Success of Groupon Inspires Imitators

When Todd Rideman first heard about Groupon, and how much money it was making, he figured he could do it, too. After all, what’s so hard about putting up a website, offering a few deals each day from local merchants—like $20 worth of cupcakes for $10—and then watching the cash roll in?

So he poured $100,000 of his hard-earned money into his own daily deal site and, at the beginning of the year, launched WowWhatSavings targeting the Boston area. But he quickly learned that building a profitable Groupon clone isn’t as easy it looks.

“I was able to get the local merchants, but getting people to come to the site was costing a fortune,” says Rideman. After six months, he had just a few thousand people on his distribution list. “It takes about a million bucks per market to build your customer list,” he says. “I came to the realization it wasn’t happening for me.” He’s since morphed his business into a deal site for restaurants only, and has seen sales perk up.

Rideman, of course, is not the only one trying to capitalize on the group buying concept pioneered by Groupon. Hundreds of companies, large and small, are angling for a piece of the action. These include well-funded, venture-backed companies like LivingSocial and BuyWithMe, as well as bootstrapped startups like CoupMe and ScoopCoups. AOL has launched a Groupon clone, as has Wal-Mart and Cox Media. Facebook has just starting offering local deals, and there’s talk of Yahoo and Twitter wanting in.

Suitors Come Knocking

In fact, Google was considering a purchase of Groupon in mid-November for more than the $2 billion to $3 billion Yahoo was offering a month earlier, according to AllThingsD. (No deal was inked as of Nov. 19, when VCJ went to press.)

Anytime you have a company on the Web that grows as quickly and makes as much money as Groupon does, you attract a lot of entrants.”

Kevin Efrusy

Acquisitions seem like the most likely exit in the space. Amazon bought Woot, which offers a single deal per day, for $110 million in June. “The Internet giants are starting to pay attention to this space because it’s an important new driver of revenue,” says Jeremy Liew, a partner at Lightspeed Venture Partners, an investor in LivingSocial. “There will be lots of jockeying in the next 18 months, but any acquisition will have to be a major strategic thrust because it will not come cheap.”

The jockeying is understandable. After all, this is a market estimated to be in the tens of billions of dollars per year. That’s the amount small businesses spend on advertising with local media like newspapers, television and the yellow pages. Group buying sites are disrupting this market, siphoning off an ever-expanding chunk of that revenue.

In the Groupon model, local businesses agree to discount their product or service by 50%, and then split the revenue 50/50 with the group buying site. Deals become valid once a specific number of consumers agree to a purchase. This encourages users to spread the deal via social media, thus the group buying aspect. It’s proving to be a very effective way to attract customers and generate new business.

“I’m not at all surprised by the number of Groupon clones out there,” says Kevin Efrusy, a partner at Accel Partners, which took part in a $135 million round for Groupon in June. “I think anytime you have a company on the Web that grows as quickly and makes as much money as Groupon does, you attract a lot of entrants.”

Nobody knows for sure how much Groupon makes, and Efrusy’s not telling. A recent article in Forbes magazine pegged the company’s 2010 revenue at $500 million. But some analysts, including Sucharita Mulpuru at Forrester Research, doubt the actual figure is anywhere near that high.

“Groupon is called the fastest growing company ever, but I think that’s a lot of hype,” says Mulpuru. “But what is for real is that this category is on fire and everybody wants to participate.”

Has Groupon fundamentally attracted customers that nobody else can attract? No, because they ask so little of their consumers—simply subscribe to a list. But by the nature of asking so little, someone else can come in and do the same thing.”

Sucharita Mulpuru

No Clear Winner

But will they be able to catch the runaway leader, or is this essentially a winner-take-all market? Mulpuru believes there is no guarantee that Groupon will remain the dominant player—mostly because a Groupon shopper today could easily become a BuyWithMe or Living Social shopper tomorrow.

“Just because one company gets 50 million people on its list one year, that doesn’t mean that next year someone else could not grow as rapidly,” she says. “Has Groupon fundamentally attracted customers that nobody else can attract? No, because they ask so little of their consumers—simply subscribe to a list. But by the nature of asking so little, someone else can come in and do the same thing.”

Today, the closest competitor is LivingSocial, which has raised a total of $49 million from Grotech Ventures, Lightspeed, Steve Case’s Revolution fund, and U.S. Venture Partners.

