Last week, I wrote about the fact that the single largest threat to Groupon’s survival is a loss of confidence on the part of its merchants, in Groupon’s ability to pay its debts. Just as Lehman Brothers was brought down when other banks stopped lending it money because they feared that Lehmans wouldn’t be able to repay, Groupon could be brought down were merchants to stop supplying Groupon with deals if they feared that Groupon wouldn’t be able to pay up in 60 days time.

Since then, Groupon’s IPO has been delayed and news has emerged that Groupon employees are suing the company (credit to Eamonn Carey for bringing that last piece of news to my attention). Meanwhile, Groupon’s competitors continue to gain ground and Google has expanded the “beta” version of its Google Offers service to five more cities.

The bad news is piling up and one has to ask oneself: “Is this the beginning of the end for Groupon?”

Groupon’s business model

Groupon makes money by phoning up merchants – offline bricks’n’mortar businesses like restaurants, beauty parlours and cinemas – and persuading them to offer a Groupon deal (typically 50% off a given product or service) through Groupon. If the merchant agrees, Groupon then advertises the “Groupon” (as they, somewhat confusingly, call the deal) to consumers through its website and mailing list. If a consumer wants to sign up for the deal, they pay Groupon and receive a coupon in return, which they then take along and present to the merchant to get the deal.

Groupon keeps about half the money and pays the remainder to the merchant within 60 days (in North America) or when the customer redeems the Groupon (in their international markets).

So, a merchant will typically only receive 25% of what a normal customer would pay for whatever product or service is the subject of the Groupon. That may not sound like a particularly good deal for the merchant but for a business whose costs are largely fixed (like restaurants, beauty parlours and cinemas) it makes sense to generate at least some revenue from a table, appointment slot or seat, rather than having it sitting empty (and staff sitting idle). It’s also a means of attracting new customers – offer a Groupon deal to get them in the door and then try to sell them other products or services at full price. So, a restaurant may offer $14 worth of food for $7, in the hope that the customer will want to eat more than $14 worth of food and/or some alcohol.

Steve Blank defines a startup as “an organization formed to search for a repeatable and scalable business model”. Clearly, Groupon have been able to repeat their core offering with thousands of merchants across dozens of markets, serving millions of consumers. However, when assessing a business model, I also like to consider competition and profitability. The overall (and, if I’m honest, somewhat woolly) question I ask myself is whether the business model is sustainable.

Groupon has two types of customer – the consumers that buy Groupon’s deals and the merchants who offer them. Most analysis of the competitive dynamics in the “daily deals” sector (as it is now commonly referred to) focuses on the former but the latter are probably more important from a competitive standpoint.

It’s important to remember that Groupon’s business is inherently transactional. The network effects are weak – there’s no particular reason why a consumer would opt to buy a Groupon deal instead of an identical deal offered by one of Groupon’s competitors. A discount is a discount is a discount – 50% off through Groupon is no different to 50% off through LivingSocial. Consumers are simply looking for a good deal. Whether they find it in their mailbox or through an advert on Facebook or Google doesn’t really matter.

Merchants, too, are looking for a good deal. This is where things start getting interesting, from a competitive perspective, because there is greater scope for variation in the terms offered to merchants. If LivingSocial wants to persuade Casa Mañana to offer their next deal through LivingSocial instead of Groupon, they can offer to pay the restaurant $4 for each deal sold, instead of the $3.50 paid by Groupon. The merchant has little to lose by choosing LivingSocial over (or in addition to) Groupon. What’s more, price is only one dimension of competition. The terms that make a deal attractive to consumers (e.g. deep discounting, few restrictions, extended validity, no limits on the number of deals on offer) are not so attractive for the merchants. In other words, Groupon’s interests (i.e. making a deal as attractive as possible in order to sell as many as possible) conflict with the merchants’ interests. As a result, a competitor that offers greater flexibility on such terms is likely to tempt merchants away from Groupon, if anecdotal evidence is anything to go by.

The bottom line is that Groupon does not have a strategic competitive advantage. It may currently have better brand recognition and a larger mailing list but there’s nothing to stop a new entrant from spending heavily on marketing to achieve the same mindshare that Groupon has today. In fact, given that Groupon has effectively established the daily deals market, new entrants will probably have an easier time of it because Groupon has already educated consumers about what a daily deal is (“Oh, so it’s like a Groupon!”).

Andrew Mason asserts that Groupon can achieve profitabilty quite easily, by reducing marketing spend while maintaining existing levels of revenue. In his recent email to Groupon employees (which was leaked to AllThingsD) he described Groupon’s mailing list as a “long-term marketing channel”. However, I’m not sure how valuable an asset someone’s email address is; lots of spammers have my email address, yet I’ve never bought cheap Cialis or a replica Rolex.

If Groupon reduces its marketing spend, it’s likely to lose ground to its competitors who, at the same time, are likely to be also offering better terms to merchants. The bottom line is that daily deals are easily commoditised. It’s likely to become increasingly difficult for Groupon to maintain its current rate of revenue growth in the face of intensifying competition, and its margins will almost certainly be squeezed.

That doesn’t sound like a multi-billion dollar business to me. I would be skeptical of investing in Groupon’s IPO even if the founders hadn’t taken nearly $1bn out of the company, leaving it reliant on future revenues to pay off its current creditors.

Can Groupon pivot its way out of trouble?

Steve Blank’s definition of a startup deliberately implies that the startup is searching for a viable business model and that the search is likely to require that the startup try out different business models. The act of switching from one business model to another is commonly referred to as pivoting.

