Is Groupon Worth $10 Billion?

Henry Blodget says "I Wouldn't Touch Groupon's Stock At The IPO Price With A 50-Foot Pole". Doubts about the company's ability to be profitable should, he says, have been laid to rest with its recent performance.  The problem: achieving that profitability meant reducing its marketing spend, and thus its bacteria-like growth.  Slower growth won't support a valuation as high as $10 billion.

Felix Salmon, who has long been bullish on Groupon, mounts the case for the defense.
Basically, Groupon's been involved in a race to get a huge email list together; its revenues have largely tracked its subscriber base. After all, if any given deal is going to be bought by X% of your subscribers, then your revenues are going to be directly proportional to the number of subscribers you have.

Recently, Groupon has found that its earliest subscribers were its most valuable subscribers, and that it's getting diminishing marginal returns from the 100 millionth subscriber. So it's spending less money on acquiring new subscribers, and that's feeding into fewer new subscribers and slower growth.

But Groupon has its huge subscriber base now -- which means it's ready to attack Phase 2 of its plan, and really start monetizing them.

Think of it like this: up until now, Groupon has been selling daily deals to customers. And it's now ready to pivot, and start selling customers to merchants on many other fronts.

Right now, customers don't spend all that much money on Groupon: in the first three quarters of 2011, its 142,865,836 subscribers spent $2,754,633,000 in total. That's an annualized rate of about $25 per year. People love deals, but it turns out that the model of showing them one deal a day in their inbox is always going to limit how much they're ever going to buy.

So Groupon is branching out into various other projects, all of which promise to increase customer spend dramatically -- travel deals, high-priced goods, spur-of-the-moment impulse buys, you name it.

I remain unconvinced.  My thoughts:

1.  Unlike Amazon (which managed the same transition in 2000-2, Groupon has no network effects that I can see.  The gimmick is that the deal only goes into effect if a certain number of people buy . . . but why does that matter?  The cost of customer acquisition is roughly the same for the merchant, and I've never been clear on why you'd want to acquire 100 customers for $1000, but not two customers for $20.  In fact, at some point, there are decreasing returns to extra customers; overloaded businesses do not deliver the kind of customer service that encourages people to come back.

No network effects means that the barriers to entry are low.  That's going to put limits on their ability to monetize their list, because merchants and users can shop around for better deals.

2.  Mailing lists decay.  People switch jobs, their accounts get overloaded by spam, they die. And again, unlike Amazon, Groupon's business is virtually all email.  How many people are going to go to Groupon to sign up again if they change email addresses?  Less than 100%, I'm sure.

Unless they manage to layer unique value on top of that mailing list, the company owns a wasting asset that's fairly expensive to maintain.

3.  Entirely anecdotally, customer experience seems to be declining.  The deals aren't as good, because merchants have gotten smarter about giving away too much.

The longer people are with you, the more ways they can experience their Groupons going wrong.  For example, the Groupon that we just lost because, unfortunately, the restaurant went out of business.  I now only buy Groupons if I can schedule to use them basically immediately--otherwise, the risk is too high that I'll forget, or an untimely bankruptcy will make my Groupon worthless.  Nor will I buy a Groupon to a one-time event, because my one experience with doing so, a scotch tasting, is in hindsight exactly what you'd expect: disastrously overcrowded.

Unfortunately, I rarely want to go to one of their restaurants or other vendors immediately.  So I don't buy them at all.  And I know I'm not alone, because I've heard a lot of others express the same frustration.

4.  The businesses they're trying to expand into are more efficient than the businesses they're in now.  Don't get me wrong: local businesses are competitive.  But there's all sorts of search costs and information problems that Groupon can help them overcome with a well-timed coupon.  Travel, on the other hand, has already been made over by the internet.

All of which boils down to: it's really hard to monetize customers in a very competitive market, which is what internet coupons have become.  I find it hard to believe that even a very large mailing list is worth $10 billion.  And I'm guessing that investors do to, because Groupon's apparently trying to prop up their valuation with an extremely small float.

Of course, I could certainly be wrong--I thought Google was wildly overvalued at its IPO.  But I'm really struggling to see what sort of unique, sustainable competitive advantage is going to let Groupon deliver an upside surprise for its shareholders.