steady or declining response rates? What's your secret?

I'd guess it was a robust board discussion and joint decision, although have no inside info. I'd also guess the founders have taken some $ off the table at some point in the various financings in order to be aligned with the investors to swing for the fences.

Yes - a loyalty/discount card and perhaps online ecommerce store all make good sense.

They certainly seem focused on the "go big or go home" path, which indicates IPO is a distinct possibility. If you say no to Google at $6B, who else are you going to sell to?!

I guess the question I have is can the same model that Groupon has become more customer driven? What I mean is, would it be a step in the right direction to allow for customers to offer the places they would like to receive the discounts at?

thanks

Interesting idea. I'm sure they're working on that.

We have seen only increasing response rates. What's our secret? I could tell you, but... In all seriousness, There is no secret. Every business should deliver extraordinary service and exceptional value. These are the cornerstones of loyalty and continued growth. These, plus quality execution have been responsible for our annual double-digit growth.

You portrayed the topic well.. Especially the concluding paragraph and the mid section made a good read... keep posting...All the best.

http://www.medexpressrx.com/

Great Post!
Thanks for the article..

I called Groupon and met with a sales rep, but she refused to let me break even on a BBQ ribs promotion we were considering. Taking a 50% cut for a few hours worth of work is just greedy. It's only a matter of time before similar microsites and perhaps Google Deals comes through for businesses more interested in forging lasting, mutually beneficial relationships. I can offer a 50% off deal on Facebook, local forum, or BBS site here in Taiwan and still make a little something, but Groupon's model won't work for business like mine that already offer great prices for awesome products.

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