Can Groupon Survive?

Jul.30.12 | About: Groupon, Inc. (GRPN)

For me there has always been something sort of scammy about Groupon (GRPN).

This does not mean I expect the company to fold, or for anyone to be in legal jeopardy. Groupon's business is perfectly legal.

Investors should see reason for hope. Its legal problems are manageable, its lock-up period has expired, and it's moving steadily toward profitability. (The company next announces earnings on August 13.)

For its March quarter, remember, Groupon reported its first profit in the "income before tax" line. It has been keeping its general expenses line steady, so growth on the top line (and that has been accelerating over the last year) should start heading to the bottom one. The company has no debt and enough cash on hand to get through six full months without revenue.

My problem is with Groupon's basic business model. Remember that the idea is to have merchants offer a bargain price, to advertise that price to people who might be in a position to buy, and to activate the deal once enough people have signed-on to it.

What's my problem with that?

  • The model is geared to hard times. You create a deal because you have trouble drawing customers at current prices. That's what happens in recessions, not in growth periods. In growth periods, those companies most likely to offer great deals are those you don't want to do business with.
  • The incentive is backward. Normal marketing theory holds that you want to offer your best deals to your best customers, not to new customers. That's what frequent buyer programs are about.

There will always be recessions, and there will always be companies that are suffering, that need something like Groupon in order to survive. How many there are, and how consistent that business can be, remain unanswered questions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.