Why Google Buying Groupon Is a Bad Idea

So the latest rumor is that tomorrow Google will buy Groupon for $5 billion.  You're not alone if you think that's crazy.  Here’s why:

  • $5 billion is an absurd valuation for a company that is in a business with virtually no barriers to entry and is younger than my toddler. 
  • That’s more than what they paid for YouTube, which had a heck of a lot more traffic when it was acquired than Groupon has now.
  • It’s a huge chunk of the cash that Google has on hand.  That’s a lot of money. 

Now if the price was something more believable, like $1 billion, that would be a little less shocking. There are after all a few attractive pieces to the Groupon story — it’s theoretically a very lucrative business model (though not sure in actuality it’s as profitable as it should be given how many salespeople it needs to get the deals it has; it has more employees than Facebook supposedly has and it's a much smaller business). It’s on a roll. It is a really different approach to local advertising where the merchant is guaranteed foot traffic and some upfront revenue. I personally love Groupon. 

But I have a lot of doubts about what is happening with the business, and I’m not sure I see how Google can successfully amplify its business, or how Groupon can help Google crack the elusive “local search” nut.

Some Groupon obstacles:

It has a million competitors. Everyone and their grandmother, from well-heeled competitors like Living Social to the Yellow Pages to Facebook are now in this space.  There is very little barrier to signing up to receive alerts to another deal site. So I’m not sure what first-mover advantage really means in this market.

This business model fundamentally attracts the wrong customer. “Half off” is not a hard idea to sell to customers. The challenge for merchants is to find those customers who like the concept of “half off” but spend much more than the deal minimum. 

Merchants still aren’t fully sold. While Groupon will have you believe that its sales force can barely keep up with the inbound volume of merchants dying to be featured on Groupon, my hunch is that getting the great quality deals that have made Groupon successful is no easy task. There’s adverse selection at play here — the local merchants that we are most likely to want on Groupon are the least likely to need or to want to promote their products at half off. This is why even though this idea of “half-off deals” (which has been around for years on sites like www.halfoffdeals.com or www.restaurants.com) hasn’t been as successful in the past — because the deals frankly just haven’t been as compelling. 

The real trick with this business is list quality. Groupon likes to say that its list size is enormous — 30 million last I heard. That’s huge. But let me say this, the winner in this space will win not because it has the largest list but the best list. By that I mean knowing who the customers are who will spend more than the value of the deal and who will come back to frequent a business. The company that can identify those people, even if it’s just 100,000 customers will win.  And the player that presents the best customers and gives better margins than Groupon to merchants stands a better chance of getting the best merchants.  That is who the “winner” (to the degree that there is only one) will be.   

The market size of this space is smaller than it looks. The challenge with this business isn’t just to take any local business and offer its goods for half off. You have to find the really good merchants that people want to do business with. And many of these merchants have a capacity limit. Many of them, because they are local merchants, can’t service more than a few thousand customers in a year — at most. That’s why Groupon is tackling larger national deals (e.g., buy at your local Gap for 50% off) — because it doesn’t have the scale problem (though ironically the Groupon site crashed that day and there have been many customers grumbling that they had problems redeeming the coupons).  To grow, Groupon is also going to have to start putting more restrictions around deals — say, you can only redeem a restaurant voucher on a weekday — to attract some of the better deals.  But let’s cut to the chase here: The universe of great deals doesn’t go on forever — there just aren’t that many great merchants, and they don’t have unlimited capacity.

None of these sites has any track record. Groupon (and its clones) are so young, and many of the markets they’ve launched in don’t even have a year of history.  One merchant I talked to who was happy with the response to a recent Groupon also told me, “I was glad I did it, but it’s going to be a long, long time before I do one again.”  Groupon may be hot now, but the fad will fade in 24 months. And margins in this business will be compressed over time. 

