Next big thing, or flash in the pan?

The future of group buying and daily deal sites has come under scrutiny recently, following poor financial listings for the second quarter by the sector’s global leader, Groupon.

Groupon posted a $103 million loss over the last three months, fuelling speculation that group buying may have seen its heyday. The industry pioneer was launched at the end of 2008, and was hailed as the fastest-growing company in history by 2010, after it launched in more than 100 new markets.

The company joined the likes of Facebook and Twitter in crossing the billion-dollar threshold in April last year and even turned down a $4 billion buy-out offer from Google in December. It is currently preparing for a stock market flotation of more than $20 billion, despite its failure to turn a profit.

On the local front, Groupon bought out homegrown site Twangoo at the beginning of the year, and has officially entrenched its local presence this month with the Groupon.co.za domain.

Groupon’s rapid success has led to an influx of copy-cat group buying sites – with no less than 600 currently operating in the US. The popularity of the business model also found its way to South Africa, and there are now 30 different local offerings.

The market space does however appear to be proving itself to be more difficult than expected, even for the big players. Facebook has decided to kill its Deals programme after just four months of testing in the US.

According to reports, Groupon is witnessing decreasing revenue per merchant and fewer Groupon purchases per subscriber in its maturing markets. The company is also reportedly struggling in its joint venture in China.

While Groupon has not been able to respond to any questions regarding its current financials, company CEO and co-founder, Andrew Mason, sent a memo out to all Groupon employees last week – which was subsequently leaked to the press.

Stronger than ever

In the long and detailed letter, Mason responds to the reports and speculation that Groupon is on the decline and bleeding money, saying that the company has “never been stronger”.

“The real point is that our business is a lot harder to build than people realise and our scale creates competitive advantages that even the largest technology companies are having trouble penetrating,” wrote Mason.

In the memo, Mason calls reports that Groupon is running out of money “nonsense” – and uses the examples of Amazon and Wal-mart to refute such claims.

“Both have often had payables far in excess of their cash. Finance geeks call this a working capital deficit. It’s normal, manageable and a lot of folks actually believe it’s a good thing and would kill to get paid from their customers long before they have to pay their suppliers.”

Not convinced

Principal analyst at Forrester research, Sucharita Malpuru, says that the Groupon has a fundamentally decent economic model, but she has her reservations about the company’s upcoming initial public offering (IPO).

In an open letter to investors, Malpuru writes: “The market opportunity isn’t as big as the industry players would like you to believe. That’s true for all the obvious reasons: it relies on discounting products which attracts the wrong customers, merchants are hard to sell, good merchants are more expensive to sell to”.

A survey conducted this year by Business Insider among businesses that had used Groupon, about 60% of respondents considered their experience a success (with 40% saying that they thought it had failed) but more than half did not want to run another Groupon deal. The survey also showed that from the perspective of the businesses, only a handful of Groupon buyers become repeat customers.

Speaking specifically of the company’s IPO, Malpuru says to investors: “This IPO game isn’t about finding value, it’s about finding a greater fool who actually believes the valuation is true. Trust me, you will be the fool.

“There will be plenty more IPOs coming up of companies with greater profitability and higher barriers to entry (for example, social networks with hundreds of millions of followers). Those will be wiser investments. Give Groupon time to actually earn its valuation.”

According to Malpuru, the biggest problem with the group buying space is that size of opportunity is limited and doesn’t easily scale. “They can be small, profitable businesses, but are harder pressed to be large, profitable businesses.”

Local gold rush

Making massive discounts profitable was always going to be difficult, but Groupon’s financial troubles could put the writing on the wall for the 30 or so local group buying sites that have emerged within the last year in SA.

Group buying first appeared in earnest locally at the beginning of last year with the launch of WiCount. This was shortly followed by the likes of Twangoo (now MyCityDeal, soon to be Groupon) and Ubuntudeal. This year has also seen the emergence of group buying initiatives from players in other sectors – including Kulula’s Daddy’s Deals and Avusa’s Zappon.

