A few weeks ago while I was down in North Carolina for Triangle Startup Weekend, I stopped by Carrburritos (my favorite burrito place in Chapel Hill and probably the world). As I went to check out, I noticed the cashier/manager flipping through a huge stack of Living Social printouts and cross checking them against a list. They had recently run a standard $10 for $20 in value deal, and it turns out they got a “favorable” 60/40 split with Living Social. When I asked how the deal went she said, “NEVER AGAIN! We’re losing way too much money.” I pondered her response, as I sat and ate my delicious burrito, and came to the conclusion I needed to write post on this crazy daily deal space. It seems like we need to cut through all the media nonsense and get some perspective on what's really going on.
Much has been written about the "daily deals" space, especially since Groupon filed for its IPO in early June – mostly bad stuff:
- Pass on the IPO because it’s spending & losing way too much money
- The company is practically insolvent because Current Liabilities >>> Current Assets
- Insiders are selling and they’re using accounting gimmicks, it can’t be a good deal
- Groupon is a straight-up Ponzi scheme
- The business is deteriorating in the oldest/largest markets
- The daily deal business model sucks – low barriers to entry, low switching costs, transactional & discretionary
To a certain extent, all of these detractions are valid. Rocky Agrawal (@rakeshlobster) has written some brilliant articles for Techcrunch stating that daily deals are terrible for small businesses and that they should just go away. Rocky makes the point that the current daily deal economics are unsustainable (generally 50%/25%/25% to consumer/Groupon/business). I agree.
“So you’re saying daily deals are going away and Groupon, Living Social, et al are going to bust??”
Here’s the truth as I see it:
- Daily deals won’t be just a fad, but will become an attractive part of the marketing plan for certain types of local businesses, in part because the current economics are unsustainable.
- Some of Groupon’s critics may be correct in the short-run – Groupon's current success with daily deals is unsustainable – but their ultimate conclusions on what that means for the business are dead wrong. Contrary to Bill Gurley’s remarks (gasp!), I believe Groupon has a massive “moat” and is poised to flourish.
“Wait, what!! How can those statements be true after all the bad stuff I just read??”
Well let’s go back and check out at all the detractions.
First, the fact that Groupon is losing money, has CL >>> CA, and is resorting to accounting gimmicks ultimately doesn’t matter… because of its working capital cycle, the company is massively cash flow positive. Finance 101 will teach you that cash flow = value. With continued growth and the liquidity of being public, their current liabilities should never pose any real problem. Groupon’s losses are really investments in acquiring subscribers and, more importantly, building a massive local salesforce (according to the amended S-1, since the IPO filing they’ve gone from 7,000 to 9,000 employees – they added 2,000 people in 45 days!). Next, in a different point in the capital markets cycle Groupon would already be public and insiders would’ve already liquidated a similar portion of their profits. Lastly, I’m not going to even justify the “Ponzi scheme argument” by writing a counterpoint… so short-sighted.
“Ok, if I believe they’re solid financially, what are they going to sell when daily deals become unattractive??”
Well, the revenue split of daily deals will change over time, perhaps drastically, but they’ll never totally go away. Some small businesses have been very successful and there are repeat customers and best practices to prove it. According to Yipit approximately 40% of the deals in May were from merchants running at least their second deal. Currently, traditional daily deals make sense for merchants in roughly 6 different situations (again via @rakeshlobster):
- You're launching a new business
- Your customers are recurring/subscription or have high customer lifetime value (CLV)
- Your product has an expiration (think hotel rooms, restaurant tables, event tickets)
- You already rarely sell anything at "retail price"
- Your real product is "eyeballs" and you need to buy circulation (think magazines)
- You NEED the cash to save the business
- (I’d add: You're confident in your ability to “up-sell” customers)
Hopefully you're in situation 1 or 2 if you're a small local business, but daily deals will remain attractive for all of these situations.
However, as is evidenced by the deterioration of older markets, the low barriers to entry and low switching costs ensure that competition will drive both the revenue split and payment terms in the merchants’ favor in the long-run. Ultimately, the aggregators like Yipit will be in the best position to succeed with daily deals. Their high volume of deals across a low fixed cost base (no giant salesforce) will allow for them to sustain profit. Additionally, their wide variety of deals across many target audiences will be attractive to publishers and individual consumers alike. If you’re a publisher, would you rather your targeting algorithm pull from 100 deals or 10,000? If you’re a consumer, would you rather get 10 daily deal-mails per day, or just one?
Looking into the future, when the traditional daily deal economics become less attractive, all is not lost for Groupon. In the medium term, they can turn their salesforce’s attention to the second iteration of daily deals – Groupon Now. Groupon Now will allow merchants to solicit instant demand for expiring products (vacant hotel rooms, unfilled appointments, empty tables, unsold tickets). Steve Cheney (@stevecheney) does an awesome job of describing how powerful instant deals will become. The instant deals model should prove to be more sustainable than daily deals because the technological barriers are higher and the service is inherently stickier with merchants. However, competition will be stiff here too, and ultimately you’d rather be an aggregator than Groupon.
Good thing for Groupon there’s dozens of other services they can sell to small businesses. With a huge market cap, Groupon can afford to either build or buy a portfolio of products (some of which they’re already publicly pursuing), for instance: point-of-sale systems (Square), loyalty (foursquare), social media and web tools (SinglePlatform), local directory, reviews, & recommendations (Yelp), coupons (SavingStar), etc. Most of these other services are much stickier than deals and are more subscription-based in nature.
Thus, like Amazon, Groupon’s “moat” is its sheer scale. Within the daily deal space, only Living Social can rival Groupon’s national reach into local businesses, and with the changing landscape, it’s unlikely any other daily deal mega-player will emerge. Building a local salesforce with feet-on-the-street is very expensive and the window of opportunity to accomplish that on a national scale seems to have closed.
In the long-run, deals will become only one part of Groupon’s portfolio of products for local businesses. Billions of dollars of spending by local merchants will transition from offline to online and Groupon has the opportunity to be the nexus of that transfer. Does that make Groupon worth $30 billion??… I don’t know.
But I do know that Groupon captured the daily deal phenomenon at the right time and convinced merchants to pay for its assembly of a huge salesforce to sell more services to those very same merchants. And that’s genius.