So, is there an alternative business model that Groupon could pivot to? I think there might be.

Through my interest in photography, I’ve been exposed, over the past 18 months or so, to the fashion industry and, in particular, to new and emerging designers, like Charlotte Taylor and Zoe Jordan. One of the challenges that new designers face is that, although they may create incredible garments that are featured in fashion magazines and worn by celebrities, it can be difficult to find those garments in stores and boutiques.

About a year ago, I came up with the idea of a mobile app aimed at the fashion-conscious shopper, that would allow the fashion victim to specify which designers, styles or trends she was interested in, and would tell her where she could find boutiques that stocked clothes by designers who matched her preferences. The search results would be derived from data entered by the designers or boutique owners, who log onto a website, create a profile for their brand or boutique and specify either where their brand was stocked or which brands their boutiques stocked.

Unfortunately, neither struggling fashion designers nor the boutiques that typically stock such designers are willing to pay a significant amount for such a service, so there’s a big question mark over where the revenue comes from (i.e. whether it’s a sustainable business model). However, the idea stuck around in the back of my head until I came across a startup called SalesGossip, which alerts shoppers about what sales are going on in their vicinity – another potential application for a location-based app aimed at the fashion retail sector. Imagine a consumer who finds herself in the vicinity of Oxford Circus with half an hour to spare. She brings up the SalesGossip app on her iPhone and can instantly find which nearby stores have sales going on.

That in turn made me realise that an app of that nature could profile its users based on their shopping interests and produce search results dynamically, from a back-end database of sales and offers. What’s more, said back-end database could be constantly updated by merchants through a web or mobile interface, or an API, with narrowly-targeted sales or deals aimed at specific demographics. A store like Zara could configure its stock control system to automatically offer a discount on slow-moving lines, targeted at consumers who are likely to be interested in that particular garment.

Once the concept was proven in one sector (i.e. fashion), it could be extended to others – restaurants with empty tables could offer discounts to people nearby who were looking for somewhere to have lunch, hotels with empty rooms, car hire companies with under-utilised fleets, hairdressers, spas – all the types of businesses that Groupon currently targets, but using a dynamic, realtime engine to offer deals based on a merchant-driven, demand pricing paradigm, instead of a comparatively static, email-based model. Placing such levels of a control in the hands of the merchants would be incredibly powerful. You would effectively be creating a local commerce platform.

The technical solution is relatively simple and inexpensive to implement (I was quoted or £16,000 for building a MVP, based on a website and iPhone app connected to an AWS back-end; unfortunately, after having put the money together, it turned out that the SalesGossip team were completely uninterested). The real challenge is reaching a critical mass of users (i.e. app downloads) and getting merchants to sign up to such a service. However, Groupon is in the perfect position to market such a service to both its mailing list of consumers and its merchants.

What’s more, such a service offers a strategic competitive advantage through network effects. If Groupon were to become the most popular “Go-to” app for finding a place to shop, eat or stay, that would place them at a significant competitive advantage over anyone else (in the same way that Google’s dominant position as the “go-to” search engine gives it a competitive advantage over other entrants into the search market). Add social recommendation to the mix (i.e. allow me to filter/rank restaurants that have been recommended by my friends) and that competitive advantage could become a strategic one.

By definition, such a platform would result in lower margins. However, that would be irrelevant because volumes would increase (instead of pushing offer to consumers, they would be pulling them from your app) and costs would plummet (you no longer have to sell a merchant on each Groupon deal; you simply sell them the platform and let them use it as much or as little as they like). You end up with the sort of model we chase in financial markets: reduce the incremental cost per trade to zero and pump up the volume.

So, is there an alternative business model to which Groupon could pivot? Clearly, there is. Groupon could become the de facto platform for mobile, location-based commerce. Closing the online/offline attribution loop could, as Rob Carter pointed out three months ago, be incredibly lucrative. It could also change the way we shop forever.

Will Groupon achieve that?

I don’t think so.

Do you want to change the world? Or just make money?

Despite the launch of ‘Groupon Now’ – an obvious vehicle to launch a mobile, location-based offering – there’s no evidence that Groupon is targeting this space. They could have used some of the money they’ve raised to build their working capital, which would allow them to pay merchants the instant a consumer bought a Groupon, thereby making the Groupon offering more attractive to merchants, while breaking free of the negative working capital solvency trap. But they opted, instead, to enrich the founders and early investors.

So, if not Groupon, who? Well, if you combine a Google Wallet based on NFC payments technology, with Google Offers, content from companies like Zagat, social recommendations through Google Plus and a “Google Local” mobile search app, you can get a glimpse of what the future might hold. That vision of the future is probably why Google offered to buy Groupon – acquiring Groupon would have allowed Google to piggyback Google Commerce on Groupon’s platform. On balance, however, Google (Marissa Mayer in particular) is probably thanking its lucky stars that Mason and Lefkofsky rejected Google’s $6bn offer.

Stephen Levy has criticised Groupon for lacking the “revolutionary quality” of eBay or Google. I agree with Stephen.

I recently attended an event where Masahiko Yamada, the President of Fujitsu’s Technical Computing Solutions Unit, asked the audience “When you wake up in the morning, are you changing the world or just getting through the day? Or just making money?”. Yamada-san went on to point out that “the best innovators’ primary motivation isn’t money. They just want to change the world.”

Groupon’s founders don’t want to change the world. They just want to make money. That’s why, in ten years time, Groupon is likely to be spoken of in the same breath as boo.com