Summary: In the fragmented space of local deals, buyers converged upon Groupon, forming a perfect storm of scale. Market dynamics and technology will invert the future equation, with a convergence of competitors and a fragmentation of buyers.
14 years ago Henry Blodget established his contrarian legacy by being among the first to recognize Amazon's (AMZN) enduring value. Now, Blodget is making another contrarian call in favor of the long-term profitability of Groupon (GRPN). Blodget consistently says of Groupon: "its scale gives it a big barrier to entry". Could Groupon be too scaled to fail?
At this moment, Groupon establishes scale relative to one competitor: Living Social. But we don't care much about this moment. We value Groupon based on its expected future earnings. So if the bull case for Groupon is scale, we need to look at Groupon's expected future scale.
Before I explain why you should doubt Groupon's future scale, let me address another defense of Groupon's optimistic valuation: the possibility that Groupon could horizontally diversify out of its niche and into a wider range of revenue.
Let's start by asking ourselves what Groupon's niche is, and what it isn't. Groupon's niche is coupons for local businesses. Groupon's niche is not group coupons.
Of course, Groupon did something clever by organizing group bids. But this cleverness is not enough to reify group bids as a niche in and of itself. The US Dollar already fills the basic market need for a liquid expression of group bids. If anything, group bids meet a human psychological need for closure, but this is a psychological need, not a market one. Psychological needs are met by brands; market needs are met in niches.
So let's assume we're clear that Groupon's niche is local business, not group coupons. Groupon can try to diversify horizontally, but it will have to do so by leaving its niche. Priceline (PCLN) and TripAdvisor (TRIP) shouldn't panic about Groupon's expansion into travel deals. Walmart (WMT) and Ebay (EBAY) will survive Groupon's move into retail. There is a reason bullish Blodget emphasizes Groupon's niche, and not its outward expansion: Groupon simply isn't competitive outside its niche. Priceline's brand communicates reliability and expediency in discount airline tickets; Groupon's doesn't. TripAdvisor results show up in search results when I look for information on local parks; Groupon's results don't. If I want to score a deal on a book, toy, or fashion accessory, I'll pick it up at Walmart, not Groupon. Groupon is successfully emulating Ebay, but only within the niche of local businesses. This is the definitive present tense, and Groupon has done little to signal a markedly better future.
Thus Groupon's opportunity exists soley in local deals. Here is why you should doubt Groupon's scale even within its own niche:
Amazon is a retailer with a track record of squeezing smaller and larger companies out of business. Amazon Local is currently partnered with Living Social, Groupon's #1 competitor, but the partnership is just a place-marker for Amazon's more decisive move into the space. Did you think Kindle was just for watching movies? Imagine searching for weight loss books on your Kindle Fire 2, and getting offered a discount for 24 Hour Fitness. You won't have time to read the Groupon emails in your spam folder offering you 35% off a pilates bootcamp, because you'll be on your way to the gym.
Do you really think Facebook (FB) and Yelp (YELP) are going to permanently give up on deal localization? Facebook and Yelp are ongoing case studies in social-done-immaculately. Facebook's fundamental business model is connecting people with businesses; to the extent these businesses are local, Facebook will be a direct Groupon competitor. Yelp's fundamental business is connecting people with local businesses; Yelp is a direct Groupon competitor, and Yelp is more likely to realize Amazon-level success, because unlike Groupon Yelp and Amazon offer extensive consumer reviews, with a frictionless shopping interface.
Groupon the pigeon has swooped in early to the local picnic. It has a few insect competitors. But now the fat cats, like Visa (V), are trotting out from the bushes. Amazon is slithering in the grass. Facebook and Google have swung from the branches and are chattering within knuckle-walking distance. Groupon's scale meant something to the insects, but it won't mean anything to the reptiles and the mammals.
The single most definitive convergence of big businesses displacing Groupon will happen in mobile apps. Mobilization complements localization. And Groupon knows this. But as better-established companies converge on local and punish Groupon for not being big enough, Groupon will also suffer fragmentation for being too big and spread out.
Internet literacy will transition from visual (reading) to auditory (speaking) via voice recognition infrastructure advanced by Apple (AAPL) and Nuance (NUAN). Many people are reading-impaired. The less reading, and more talking, they need to do to communicate with an interface, the more they can accomplish with technology.
As a result of voice recognition, increased Internet competence among illiterates will undermine the role of simplifiers. A main value provided by Groupon is that of a simplifier. But with simplicity integrated throughout the auditory web, simplifiers will be made redundant. An Internet that takes verbal instructions will simplify interactions for both consumers and local businesses. More local transactions will be able to slip through the Internet without touching Groupon's interface.
The slow, steady move of big companies into localization will squeeze Groupon's margins: Groupon is too small. The auditory Internet will fragment Groupon's simplifier position: Groupon is too big. Groupon is not too scaled to fail. Don't bet against Tilson on this one. Bet against Henry Blodget's lonely understanding of scale. Just don't bet against Blodget himself; even Blodget thinks Groupon is overpriced.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.