Groupon probably won't transform local search. “Local” has been a VC buzzword for some time now. How that will play out on Google is unclear.  When you Google a local business, will you be offered a Groupon? Doesn’t seem likely because that wouldn't be relevant; there are far fewer Groupons at any given time than local searches happening. When you do any Google search, will you receive notification of the local Groupon going on in your area? Possibly but unlikely — you know how Google hates clutter on its search results pages. Will we start going to Groupon to find local businesses? Doubtful; most people still don’t even use Yelp to do that yet. Will Google serve up Groupon offers on mobile search results pages? Maybe, but Google has always been schizophrenic about whether or not to let competitors advertise on the trade names of others (most customers use mobile to find the address of retail establishments they already intend to use). Will Google sales reps now bug Groupon merchants to buy some Google search words? Hmm, maybe there are some synergies after all.   

$5 billion is a pretty big bet to place on something that could be a one-trick pony. But then again, this would be a way to get a huge infusion of talent when you’ve got such a big brain drain you have to give your employees an across-the-board 10% pay raise. Compared to the $20 billion that it's likely to cost, Groupon looks like a downright bargain. And from Groupon's perspective, it should be itching to close this deal as quickly as possible lest its suitors get cold feet. A year from now, Groupon will receive a report card and when growth and margins go down as the laws of gravity and economics dictate they do, so will its valuation.

Comments

Is it really such a bad idea ?

There are also rumours that Googles new social media is coming up in spring http://mashable.com/2010/11/29/google-social-2011/

Then when you add two and two together ...doesn't it make sense ?

I agree 6Billion is too high for aone time pay-out. Maybe they should stagger it out, based on Groupon's performance over the next 3 years.

one word...orkut

Maybe they'll pony up $5B for MySpace now that it's up for sale. Seriously, it would make logical sense to have the valuation based on performance, but then the bankers and VCs wouldn't make as much money.

Why not build a "Groupon"

I wonder if it would cost Google lesser if they developed a "Groupon" kinda solution and integrated it with their futuristic social media....

How will they kill competition from 1000s of local "Groupon" type platforms within various geographies? Really clueless !!

They have done this - Google to Launch Groupon Competitor

When they actually decided to bid for Groupon, i wondered why Google could'nt really do this on their own, was it really worth a $5 Billion or $6 Billion of an investment.

Mashable just published a copy of what looks like a leaked fact sheet for the service, called Google Offers.

Take a look: http://mashable.com/2011/01/20/google-offers/

Regards,
Sanjeev

Reply

Well, that's unless Google sees something shiny about Groupon.
Let's take each point separately:
-They have a million competitor: True, but it's Google we're talking about. Integrate Groupon within the Google microcosm, you get rebates on Google searches, on Google Addwords, on Google maps, etc... in this market, it does not matter whether you have a million competitors, as long as you get seen a million more times than each one of them.
-This business model fundamentally attracts the wrong customer: That's not (entirely) true. Most restaurants and shops I regularly go to I discovered while they were having a rebate. Just last week, I finally subscribed to Netflix.ca for the only reason that they gave away a free month of services.
-Merchants still aren’t fully sold: Brand is the word. As a merchant (retailer, supplier, etc...), I would much rather trust Google than Groupon, which, as you say, is younger than your toddler...
-The real trick with this business is list quality: There's a paradox with that assertion: if each merchant in your list were of high quality, they would not have to have a rebate in order to attract customer. The entire point of a rebate is to make the market aware of your quality by attracting them at least once with a periodic bargain.
-The market size of this space is smaller than it looks: For Groupon maybe, but not for Google. Example: integrate Groupon's service to Google map and every single retailer in every street in every city in Google Map (i.e. the world) would be capable to advertise a rebate. It does not matter whether that Chinese Restaurant in the south part of Chicago will give you explosive diarrhea, as long as their rebate on spring rolls was on your listing (along with that awesome Italian restaurant across the street to which you will go every Tuesday evening, rebate or not).
-None of these sites has any track record: Every company was young at some point, including Google. Besides, "young" is very relative: Google was incorporated in 1998 (12 years old), whereas the Hudson Bay Company was incorporated in 1670 (340 years old). What matters is not the age or track record, it's the validity of the idea and business structure, especially with .com companies (the Internet as we know it can't be more than 30 years old itself...)
-Groupon probably won't transform local search: Think Latitude, think Android: wouldn't it be awesome if, while visiting NYC, you could just ask your cell phone for a nice second-hand bookstore nearby, find one within 200 yards that also offers rebates on the entire Harry Potter collection? It won't transform local search, granted, but it might transform a lot of other things, one of which being how you shop when you're a tourist.

