Will Groupon's Loss Be Amazon's Gain?

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

Investors in online deals company Groupon (NASDAQ: GRPN) had a roller coaster ride after earnings as the company posted wider losses in the fourth quarter. The company posted a quarterly loss of $81 million in the latest three months, up from the $65 million reported in the same period of 2011.

The recorded loss came despite revenue increasing 31.3% to $638.3 million. It’s not that the market had no inkling of the poor results, but the fact that the financial performance fell short of street expectations resulted in a 24% drop in stock price in a single day.

What happened after these disastrous but not entirely unexpected results is nothing short of a high-pitched drama. The results put the board under pressure to fire quirky chief executive and co-founder Andrew Mason, who had been with the company for more than four years.

The move was seen as a positive development for the company and marked an end to the era underlined by controversial accounting techniques and deep drops in the share price. The company’s stock price has tumbled more than 75% from its IPO price of $26 in November 2011.

“The events of the last year and a half speak for themselves,” Mason wrote in his departing notes to employees. “As CEO, I am accountable.”

While Mason’s misplaced confidence is well documented, there is little doubt that his departure is not a solution to Groupon’s problems. The company’s real problem is its business model, which is ludicrously simple to replicate with very low entry barriers.

While Groupon’s solution initially seemed to favor both merchants and customers, the market began to understand the flaws only after the company got listed. Following Groupon’s record breaking success with group discounts, it was inevitable that it would be followed by its competitors.

What ensued was intense pressure on margins, which forced the company to get into direct deals – a marked departure from Groupon’s original strategy of just connecting buyer and seller and taking its cut for doing so. The move into direct deals brought the company in competition with Amazon (NASDAQ: AMZN) and eBay.

Amazon playing catch up

Almost simultaneously, Amazon sensed the potential in daily deals and online coupons. Unlike Groupon, Amazon’s view recognizes that daily deals is a viable business, although the margins seen earlier have been permanently eroded now.

In retrospect, Amazon’s bet on the business through its Amazon Local service and the substantially controlled LivingSocial site appears to be better placed with multiple lines of business and a proven business model enabling the company to withstand unwanted surprises. Interestingly, Amazon has written down a part of its investment in LivingSocial, but the update was no deal breaker when Amazon reported its results in January.

Amazon Launched Amazon Local in early 2011. Amazon Local is a local deal platform that uses both LivingSocial sourced deals as well as Amazon sourced deals. Based on Living’s Social’s Statement of Operations analysts at Bank of America Merrill Lynch think Amazon Local remains in investment mode and will likely not see significant profitability for several years. Assuming Amazon local is between 5-10% of the scale of Living
Social, they estimate Amazon Local will generate $45mn and $65mn in revenue in 2013 and 2014.

EBay a tough competitor

eBay (NASDAQ: EBAY) has also proved to be tough competition for Groupon since it announced its Lifestyle Deals section in October last year. The online merchant has taken to social media in a big way by incorporating Facebook-like features in a bid to boost revenue from its services. Traditionally, eBay has focused on products, but understands the transition to services is a critical one.

eBay is rolling out a more robust search functionality and enhancing the personalized shopping experience. On the merchant side, eBay is creating an omni-channel approach for small businesses, helping brick & mortars leverage their stores base with location based services, eBay Now! and buy online pick up in store features The BRIC countries represent the next phase of growth, where pent up demand should be captured from localizing the shopping experience and enabling global shipping.

Similar to Amazon, eBay has formidable and profitable operations to internalize the initial losses generated by the group deals business. Facebook was also among the adopters of the daily deal businesses, but has since abandoned its efforts here.

Foolish bottom line

Like any growing industry, the daily deals business is evolving, and it is too early to say Groupon has lost the bet, although any negative publicity is only going to push its customers to Amazon and eBay, both of which have the means and the intent of growing this business.

Jacob Wolinsky has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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