December 3, 2010 7:17 pm

Groupon discount deals catch Google’s eye

Google’s potential acquisition of Groupon for up to $6bn and Amazon’s $175m investment in LivingSocial has turned the spotlight on one of the fastest growing intersections between the web and local commerce.

Both Groupon and LivingSocial have the same business model: they work with local businesses to offer steep discounts, which are e-mailed to subscribers.

For example, subscribers could pay $25 for a $50 gift certificate to a Thai restaurant, with that $25 split between the restaurant and the website.

The formula has proved lucrative.

In about two years, Groupon has sold coupons totalling nearly $2bn.

Of that, about $500m has gone to the merchants while the company has kept nearly $500m for itself.

“We believe the local ad market is [worth more than] $100bn a year in the US [and more than] $200bn globally, and so far no one has cracked the code to bringing this online,” says Sandeep Aggarwal, senior analyst at Caris & Company, in a note.

“But Groupon has the most compelling model.”

While Groupon remains the largest in its class, with a reported 35m users signed up, it has plenty of competition.

LivingSocial is the largest but others such as Gilt City are moving into the marketplace fast.

There are European clones. This year, Groupon acquired one of these: CityDeal, a service based in Germany.

The number of competitors points to an uncomfortable truth about Groupon.

“There is very little barrier to signing up to receive alerts to another deal site,” says Sucharita Mulpuru, Forrester Research analyst in a note.

“So I’m not sure what first-mover advantage really means in this market.”

Once Groupon’s success became evident, dozens of similar sites sprang up in the US and Europe.

Some focus on regions while others focus on products.

The result has been a fragmentation of “deals”, with users having to sign up for ever more e-mails to have access to them all.

Another concern is that, while businesses have been keen to sign up so far, there is a finite number of local businesses that can afford to offer such steep discounts.

“The universe of great deals doesn’t go on forever. There just aren’t that many great merchants and they don’t have unlimited capacity,” says Ms Mulpuru.

In this way, while Groupon has been a hit so far, there is little evidence that it is a sustainable business model.

Andrew Mason, Groupon chief executive, seemed to acknowledge as much during an appearance earlier this year.

“We’re just a product of our times,” he said.

“We had a good idea. We have a great team. And we’re living in a time when the social web has made it possible for companies to grow faster than they ever have before.

“So we kind of take it all with a grain of salt.”

For merchants who offer deals, the experience has not always been so savoury.

Many small businesses are unprepared to handle a sudden influx of customers with discount coupons.

“After three months of Groupons coming through the door, I started to see the results really hurting us financially,” Jessie Burke, owner of Posies café in Portland, Oregon, wrote in a blog post in September.

“There came a time when we literally could not make payroll because at that point in time we had lost nearly $8,000 with our Groupon campaign.”

Ms Burke had to draw from her personal savings to cover payroll and rent.

“It was sickening,” she says. “Especially after our sales had been rising.”

Google and Amazon still seem eager to get a piece of the action, though analysts are suggesting that, at $6bn, Google could be overpaying.

Given the unproved nature of Groupon’s business model, Mr Mason seems to understand that this may be his business’s five minutes of fame.

“We’re kind of like N’Sync [Justin Timberlake’s boy band from the early 2000s],” Mr Mason said earlier this year.

“Maybe there are some talented people there, but they’re not better than The Beatles.”

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