Groupon's model: Irrational, but it works

Why Topix CEO Chris Tolles thinks Groupon will succeed despite the quirkiness of its business model

It’s been dark times for Groupon ever since the group buying giant filed to go public.  The company has been shredded in the media—so much so that it published a mostly-funny but sort-of-sad retaliation blog post.  And now it looks like the SEC is delaying its IPO over its less-than-clear accounting methods.  But does Groupon deserve the beating that the media and government have been dishing out?  Not everyone thinks so.  The fact is that regardless of how irrational Groupon’s business model and accounting practices may seem—and indeed, regardless of how irrational it may seem for merchants to sign up with Groupon and give away half their revenue—it works.  Why?  Because that’s what people want, according to Topix CEO Chris Tolles.

I chatted with Tolles recently about Topix, the local news aggregator, and the current state of all things local.  When the topic of Groupon came up, he had some interesting points to make. 

Now, first, I should say: I love Groupon.  LOVE my Groupons.  Love my cheap meals and facials.  But facts are facts, and some of them aren’t painting a pretty picture of Groupon’s future.  The company has some screwy accounting practices—its S-1 form lists revenue, then gross profit, then net income.  The problem is that what Groupon counts as revenue includes the merchant’s cut as well.  So gross profit is what Groupon walks away with after the merchant’s cut has been divvied out.  But Groupon isn’t calculating gross profit after advertising and marketing costs.  It’s a little concerning.

And then there’s the question of whether or not Groupon even works.  Studies have shown that some merchants—namely restaurants—don’t really benefit from the Groupon model.  They submit their deal, get a rush of cheap, ill-mannered customers who don’t tip, and after giving up half their revenue, they’re not likely to see any of those customers again. 

“People will get tired of it and when economic times improve, retailers may not be so eager to give away restaurant seats if more and more people have discretionary income. Those seats may be full and they may not need to give them away at discount,” said Jeffrey Grau, an analyst for eMarketer.com.  And as for the people: “Daily deals are attracting people that are deal sensitive, not loyal.  They see it like a game.  They’re drawn based on impulse, seeking the next thrill.  They’re very different from people who shop on online coupon sites—those are disciplined shoppers who plan a trip to the grocery store and go on coupon sites to get discounts on the items they want.  They take a much more tactical, surgical approach to getting the deals they want and they’re more loyal to their retailers.”

But Tolles argues that it’s the perception of being busy that merchants are after. “You’re selling marketing on credit to people who can’t do it rationally. You have to run your business on a perception, not on a rational deal. The perception of the restauranteur is key,” he explained.  “Giving people something they want versus something that makes sense works much, much better.”

Based on that logic, Tolles claims, Groupon is not going to go gentle into that good night any time soon.