The Demise of the Groupon Model

NEW YORK ( TheStreet) -- Two decades ago, before most reporters had even heard of it, I became an expert in Internet commerce.

I learned that all publishing is an effort to push people down a sales funnel. Ads are not really meant to be clicked; they're meant to draw buyers. The closer an ad gets someone to buying something, the higher its value.

The big argument has always involved intrinsic or extrinsic targeting. Do you click on an ad because it knows who you are, or because the content surrounding it describes what you might buy now? If you see a local ad at the BBC News' Web site, that's intrinsic targeting. The ads here at represent extrinsic targeting.

Social media is designed to create targeting without the cost of creating relevant content. You associate with like-minded people and become more easily identifiable to advertisers. The hope is your friends might even drag you down a sales funnel with them -- that you will buy what they bought because you trust their judgment.

Groupon ( GRPN) bypasses much of the targeting argument. It gives you a merchant's best price, but it also removes risk from running a sale. The merchant doesn't have to sell until enough people agree to buy for him or her to at least break-even.

It was a compelling idea a few years ago. Early Groupon letters were crafted by trained writers, dramatically boosting their yield. But just as with the original Yahoo!, which was a directory created by editors, this couldn't scale. Good writing and careful targeting are rare, not plentiful.

Another Groupon problem is faced by players pursuing every new Internet-commerce idea: Innovation wears out. Once, people clicked regularly on Internet banner ads and responded to email appeals. Internet-commerce concepts aren't like safety razors, they're more like razor blades.

Supporters of Groupon consider its business just another form of advertising, paid for by coupon redemptions over time rather than up-front, as I learned while writing about the company for Seeking Alpha recently. Opponents say Groupon offers only attract bargain-hunters, and merchants don't get repeat business by giving their best deals to those people.

Groupon has also expanded into physical goods, taking on inventory risk, The Toronto Globe & Mail reports. Critics of the company question whether Groupon accurately accounts for its cost of goods sold, or COGS.

But the biggest problem with Groupon may be that it's easy to copy. ( AMZN) owns 31% of LivingSocial, another deals site, and therefore reports that company's numbers. For the most recent quarter, it posted a loss of $93 million on revenue of $138 million, Business Week reported.

Amazon and Google ( GOOG) have also entered the market aggressively. Amazon calls its offers "AmazonLocal." Google calls them "Google Offers," and integrates them with maps and other Google services.

Since Groupon went public late last year, it has been on a steady downward trajectory. From a high of over $26 a share, it now trades at closer to $7 a share. Even at that price, the company is said to be worth $4.46 billion.

This is a company with a shrinking moat that will find new customers increasingly hard to come by. It's a company that can't scale effectively, because it's so dependent on people to organize the deals and write the copy. And over time, people become increasingly resistant to every form of Internet come-on, and the old verities -- give your best prices to your best customers -- always come to the fore.

If I had put money into the Groupon IPO sight unseen, if I were put into it by an aggressive broker, I might think this whole Internet-commerce thing was nonsense. I would be wrong, but as DailyDealMedia notes, I would also be poorer.

At the time of publication, the author was long GOOG.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

If you liked this article you might like

How to Balance the Short and Long-Term Views of Groupon

How to Balance the Short and Long-Term Views of Groupon

Dow Soars Over 250 Points to Post Its Fourth Straight Day of Gains
Inflation, Chipotle, Credit Suisse and Sam's Club - 5 Things You Must Know

Inflation, Chipotle, Credit Suisse and Sam's Club - 5 Things You Must Know

Will Inflation Set Stocks' Hearts Aflutter or Be a Poison Arrow? -- Market Recon

Will Inflation Set Stocks' Hearts Aflutter or Be a Poison Arrow? -- Market Recon

The Really Big Money Rushes to Super Bowl

The Really Big Money Rushes to Super Bowl