Groupon anxiety; Online-coupon firms.(Groupon will have to move fast to retain its impressive lead)

The online-coupon firm will have to move fast to retain its impressive lead

GROUPON has arrived in China. On March 16th the online-coupon firm's new site there--a joint venture with Tencent, the country's biggest internet company--began offering daily deals such as 75% off the regular price of a trip to an indoor hot-springs resort. Initial signs were that Chinese consumers will rush to snap up Groupon's offers, as they have in many other parts of the world.

In 2009 Groupon was a virtual nobody, confined to just 30 American cities, with 120 employees, 2m subscribers and just $33m in revenues. By the end of 2010 it had become a global success, with more than 4,000 staff, 51m subscribers in 565 cities worldwide and $760m in revenues.

Yet amid all the excitement over the "world's fastest-growing company ever", as some have breathlessly described Groupon, words of caution can increasingly be heard. Even Andrew Mason, the firm's habitually cheerful boss, seems to harbour doubts. "By this time next year, we will either be on our way to becoming one of the great technology brands", he recently wrote in an internal memo, "or a cool idea by people who were out-executed and out-innovated by others." More fundamentally, the whole idea of "daily deals" may have serious flaws.

The basic idea is nothing new. Consumers sign up to receive offers from local firms by e-mail each day, ranging from restaurant meals to pole-dancing lessons, at discounts of up to 90%. But Groupon made virtual coupon-clipping exciting by, first, having offers expire after just a few hours and, second, cancelling them if they do not attract a minimum number of buyers (the "group" in Groupon). Although this rarely happens, it induces buyers to spread the word among friends and family, boosting the uptake.

The daily frenzy has already spawned new phrases, such as "Groupon anxiety"--"the preoccupation and feeling of anxiousness and not being able to sleep knowing that a new Groupon will be released after 1am", according to The Urban Dictionary, a website which tracks such coinages.

Unlike lightly staffed but equally hyped internet firms such as Facebook and Twitter, Groupon needs an army of salespeople to negotiate deals with local businesses in each city it covers, and a further platoon of bright young copywriters to churn out the witty, whimsical e-mail pitches it sends out to consumers.

What makes Groupon really stand out, however, are its margins. It typically charges businesses half of the discounted price of a voucher. Venture capitalists say they have never seen such impressive numbers. This goes a long way towards explaining why the start-up was able to raise a whopping $1.1 billion in financing and why, in December, Google was willing to pay an even more astounding $6 billion for it.

Mr Mason walked away from the deal and has started the process of getting a public listing. This decision may come to haunt him. Groupon's position is not as unassailable as it appears from its rapid growth and huge market share--more than 60% in America, according to neXtup Research, which analyses tech firms. To ward off competition, neXtup reckons, Groupon will be forced to lower the share of revenue it keeps from its deals.

Deals a dime a dozen

For starters, almost anyone can set up a daily-deals site. And many already have. There are hundreds of clones in America alone, most specialising in certain product categories. To help overwhelmed consumers, there is even a service, The Dealmap, which lists all the daily deals available in a city. More dangerously for Groupon, big online firms have begun to enter the fray. In December Amazon invested $175m in LivingSocial, the market's number two, which is said to be in talks to raise a further $500m. And Facebook, the world's biggest social network, will soon start testing local discounts.

In addition, Groupon cannot rely on the "network effects" that have given companies such as Facebook and eBay, the world's biggest online-auction site, an almost unassailable lead: the more users such services have, the more valuable they become, thus attracting even more users. In the case of Groupon the network effects are comparatively weak. Being the biggest kid on the block is certainly an advantage: a long mailing list attracts better merchants, which pull in more consumers. But both businesses and consumers can easily switch to other sites.

Groupon's managers are aware of all this. Rob Solomon, its chief operating officer, agrees that the barriers to entering the daily-deals market are low and the network effects weak. However, he believes that, with the right strategy, the company can create competitive barriers to shore up its dominant position. One way it is doing so is to make better use of all the data it collects, for instance to personalise deals and help local businesses design their Groupon offers. Last year the firm hired as chief data officer an executive from Netflix, a film-rental business noted for its data-mining skills. In America Groupon already tailors some offers depending on the sex, location and buying history of a subscriber.

The next step is for Groupon to become a broader "platform for local commerce", in the words of Mr Solomon--a bundle of services that make that market more efficient. In America it has already started testing virtual storefronts where a city's businesses can organise their own deals. It is said to be working on a smartphone application that alerts consumers to a local business's special offers whenever they walk past its real-life storefront.

Besides having to keep one step ahead of its many competitors, there is another reason why Groupon needs to grow into a broader local-commerce operation: the daily-deals phenomenon, despite its remarkable recent growth, may have its limits. Although Mr Solomon claims that 95% of local firms using Groupon come back for more, independent research comes up with markedly less impressive numbers. Last summer Utpal Dholakia of Rice University interviewed 150 businesses that had done Groupon promotions. One-third said they did not make any money from them, and 42% said that they would not do another daily deal.

The reasons for such numbers are various. Businesses grumble that the deals attract mainly bargain-hunters who do not spend more than the coupon's face value and do not become repeat customers. Although these problems may be fixed by designing the promotions better, there are some longer-term worries. Studies have repeatedly shown that price discounts erode brand value, says Mr Dholakia. They may be good for giving businesses some exposure but the benefit of this is likely to wear off after a few such promotions. Mr Solomon will have none of this, calling Mr Dholakia's survey unrepresentative and insisting that Groupon has a queue of new companies keen to sign up.

Even so, there is a risk that local businesses, having given Groupon a try, will abandon it. How the behaviour of consumers will evolve is harder to predict. So far the hunger for online coupons seems insatiable. Groupon's best customers are young, female city-dwellers, who tend to be avid followers of fashion; but fashions change. Mr Dholakia has already seen signs of what the Urban Dictionary will probably call "Groupon fatigue".

Does this mean that Groupon will go the way of Napster, Friendster or MySpace, all of which had meteoric rises before crashing and burning? This is clearly a risk. But with its powerful momentum, strong management and hefty financial backing, the firm certainly has a chance of becoming the dominant platform for local service businesses to pull in the punters, much as Amazon has come to dominate online shopping for all sorts of physical goods. If so, though, daily deals will probably be just one of Groupon's offerings.