Singing the praises of the group buy

Groupon‘s (NASDAQ:GRPN) run up to its IPO this morning has been over a pretty bumpy road. Questionable accounting metrics that failed to take marketing costs (one of the company’s largest expenditures) into consideration raised flags at the SEC and among tech journalists. A significant amount of the $1.14 billion the company raised from angels and venture capitalists went towards buying out early employees, leaving Groupon with more liabilities than cash on hand or assets to cover them should growth stall. And to top it off, top talent from Yahoo and Google never lasted more than a few months at the head of the company. Originally expected to reach a valuation of $30 billion, it’s expected that today’s IPO will value the company at less than half that amount – $13 billion. Insert your own joke about 50% off coupons here.

So why would anyone still want to put group money behind the group buying startup? It really comes down to just two reasons: demand and traction.

Groupon’s been touted as both a small business killer and savior. The reality is that it comes down to the person running the business, and their ability to come up with a pricing formula that allows them to cover costs while presenting an attractive introductory offer, as much as it does to Groupon. Some business owners will miscalculate the amount they can afford to discount, and have a bad experience. Others won’t though, and by all accounts Groupon still has lists of merchants in countries in the US and around the world who are lined up, waiting to give it a try.

And the fact is, aside from LivingSocial – the 2nd most popular daily deals site on a global scale, there isn’t a single company who has the type of scale to satisfy local merchant demand in as many cities, to as many subscribers as Groupon does. Newspapers? Radio ads? They’ll always have a base with car dealers and real estate agents, but businesses are finding that nothing gets new customers in the door like a group coupon. In fact, the one thing fueling much of Groupon’s competition is the fact that Groupon doesn’t have enough deal supply to satisfy merchant demand. Which seems to indicate healthy, sustainable at the very least, consumer demand.

Which leads us to competition and traction.

Google Offers might become a nice lead generation tool to get local merchants advertising on search terms, but the reality is that getting consumers to think of a site as the best place to go for local deals is a full time endeavor. It’s why Facebook and Yelp threw in the towel on their deals products. In Facebook’s case, the deep pockets are there, in Yelp’s case the local merchant relationships are there, but neither on its own is enough to gain serious traction. Groupon’s sales heavy 10,000 strong employee roster (estimates put sales staff at 4-5,000) isn’t a challenge that can be overcome through better algorithms, and as smaller competitors consolidate (BuyWithMe was recently sold at a fire sale price to Gilt), it’s become obvious that it’s no longer a challenge that can be overcome by buying or acquiring to growth.

Groupon is probably nearing the top of their hockey stick growth – blame it on everything from competition to deal fatigue, but the fact is that they grew faster in 3 years than some companies have in 30. Percentage wise, they aren’t growing like they once were, but you can’t discount the fact that they’re still growing on hundreds of millions of dollars in sales.  And those much maligned marketing expenses? They may have taken away from profits, but they also created a barrier to entry significant enough that only one other company has been able to truly compete thus far.

While smaller players will undoubtedly carve out a niche and see some success with group buying, Groupon has become the 800 lb. gorilla of local/small business advertising. A few monkeys, who have a fraction of their attention and an even smaller fraction of their resources, on their back may slow them down, but won’t be what brings them down.

Groupon for one, please.

For $6 billion, this site would be sold in a nanosecond (possibly with a kidney included), but Groupon looked the multi-billion dollar offer in the face and decided to walk away. Chicago Breaking Business {via TechCrunch} reports that two sources close to the deal have confirmed that Groupon has decided to stay independent, possibly in advance of a IPO filing, though a decision on that won’t come until 2011.

How could anyone possibly walk away from $6 billion? According to Kara Swisher at AllThingsD, the $500 million annual revenues that everyone’s been tossing around (including us) are actually closer to $2 billion. While that figure doesn’t take into consideration what Groupon pays out to merchants, most estimates have Groupon taking a 50% cut of each deal that passes through its site, which means the company could be seeing $1 billion from the deals that pass through their system. Considering this is still in a span of just 2 years, heading for an IPO might make more sense. With their own focus on acquisitions – of both smaller companies outside the US and new customers – Groupon hasn’t been resting on their first to market status to grow, and it’s obviously working out amazingly well. If they hit $3 billion in revenue next year, an IPO could easily see the company valued at much more than the $6 billion Google offered.

Only time will tell if this is the right move: when Facebook turned down a $2 billion offer from Yahoo!, many observers who’d seen Friendster’s rise and fall thought it was a risky move. Today the company is valued somewhere close to $50 billion and it looks like the right bet. As successful as they’ve been, it’s still impossible to know for sure if Facebook will continue to hold the number one social network spot that MySpace once held, and officially conceded. For Groupon, the loudest criticisms of their multi-billion dollar valuation have been over the fact that the model can be easily duplicated, and that there’s not much that would keep someone loyal to Groupon exclusively.

While they may not be the only daily deal site that customers keep up with, Groupon is quickly turning the space into a winner take most market and sometimes that’s enough to build a defensible business on. The momentum Groupon has going for them at the moment may be a challenge to sustain, but it would be an even tougher battle for competing companies to overtake them.

Meanwhile, this puts Google back to square one. Amazon recently offered competitor LivingSocial $175 million, BuyWithMe is the next largest competitor, but not in enough cities for Google to spend money on an acquisition rather than trying to build its own product and sales force. Will we see Google Deals/Goopons making their way into local listings? Google branded products have been hit (Maps, Earthview, Gmail, News) and miss (Video, Buzz, Wave, Froogle, Base) so it’s difficult to say how they’ll move forward, but we can’t see them walking away from the  daily deal model after what was on the table.