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Why is Groupon overvalued?

June 18, 2011

We are right in the social media decade, which started back in 2004 with Facebook, and it seems to evolve to a new level with Groupon. With more than 83 million of users and a presence in 500 markets, Groupon turned the basics of social networking into a business model in less than 2 years. The start-up from Chicago has recently filled up a $20 billion IPO , despite a funding of only $1.4 billion and a loss of $400 million in 2010. So is Groupon worth it?

Based on a simple business idea – the good old coupon to which it added the power of internet – Groupon has the ability to make a huge profit. As long as it has a important customer base. And it does, but at a high marketing cost. Groupon is said to acquire each new customer for $5.50, and need them to purchase 3 coupons to break even. And customers are far from reaching such figures. Groupon simply expects that in the future the trend will change, as 44% of the suscribers expressed the desire to spend more over the upcoming year.

But beyond a simple discussion over figures, this is the business operation itself that makes Groupon far less attractive than it seems to be. It is true that Groupon can help a local business to reduce its loss during a slow season, or attract new customers for a specific time or offer. For example, a cafe willing to increase its sales during quiet afternoons might simply launch an offer via Groupon to sell its products at this specific time, and suddenly see an increasing number of customers changing their habits to get the hot deal. Eventually, the cafe’s owner simply turned an expected loss into a profitable operation. But the problem is two-dimensional here: first, such operation can be financially disastrous for businesses, such as forthe Posie’s Cafe. Groupon takes an average gross profit of 42% on deals, expecting over 50% discounts on products from the businesses. Needless to say, there isn’t much left for businesses to make a profit out of it, even if the marketing operation might be profitable afterwards. Second, Groupon customer base is largely composed of bargainers with a low loyalty dimension. They might increase the sales figures of the business at the time the offer is running, but won’t come back unless another offer is up. Which is the contrary of the marketing operation run by the local business. Moreover, the time-limit of the offers might as well hurt them, as many Groupon buyers try to use them after the deadline and feel upset when the refusal occurs.

This situation might not last forever: as more and more businesses will feel disappointed by the business model, Groupon might simply have difficulty to have any offer to propose to its customers! Moreover, Facebook and Google just entered in the business, and might force Groupon to reduce its profit margins in order to remain in the business. Facebook, with a “customer base” of about 600 millions might in a soon-to-come time take over the entire industry if played well. Groupon should better hurry getting its initial public offering approuved if it wants the cash to sustain its growth…

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