Digital MD of the Avusa Group Elan Lohmann says the group buying market has proven to be “not as easy as it seems” and extremely expensive. According to Lohmann, a “gold rush” in the group buying market was always on the cards due to its novelty and appearance as a source of easy money.

Zappon is, however, not doing as well as initially hoped, and Lohmann says a re-write is currently in progress. “We have realised the expense to buy users and our appetite is nothing like a Groupon. In a way we are happy for them to continue creating a market. We have invested pennies into the business so far and will maintain a low cost sustainable approach.”

Lohmann adds on a personal note: “I am not sure that if I was an entrepreneur in a garage I would have gone after this space.”

Flush-out ahead

On the other hand, according WiCount, the local pioneer in the group buying sphere, their local site is growing in “leaps and bounds”. Its founder, Aaron Toys, however, acknowledges that there is now big competition locally – especially from Groupon.

“My gut feeling is that Groupon is doing its best to grab as much of the market share as it can. While in this arena, spending money on marketing is the equivalent of spending money on capital assets, my feeling is that they may be taking it a bit far.”

From Toys’  perspective, there’s still room for growth and innovation in the market – especially in terms of localisation, which he says we’ll be seeing in the next two years.

Lohmann is, however, unimpressed by the local players. “Many got a few million from investors – but that is not enough to weather the storm in my opinion if they want to make a real play. The disappointment for me is that everyone (including ourselves) said we would be different and offer better quality deals. Honestly, I think we have all failed so far,” says Lohmann.

“No one has cracked it. I have not been impressed by any of the deals any of the players have been able to crank out with regards variety and quality.”

Both Lohmann and Toys say that the future of the market will be shaped by consolidation. “We’ll be seeing a number of closures and offers for sales. The big players will want to absorb the smaller ones,” says Toys.

Lohmann agrees: “I predict three to five major players will remain after the flush-out.”

Overtraded

Senior analyst and MD of World Wide Worx, Arthur Goldstuck, says that it comes as no surprise that Groupon is currently running at a loss.

Referring to the case study of Amazon, where the company only turned over its first profit after five years, Goldstuck says analysts may be underestimating Groupon’s business model.

“The same analysts today, who only see the losses of Groupon and don’t see the bigger picture, are the same as the analysts and media that were saying that Amazon proves that e-commerce can’t work since after a few years in the market it was still running a loss.”

Goldstuck explains that Amazon steadfastly maintained its policy despite criticism – and it set itself up as one of the most successful retailers in history.

“South African players will, however, struggle to afford the same level of sustained loss that Groupon is currently going through, since the local market is simply not big enough to recoup it,” says Goldstuck.

“While there will always be space for the highly localised niche players, in South Africa there just isn’t room for the hundreds of group buying sites that there are in the US.”

Volume at expense of margin

IDC’s research director for the Middle East, Africa and Turkey, Mark Walker, says that the future of group buying will depend on the level of demand, barriers to entry and the draw or attraction of deals.

“In terms of demand, one has to consider how many South Africans actually have Internet access, a decent level of education and a disposable income,” says Walker. “Realistically, we’re looking at about one to 1.5 million people who would meet these criteria.

“That group of qualified buyers needs to be much, much bigger if it’s going to sustain growth in the market.”

“The primary focus of these sites is SMBs, because daily deals give the businesses much needed marketing and exposure,” says Walker.

“However, for a small business owner, it’s a risky proposition and they have to take into account the fact that with a group deal they will be getting volume at the expense of margin – so they have to weigh it up.”

“Businesses will generally be losing at least 50% on a deal and the question is who carries the risk? In my opinion, it is often disproportionate.”

Walker says that consolidation will be inevitable, but that the speed at which it happens will depend on market conditions.

“The market conditions here are still pretty easy, but SA doesn’t know what recession is. The harder the market, the quicker the fallout in this sector will be – and we’ll be witnessing that fairly soon.

Success in this space will be based on the quality and range of products a site can offer.”