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Groupon – the financial crisis reincarnated

Marc Anthony Rosa | Tuesday, November 1, 2011

Welcome to the Groupon Economy. We’ve entered a new age where coupon-clipping grandmas of the world live in harmony with 20-something-year-olds. Labeled by “Forbes Magazine” as the fastest growing company ever, Groupon merges internet retail with brick-and-mortar stores, providing cost-conscious customers staggering discounts for everyday products and services.

But, to a handful of wary merchants, this is too good to be true. Originally hailed as the savior of small business, Groupon represents a machine that could cause the death of small business itself. And the “et tu Brute” of it all is that we’ve seen this story before: The fundamental mechanics behind the Groupon business model share a striking similarity to those of the subprime mortgage industry. To make sure we’re on the same page, that’s not good.

Groupon’s business model is nothing short of fascinating. Groupon is a daily deals site that sells heavily-discounted gift certificates for a variety of businesses. Millions of users receive emails about Daily Deals, which feature products or services at significant discounts. Users opt in for these deals, and once a threshold is reached, “the deal is on.” Thanks to the committed buying power of large groups, Groupon is able to offer discounts between 50 and 90 percent.

Why would any merchant offer their products at unrecoverable low prices? Advertising. In theory, these heavy discounts lure in an untapped, price-sensitive market. The name of the game is to target on-the-fence consumers, get them into the store and ultimately convert this to repeat sales. This is especially beneficial for struggling local businesses, where immediate cash needs and a desire for new customers are high on their lists.

The business model is touted as a “win-win-win.” Customers reap the benefits of insane bargains, businesses reap the benefits of repeat business and Groupon, all the while, gets a piece of the action. Unfortunately, it’s a model that’s severely flawed. Let’s see why:

The average Groupon is 50 percent off of a normally-marked item. Right off the bat, any business just eliminated half its revenue. From there, Groupon pockets half of those sales just for just being Groupon, so what looks like 50 percent is actually only 25 percent for the retailer. Take this to the next level: Groupon pays a third of sales after five days, waits a month to pay 1/3 more and then waits another month before paying the last 1/3. An item that normally goes for $50 ultimately returns under $13 dollars for any given business, spread unevenly over a quarter of a year. Long story short: Businesses working with Groupon are being sold an advertising campaign that resembles a very, very expensive loan. With a Groupon, the business is given a small amount of cash over three months from the coupon sales from Groupon and in exchange, businesses must sell customers tremendously undercut products.

This is a machine that Bernie Madoff would be smitten with. And worst of all, the goal that makes it worth it for businesses — to target new repeatable sales — lacks any substance. The benefits should come in the form of a larger loyal market, but the reality is that Groupon buyers aren’t actually any of those promised loyal consumers. Instead, Groupon purchasers represent a price-sensitive, bargain hunting demographic with little to zero expressed loyalty in Groupon businesses, outside of that initial discount.

Step back and take a deeper look into the mechanics. You begin to realize something eerily reminiscent of the mid-2000’s, when housing financing instruments were boundless. A keen look into the Groupon model reveals cash flow mechanics that parallel the subprime mortgage industry. Replace “business” with “mortgage-bearers,” “Groupon consumer” with “subprime mortgage investor” and “Groupon” with “security issuer” and it suddenly becomes an analogy for debt securities considering how cash flows between parties. Take a pen and paper and actually trace the money flow for both Groupon and MBS issuances. It’s mind-blowing because the mechanics are parallel.

Sure, I could probably create analogies between the yogurt industry and Ponzi schemes if I wanted to, but the main point is to illustrate what happens when the Groupon ecosystem crumbles. It all comes down to the weakest link, which in this case is the struggling local businesses that are resorting to advertisements. What happens if they go out of business because of the Groupon? What happens if they anticipate bankruptcy and refuse Groupons halfway through? In both cases, businesses and customers lose. And, in both instances, buyers flock to Groupon to make a claim against their purchase. Because Groupon constantly needs cash to finance new Groupons, rebating these customers would upset a truly vicarious cash flow balancing act. Slowly but surely, a machine too big to fail can suffer from the same incremental micro-events that occurred during the housing crisis, collapsing Groupon and bankrupting thousands of small businesses whose Groupon account receivables well exceed their almost-nonexistent cash balances.

Rational people would never submit to this. But thousands of struggling businesses are doing so in record droves. You can’t fault them. Millions of consumers are buying Groupons because they’re worth it, building unprecedented buzz that small business owners have zero reason to question.

Until now.

Marc Anthony Rosa is a senior management entrepreneurship major. He can be reached at mrosa@nd.edu

The views expressed in this column are those of the author and not necessarily those of The Observer.