So, bottom line: $5 billion is, as financial analysts say, a "damn whole lot of money", but it's Google behind this money: the best developers on the planet, a tradition for thinking out-of-the-box, a cell phone OS that rivals Apple's iOS, a huge environment, etc... On the other hand, Groupon might have something interesting: revolutionary proprietary code, very valuable personnel, a very promising structure for innovation, etc...

In this case, $5 billion is not really a waste, more of an investment.

Best regards,
Jul'

good thoughts...

They should hire you to be on the integration team! I don't think the value is there but only time will tell.

Well, they'd probably say I'm

Well, they'd probably say I'm a bit like Groupon: too young, not a large enough track record...but $5 billion is definitely within my acceptable salary range, though :p

Jul

Not So Crazy

A couple of quick points to consider: 1) This is certainly not a traffic play, which YouTube was. That comparison doesn't work in this situation. 2) Groupon is not a local play. It is a "crowdsource" ecommerce play. They can just as easily point their subscribers to excess inventory at Gap, Target, and Home Depot as they can mom and pop. That makes them very unique and valuable. 3) Since they have first-mover advantage they can play in new verticals. They've tipped their hand in areas like entertainment and online dating. Look what they did recently with Rihanna's album release and Grouspawn. While Grouspawn is a comical and perhaps ridiculous marketing play, it certainly got me thinking about how much better Groupon could do around dating than say Match.com.

I don't know that I agree

I don't know that I agree with your take on this. Certainly Google will quickly expand the 30M plus groupon subscribers to include their 100M plus gmail users, not to mention maps and places. Does this make it a no brainer for local businesses, and at very low risk to those businesses? I also think there are lessons learned here for product managers, marketers and developers. some thoughts on that here - would love your opinion on what this means to this crowd. http://www.inflectionmethods.com/2010/12/01/google-and-groupon-what-can-...

The barrier doesn't matter

"It's better to be first than to be better" - Al Ries
And Groupon is first.

Well...

Friendster just had a good chuckle over your Al Ries quote.

Community

The Groupon discussion continues on our community site: http://community.forrester.com/thread/3796

Sanity Prevailed!

As a Google shareholder, I am glad to see that sanity prevailed and the deal is now off! Did Groupon really reject the offer or was this a face saving announcement to enable both parties to move on now? I could not believe that Google even allowed this news/rumors to go so far in public! Now that this deal is off, my faith is Google is now restored.

Do you think Google should now stop wandering in all directions, remain focussed on Search business, forget about getting any bigger and start paying dividends to shareholders as a mature company?

Not really sanity ...

The deal died because Groupon's Russian investor was not prepared to open the kimono this soon after plopping down his $135 million.

Did Google really offer $6 Billion?

Neither Google nor Groupon has ever confirmed that $6 billion solid offer was on table. When asked this specific question, they beat around the bush! I think Google ultimately realized that ta mistake was made and needed to get out. "Groupon rejects Google's $6 Billion offer" was an acceptable headline for Groupon and good way for Google to save face and get out of the deal!

Over-priced IPOs

Much of this will end in tears, as was the case in 2001. As Marx commented on the Bonapartes, "First time tragedy, second time farce."