The more I read about Groupon (GRPN) and its hyper-growth and rapid expansion, the more I kept thinking the story sounded familiar, like someone I know had lived through it before ... and then I realized that someone was me. A little more than a decade ago, fresh out of college and ready to conquer the world, I found myself squarely in the middle of the dot-com boom.
I was determined to take advantage of the hysteria and used my experience (in retrospect I really knew absolutely nothing) to land a senior consultant role at Internet superstar, Commerce One. A 20 billion dollar business-to-business ((B2B)) powerhouse at the time, Commerce One built B2B exchanges in different vertical markets that allowed businesses to send "transactions" to one another. These transactions could be any business related electronic document, such as a purchase order, invoice or shipping notice. Commerce One's model was to act sort of like a toll booth, charging companies a fee as transactions passed through these exchanges and eventually expected to make billions collecting toll.
I remember early on I was in a Commerce One corporate training class that outlined our business strategy and consulting approach for the professional services group that I was part of. The room was filled with consultants in their 20's and 30's and from the idle chatter before class, it seemed to be a brag-fest with everyone touting themselves as an expert in Internet commerce. During a corporate training class, the 30-something instructor stopped the class without warning after getting a call on her cell and abruptly darted into the hallway. I could see through the frosted glass door she was pacing back and forth wildly and in deep and semi-hysterical conversation. I asked the colleague next to me (a veteran employee that had been there all of 9 months) what was going on. He nonchalantly turned to me and said with a hint of arrogance:
"Most of her stock options just vested and she cashed out. that was the broker calling to tell her she can retire. I'll get my call in about 3 months."
I thought he was joking and went about my business after calling him an idiot in my head. After 15 minutes, the instructor came back in with an ear-to-ear grin and felt the need to share the news on how much she had pocketed. My arrogant colleague looked at down his phone and programmed the brokers number into his speed dial. Everyone around me starting jotting down notes on exercise prices and retirement projections. Training ended early that day and no one in the class remembered a single word but "millionaire."
A month later I was already drinking, perhaps chugging, the Kool-Aid. Fueling my attitude was the fact that my unvested options were now worth more than six-figures. I ran into an acquaintance at a bar in Georgetown near where I was consulting for a client in DC. Fresh out of Duke, he was in his early 20's and had landed a job as an Associate at the Carlyle Group in DC. At that time, even though Carlyle group was a prestigious firm with 100 billion in management, it was also viewed as a institution with "old school" thinking that was aligned with fundamentals and slow steady growth. Pretty much the opposite of the wild west mentality with Internet business models. I sat down at a table with him to talk/brag about my new gig. "Commerce One keeps going up, at this rate, it may end up being bigger than Microsoft (MSFT)," I said confidently. He scoffed, and retorted back, "I don't think its going anywhere but down". As a Commerce One Kool-Aid drinker, this view was blasphemy and I would have none of it. I responded with a twinge of annoyance, "You probably just don't understand the business model, let me explain it to you and you'll change your thinking, How about I go over". He quickly interrupted me. "I know the business model, sell the software at a loss, charge a few bucks per transaction and grow the number of transactions into billions". "So what's the problem then?" I asked. He shook his head slightly,
"Look at the largest transaction exchange in the world. The stock market, the NYSE, NASDAQ, all of them, As time goes on, transaction costs are commoditized due to competitive pressures, Most transaction fees in these markets gravitate to nickels and pennies, if not less. It's inevitable and unavoidable ... your business model is FLAWED."
My heart skipped a beat, out of pride, I continued to banter for a few more minutes, but I realized he was right ... I thought I was the smartest guy in the room. I wasn't even the smartest guy at the table. A few months later the official implosion began and by the end of the year, Commerce One had lost the vast majority of its 20 billion market cap and my naive dreams of retiring by 30 were appropriately dashed.
In looking at Groupon hyper-growth and plans for greatness, i see a number of parallels to dot com busts of the past:
Customer Land Grab - The idea of acquiring customers as quickly and aggressively as possible is very dangerous. For Groupon, they are trying to capitalize on a First-to-Market strategy and scaling the business at warp speed but with high overhead costs. Groupon has managed to gain 15 million customers but accumulated a deficit of over $500 million dollars in the process. If you do the math, the acquisition costs seem to well outweigh the profits derived from the groupons themselves. And why would anyone believe that any of these customers will be loyal in the long (or even short) term? Every Groupon user I know personally has scaled back their use and that tends to happen after in-your-face overexposure. Will consumers find Groupon any more interesting than Living Social, HomeRun, Social Buy or the other myriad of deal-a-day sites? I know I won't.
Customer Fatigue - I followed Groupon religiously for a few months, and after a few wasted Groupons, I use it about once every few months and most of my peers who use the service have similar usage patterns. Also the 3 other deal-a-day sites that popped up with deals in my immediate area add to the fatigue. Once the sentiment turns from highly enthusiastic to neutral and consumers are at peace with letting deals pass by, the whole deal-a-day sector is in trouble. Remember those mailers you get with a hundred coupons and you toss right in the trash? What about woot.com or Amazon Gold Deals? Do you visit those on any regular basis? I didn't think so.
Commoditization - Groupon's gross operating margin is still above 40%, but I'm pretty sure its started it's downward spiral. With no barriers to entry, well-funded competitors have peppered the landscape, and all players will be lucky if margins persist over 15% in the long term. At 15% margins, Groupon existence as a going concern is in serious jeopardy. Look at restaurant.com, its a fantastic service that gives deep discounts on local restaurant deals. I don't have any visibility into their books, but I doubt the owners of that site are billionaires.
In a best case scenario, these pressures will cause growth to stall , Groupon will adjust and adapt with a smaller footprint but will survive. However, if the timing and scale of these pressures plays out like a perfect storm, Groupon may end up being the biggest train wreck in Tech history. Analysts gave Groupon a hard time for passing on the Google deal but I think this criticism may have been premature. Google is not stupid and I would venture a guess that acquisition terms and the ability of Groupon investors and execs to cash out were predicated on performance targets that Groupon knew it couldn't meet. The only choice it has now is to go public and raise capital to fund the business. Unfortunately for Groupon, it isn't too big to fail.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.