Groupon and its compatriots in the much-hyped daily deals business were supposed to change the very nature of small- business advertising. Instead, it is the daily deal vendors that are racing to change as evidence mounts that their business model is fundamentally flawed.
Groupon last week reported another quarter of disappointing earnings as its core business stagnated, sending its stock down 30 percent to an all-time low of $2.76. Its biggest rival, Living Social, is piling up losses, and part-owner Amazon.com earlier this month recorded a quarterly loss after writing down its Living Social investment.
Both companies are racing to diversify, venturing into more generic e-commerce areas like off-price sales through ventures such as Groupon Goods and LivingSocial's Shop. Meanwhile, upstarts are developing new variations on the discount coupon theme.
It's clear that they need to have other models besides the email daily deals business, said Aaron Kessler, an analyst at Raymond James. The problem is that a lot of these newer businesses have lower margins.
Critics say the torrid growth that enabled Groupon to go public at $20 a share just a year ago was fueled by merchants buying into a new type of marketing that they didn't fully understand. The discounts offered through the Groupon coupons have turned out to be costly, and the repeat business they generate uncertain.
A lot of people made the mistake of overlooking the price-promotion part of this model, said Utpal Dholakia, Professor of Management in Rice University's Jones Graduate School of Business. Normal advertising, yellow pages advertising, it really doesn't have a price promotion, it doesn't have discounting component. That's what makes this difficult to do again and again.
A Raymond James survey of roughly 115 merchants that used daily deals services during the fall found that 39 percent of merchants said they were not likely to run another Groupon promotion over the next couple of years. The top reasons cited were high commission rate and low rate of repeat customers gained through offering a promotion.
The survey also found that 32 percent of the merchants reported losing money on the promotions, and nearly 40 percent said the Groupon offer was less effective than other types of marketing.
I've always maintained that this is a hype driven business built on an unsustainable business model both for the merchants and for Groupon, said Rakesh Agrawal, principal analyst at reDesign mobile, a San Francisco consulting firm.