Liew, the partner at Lightspeed who spearheaded a $14 million Series C round for LivingSocial last April, says, “You need tens of millions of dollars to be a player in this space. We told LivingSocial that they needed a sufficient war chest to run fast and catch up with Groupon. At first they weren’t convinced, but then they came around to our way of thinking.”

Groupon, for its part, has raised a total of $169.8 million since 2008 from Accel, Battery Ventures, Digital Sky Technologies and New Enterprise Associates. The money is primarily used to enter new cities across the globe. Groupon is actively acquiring local copycats in places like France, Russia, Chile and Japan. The money is also being used to build up its sales force and advertise like crazy. You can’t go anywhere on the Web these days without seeing a flurry of ads for Groupon and its closest competitors.

To be a meaningful contender in this space you need to be in tens if not hundreds of cities … and you can’t do that for cheap.”

Jeremy Liew

“To be a meaningful contender in this space you need to be in tens if not hundreds of cities,” says Liew. “So you need to acquire lots of users around the country, and you can’t do that for cheap.”

Bring in the Clones

Despite the intense competition (industry watchers estimate 100 new entrants have entered the market since the start of the year), the top two players—Groupon and LivingSocial—control the vast majority of the market, and their share is growing, Liew says.

How can that be? “This is a very low-barrier-to-entry business, but it is a real high barrier to scale,” says Liew. The business entails a lot more than shooting out an email with an offer, he says. It also involves a significant investment in infrastructure and technology as well as the ability to track and acquire customers and merchants.

Liew doesn’t anticipate too many new venture-backed businesses entering the market at this point. At least none that can put up a real challenge. “At this point it would be daunting for a venture firm to back the number four or eight or 15 player in the space,” he says. “Are they really willing to write a check for tens of millions of dollars to do what’s needed to compete here?”

Perhaps they are. In the last few months alone, several new companies have landed venture funding. One-year-old Bloomspot, which is applying the Groupon model to luxury purchases like spa getaways, raised a $9 million Series A in September from Menlo Ventures (which led the round), Harrison Metal Capital and True Ventures. Meanwhile, Google Ventures invested an undisclosed amount in October in newcomer Signpost, a community-powered deals site that raised $1 million from Spark Capital just seven months earlier. There are even aggregators, like Yipit, which collects deals from 130 different group buying sites and presents them in one place. The 2-year-old company raised $1.3 million in Series A funding in June from DFJ Gotham Ventures, IA Ventures, RRE Ventures, Ron Conway’s SV Angel and a host of other angels.

The bulk of our money is not being spent on marketing and customer acquisition [for BuyWithMe]. We are actually spending a disproportionate amount of our budget on product engineering and technology that will help ensure every transaction is a high-quality one.”

Jeffrey Glass

But perhaps the biggest threat to Groupon is not the massive influx of competitors, but the sustainability of the business model itself. The company has come under fire from some small businesses who complain that they have been overwhelmed by coupon-wielding customers. One cafe owner in Portland said her Groupon offering cost her business $8,000 after swarms of people descended on her shop with half-off coupons. She says she had to dip into her personal savings just to make payroll.

In fact, a new study from the Jesse H. Jones Graduate School of Business at Rice University found that one-third of businesses don’t make money from promotions on Groupon and that 40% of businesses said they wouldn’t do a social promotion again. “An industry in which 2 in 5 customers are hesitant after a first purchase … may need to modify its overall strategy,” writes Utpal Dholakia, author of the study.

It is precisely this dissatisfaction with Groupon that is opening up the door to competitors, insists Jeffrey Glass, a managing director at Bain Capital Ventures, which led a $16 Series B round in July for BuyWithMe. Glass believes it’s not how many markets you enter, or how many new customers you sign up. Instead, he says, the real battle is ensuring a great experience for both merchants and consumers.

“The bulk of our money is not being spent on marketing and customer acquisition,” he says. “We are actually spending a disproportionate amount of our budget on product engineering and technology that will help ensure every transaction is a high-quality one.”

Glass declines to comment on new features under development, but Forrester analyst Mulpuru hopes it looks something like this: “Someone needs to build an interface that can capture feedback on who are the good customers and who are the bad ones,” she says. “Merchants want to avoid the troublemakers and embrace the profitable customers who spend the most money. That’s the real magic.”

The group buying concept has clearly been magical for Groupon. But how many more rabbits can be pulled from the same hat?