Groupon skeptics have never been in short supply. They’ve long said the business model was flawed and that the growth of the company and its sector was based on hope. Critics predicted it was only a matter of time before it would all collapse. That time appears to be now.

Groupon

Groupon

LivingSocial, Groupon’s main competitor, was once the object of $175 million worth of investing love from Amazon. At its height, LivingSocial was valued at $6 billion. Today, it has withered away, and its remains were recently acquired by Groupon for $0.

Groupon, once named by Forbes as the fastest-growing company in the history of the web, has also become a shadow of its former self. Its stock has been on a long slide since an IPO high of more than $28 in 2011, to trading around $4 per share today, and observers are leery about its prospects for ever being viable.

“Groupon was nonsense from the beginning,” says Eric Clemons, Wharton professor of operations, information and decisions. “You have to remember that their original business model was to implement group buying, so that we could all have the buying power of an Amazon, or a Wal-Mart, or a Bed Bath & Beyond. We just needed to wait until enough of us wanted to buy the same thing, and Groupon would get us a great price. This was simply ridiculous. There was never any validity to the original group buying business model.”

Groupon, once named by Forbes as the fastest-growing company in the history of the web, has become a shadow of its former self.

Ultimately, there are too many flaws in the business model used by Groupon and other daily-deals sites to make for happy customers and vendors, says Pinar Yildirim, Wharton marketing professor. “Of course, eventually, when both consumers buying the Groupon and vendors enrolling in the service are not happy, discount-buying sites cannot last too long profitably. I do not expect Groupon to go back to its profitable days.”

Wharton marketing professor David Reibstein says that while there was never a compelling argument for Groupon and the like, the case is even less persuasive today. “[This] is a business model that made much more sense during a downturn in the economy,” he notes. “As the economy has picked up, there is less idle capacity and extra inventory, and there is less to be available, period. And so I’ve never been enthusiastic about the business model, and I think the valuation of LivingSocial today is indicative of that business model.”

Groupon continues to experience net losses, and has responded by exiting poorly performing operations in 11 countries and trying to re-tool its business. But analysts are wary. Says a report from Raymond James & Associates: “While optimistic on the improved execution, we continue to believe the turnaround remains in its early stages and would like to see additional signs of improved growth to become more constructive.”

High Price for a Low Return

In you ever find yourself hungry in Pottstown, Pa., you can get $30 worth of food at Salad Society or Society of Burgers for just $15. A 60-minute massage at Ango’s Beauty Concept in Chicago, a $75 value, can be had on Groupon for $29. Recently, you could book a non-stop flight from Atlanta to Cancun for $199. Restrictions apply.

“The internet has never been really very good at bridging the gap between traditional commerce and the web. Then we came along,” Rob Solomon, Groupon’s former president once said.

After its overheated IPO and first incarnation, Groupon positioned itself as a matchmaker between customers wanting deals and vendors in search of new customers, and it “did not do very well with that, either,” Clemons says. “Groupon was intended to give sellers a way to get new buyers to try their product by offering selective discounts. If a seller has a superb new product in a growth market, then using Groupon to get it out in front of new customers makes sense. If a seller has excess capacity and it costs very little to provide discounted trials, then again, Groupon makes sense. If Groupon can provide a great opportunity for access to a select group of influentials who will attract lots of new buyers for the seller, then it makes sense for sellers to use Groupon.”

But Groupon was not designed to do any of these things well, Clemons notes. “There was no way of guaranteeing that you weren’t cannibalizing your existing customers, giving a discount to people who would have bought from you anyway. There was no way to guarantee that the customers you attracted would ever come back without a discount. There was no effective way to limit the quantity of items you sold at a discount. Shops were driven into bankruptcy because Groupon sold thousands of items below cost. That’s crazy.”

In other words, the company never did become adept at bridging the gap between traditional commerce and the web. “It is not surprising that online companies like Groupon and LivingSocial are struggling, because they rely on the consumers who are highly price-sensitive and are not loyal to any particular brand,” says Yildirim. “Most vendors participated in Groupon type of activities with the hopes of earning new consumers for future business, but, unfortunately, when you are attracting mainly these price-sensitive consumers, it is unlikely that they will stick with you at full prices.”

Groupon offers mostly local services at discounted prices, and it is not very likely that consumers will be highly excited about these services, she says. The other issue is the constraints on using services bought on Groupon. “Consumers need what they need at a given time, and Groupon’s business relies on having enough consumers interested in a product over a period of time.”

Moreover, it is not clear that consumers really get the best experience when they walk into a store with a Groupon voucher. “I believe many vendors did treat them as half-price consumers,” says Yildirim. “This is an agency issue, because vendors have to motivate their employees to treat customers using Groupon the same way as their regular customers, which does not always work out. The employees were either burned out on the increased demand over a short period of time, delivering less than ideal service, or figured a consumer using Groupon was less likely to come back again at full price than a consumer paying the full price, so they did not care as much to deliver service.”

Early research into the sector bore out some troubling flaws in the business model. Only a relatively low percentage of deal users, 35.9%, spent beyond the deal value, and just 20% returned for a full-price purchase, according to one examination titled, “How Businesses Fare with Daily Deals: A Multi-site Analysis of Groupon, LivingSocial, OpenTable, Travelzoo and BuyWithMe Promotions,” by Rice University professor of management Utpal Dholakia. Groupon’s own, more recent figures are more flattering to the company: 91% of Groupon customers return or “plan to return to the business,” the firm states in promotional material.

“Shops were driven into bankruptcy because Groupon sold thousands of items below cost. That’s crazy.” –Eric Clemons

The Rice University study examined performance of daily deals through five major

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