The Case for Eternal Groupon Skepticism

Groupon has broken some bad news recently, and their stock price at pixel time (8/14/12) is down about 26% today.  This should surprise absolutely nobody.  They are (very narrowly) profitable this quarter, with net income of $28M on $568M in revenue. Guidance is down for next quarter.  Predictably, investors are panicking and Groupon is preparing for mass layoffs.  Honestly, I just don’t get the whole hubbub over Groupon on both the way up and the way down.  I’ve always had the same thesis over Groupon’s business model, which I will share here.

Groupon’s business has negative returns to scale.  It is a promotional engine for small businesses.  As it grows, its audience grows and Groupon is more useful to those small businesses.  As it grows, since they’re selling primarily to small businesses they need to build a direct sales force in direct proportion to the scale of their business.  However, Groupon’s audience is going to become less responsive to promotions over time.  Offers will generate less returns for advertisers, which will in turn be less likely to advertise at the price Groupon demands.  Groupon is eventually going to have to yield on the 50-50 Groupon-seller split – you don’t pay 50% to your direct sales agent, you pay 10%.  If it doesn’t yield, it’ll go under.  So it will, and it will take a truly punishing hit to its top line.
Now, this is just a high-level overview – it doesn’t take into account Groupon-specific issues like questionable accounting, releasing seller’s payments, ease of competition, or the various side businesses it is trying out.  Nor should it be taken to contain a prediction of where GRPN’s price will go.  It probably won’t even go under – there is probably a level where it can stabilize and grow slowly from there.  I just think that the basic picture of their business is clear enough, and has been for at least two years, that it’s ridiculous that it was priced for aggressive take-over-the-world growth.  It just isn’t a 6-billion dollar business and won’t be anytime soon.

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