Lesson From the Coupon Debacle

Margie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Groupon (NASDAQ: GRPN) came public last year at $20 p­er share, today they rest below $3 a share. The question I have is not so much should you buy or sell the company today, but what can investors who bought in early learn from this debacle to keep from making the same mistakes.

The Company

Daily deals via the internet are not unlike the envelope full of coupons you get in the mail every week for local merchants. (I pray those of you considering the half off Dr. Kevorkian’s assisted suicide coupon read to the end of my column, there is hope!)

The advantages of taking the local coupon model to the Internet are obvious, and Groupon being the first to market, built a 150 million person subscriber base. Good for them, ingenuity, a plus.

Why You Invested:

Probably because like many novice investors: you liked the product. You signed up for Groupon, got 50% off a restaurant you enjoyed, did so again, and said, “Wow, this company is great! I think I’ll buy some shares.”

I’m not against this style of investing, I use it as well, and in general you are likely to do pretty well with this “strategy.” However, we’re trying to improve your accuracy, and it takes more than just this one criteria. We’ll get to that in a moment.   

Company Financials and History

The company came public about a year ago as mentioned above at $20 a share, which popped initially, but has since been mired in a steep downtrend. Insiders by in large have been cashing out.

In the latest quarter, quoting bizjournals.com: "For the Chicago-based company, revenue per average active customer fell to $63.96 in the 12 month period that ended Sept. 30, compared with $76.49 in the same period a year before."

Basically the company is struggling to make any money, and despite expanding its number subscribers, the customers on average have been spending less money with them.

Groupon now has market cap of $1.6 billion, substantially below the $6 billion Google (NASDAQ: GOOG) offered for the company before they went public, which as a Google investor, I am ever thankful they turned down.

Google has since been able to replicate the business with Google Offers. I’ll grant that purchasing Groupon would have given them added brand power, and the multi-million person database, but there is no chance that would be worth $4 billion plus which Google saved.

Why They Are Down

The number one reason: competition.

There is very little in the way of barriers to entry into the space. A couple computer programmers, a few salesmen with telephones along with a database of bargain hunters, and you have essentially replicated the business. (of course for you literalists out there, it’s not that simple, but close.)

Right now we have Google Offers, Living Social (which Amazon (NASDAQ: AMZN) has a large stake in) ebay has a daily deal section, and Amazon as well has its own deals. When Groupon first came out, I used to look at their offerings most days of the week, now my inbox is flooded with offers from all these companies that I rarely check, (Groupon being my #2 choice behind Google Offers when I do.)

That competition is doing serious damage to Groupon's revenues in addition to consumer attention, which explains the quote from bizjournals at the top. 

A Flawed Business Model

My friend has a small business in Europe, and was called upon by one of the daily deal companies who promised her that they would be able to sell "thousands of discounted vouchers." More revenue for your company, sound good? Not at all actually, doing the deal would have cost her thousands of Euros in losses, and she doubted that enough bargain hunting consumers would frequent her establishment at normal prices to make up for the loss. 

Here’s the thing, these deals don’t necessarily create a win-win for the merchant and the consumer. What happens is these bargain hunters, like locusts, eat away their deal offers at the local restaurant and then move on, creating losses as they move across the lands.

After all, how many businesses have margins of 75% (after splitting revenues from the 50% reduced price with Groupon.) Additionally, the new competition is often able to offer merchants better terms than Groupon does. And why not, they don’t have to exert much effort to rake in the fees as the middle men.

The Take Away

So, if you didn’t see this coming, please learn from the Oracle of Omaha, the greatest investor of all time, Warren Buffett of Berkshire Hathaway (NYSE: BRK-B).

According to this article, Mary Buffett, Warren’s daughter-in-law, describes some of Warren’s qualitative criteria: “Does the business have identifiable consumer monopolies? Buffett is looking for consumer monopolies, selling great products in which there is no effective competitor (e.g. USA Today, Coca-Cola, Marlboro, Disney). This could be either due to a patent or brand name or similar intangible that makes the product unique. In addition, he prefers companies that are in businesses that are relatively easy to understand, and that have the ability to adjust their prices for inflation.”

Imagine trying to compete globally with Coca-Cola, opening up a theme park next to Disney World, etc. There are serious barriers to entry.

You might like a company, but at MINIMUM please look deeper at the competition that already exists, or is likely to come. How easy is it to replicate the business? What advantages do they hold? In technology it might be Facebook and the billion users they have interacting that would make it incredibly difficult to migrate them to a new site. In the case of Google the vast amount of data they have compiled, the algorithms, and the talented team of engineers they have.

In Groupon’s case it’s next to zero. The key is to learn to be able to apply this in the future. Now throw away that Kevorkian coupon. 

margiecfl has positions in Google and Berkshire Hathaway. The Motley Fool owns shares of Amazon.com, Berkshire Hathaway, and Google. Motley Fool newsletter services recommend Amazon.com, Berkshire Hathaway, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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