That didn't take long. In December 2010, Amazon invested $175 million for a minority stake in daily-deal site LivingSocial, right around the time rival Groupon turned down a $6 billion buyout offer from Google. The next big thing in selling online had arrived. Yet last week Amazon wrote down the value of its LivingSocial stake by $169 million, and Groupon's stock is down more than 75% from its initial public offering price of $20 a year ago. Apart from the cash on its balance sheet, Groupon is worth less than $2 billion. Pretty quick fall from grace.
Millions know that daily-deal sites collect emails and pitch 50% off local sky diving lessons or 40% off aromatherapy sessions if enough people sign up. So LivingSocial and Groupon were smack dab in the center of three hot trends: social, mobile and local. Amazon CEO Jeff Bezos has a pretty good nose for what works. So why the return to earth?
First, neither LivingSocial nor Groupon was really a technology company even though both were valued like one. Groupon has 10,000 employees, most of whom are sales people who solicit deals and write up enticing offers. This doesn't scale well because if you want to grow in Cleveland, you have to hire lots of people in Cleveland.
Second, the model may not be self-sustaining. It took huge amounts of capital to keep increasing the number of subscribers while trying to turn them into revenue-generating customers. Groupon even attempted to hide these massive marketing costs, telling investors to focus on something called "adjusted consolidated segment operating income," which amortized marketing costs over quarters or years. The Securities and Exchange Commission called foul. Big marketing costs are often explained as "priming the pump," but if the well goes dry, you can only pump until you run out of capital.
In addition, it is still unclear if daily-deal customers can be reliably converted into repeat customers paying full price. Much like Apple Store wizard Ron Johnson's slow turnaround of J.C. Penney as customers just wait for inevitable sales, the daily deal is more about promotion than changing the nature and productivity of online retailing.
Third, neither Groupon nor LivingSocial could unseat the online price-shopping model that does work: Google's search. Apparently when the owners of Joe's Big Screen in Brooklyn want to sell a $300 wholesale LCD TV for $350, they're willing to pay half of gross margin (or $25) for enough Google ads and click-throughs to lure paying customers. Groupon and LivingSocial, by contrast, would demand $100-$175 from Joe's Big Screen for a daily deal, or up to half of sales—not a long-lasting model.
Lots of consumers looked at these deals as a game—something to try once before moving on, akin to "Words With Friends" (a kind of Scrabble for mobile phones) and many games from San Francisco-based Zynga. The same problem plagued the stocks of Pandora and Angie's List, which have similarly dropped like Groupon's. Elsewhere in the market, services that drive real economic productivity—such as LinkedIn for job seekers and maybe Yelp for restaurant and store reviews—are still provided capital and additional time to grow.
That is the bigger lesson here for investors. Confounding market purists, investing can be like fashion, with certain styles coming in and out of favor. The stock market values future earnings, but early in the cycle for new industries and next-big-thing hopefuls, the market will look far into the future for potential profits and provide oodles of capital to get there. Sometimes it works: Microsoft was always an expensive stock anticipating world domination, and a decade ago Google had a huge valuation even after the collapse of the dot-com boom reminded investors that the market often pays for a future that never materializes.
There are plenty of painful lessons. Solar and biofuels and smart grids and batteries for electric-car companies all got huge valuations and access to capital for markets that never met their lofty expectations. So funding gets pulled until the ever-wise market finds its next segment of interest (leaving the federal government to keep throwing money at green projects). Facebook couldn't live up to its $100 billion initial value because of fears that the company had no mobile strategy. But, voilà, now Facebook's mobile ads have gone to 14% of sales from zero and the stock is ticking up. The market eventually gets what it wants.