A Scientifically Proven Way to Lose With Groupon

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We all know social-media companies love to focus on metrics like page views, users, likes, and tweets. It's so prevalent that investors might begin to believe in the hype that something other than earning money by providing a valuable product or service has meaning. However, when it comes to the bottom line, a company's value can be based on the usefulness of the good or service it provides. If it's a useful product that a lot of customers will pay a good price for, that company will probably have a sustainable business. If it's not a useful product, that company will only survive for as long as it can fool its customers.

And according to a recent academic paper, Groupon (Nasdaq: GRPN  ) has little time left to fool its customers or find a new model.

The study
Researchers collected information on deals held on LivingSocial, of which (Nasdaq: AMZN  ) owns 29%, and Groupon, as well as reviews for the companies selling deals on Yelp (NYSE: YELP  ) . The findings:

  • Companies increase the number of Yelp reviews by 84% the month after they run a Groupon compared with usual review growth of 5%.
  • These companies also lose about 0.12 points from their Yelp rating, which "suggests a significant number of merchants may lose a half-star [because of] rounding."
  • It notes that a previous study found that "a one-star increase in Yelp rating leads to a 9% increase in revenue."
  • Yelp reviews that mentioned "Groupon" or "coupon" had a 10% lower rating than average, and those that mentioned both had a 20% lower rating than average.

The study (link opens a PDF) takes note that some reviews on Yelp are hidden, and though it does not know how those hidden reviews are selected, it could not access 23% of all reviews.

The meaning
So while Groupon can give a business exposure and customers, it can have a negative effect on your Yelp rating. It's up to businesses to decide whether this trade-off might be worth it, but it seems there might be better ways to drum up business than paying for customers who end up writing slightly more negative reviews.

On the flip side
Groupon CEO Andrew Mason said in the company's IPO filing: "Expect us to make ambitious bets on our future that distract us from our current business. Some bets we'll get right, and others we'll get wrong, but we think it's the only way to continuously build disruptive products." It seems he knew that there was always the possibility that heavily discounted deals might not work out best for small businesses, and Groupon might have to come up with something new.

With its launch of Groupon Scheduler, which helps small businesses schedule appointments and staff, and acquisition of Fee Fighters, a company that helps comparison-shop for credit card processing, it appears Groupon does want to pivot to provide better value to its customers. However, as the market destroyed the stock's value and accounting issues sprang up, Mason took a different tone and said the company needs to focus on "not taking stupid risks." If Groupon sticks with its current model, I would fear that its value proposition to customers erodes, eventually cutting into its margins and proving skeptics correct.

Selling murky value
(Nasdaq: FB  ) has run into the same issue: Does advertising with the site actually work? You can argue that the $992 million in revenue it generated through advertising last quarter proves that it does. On the other hand, the third largest advertiser in the U.S., General Motors (NYSE: GM  ) pulled its $10 million in advertising from the site after deciding the ads had little impact. Of course, General Motors still keeps up its Facebook page and pages for its brands, which allows it to connect with the users who like the pages for free. However, Facebook recently disclosed that 83 million users might be duplicates, misclassified, or undesirable accounts. Think dogs with a Facebook profile. This back and forth could go on.

If only measuring the value of Groupon and Facebook were easy. As their customers have doubts, they will both have to prove the value of their service. If they can't, customers will take their bets off these new advertising channels, and investors will follow.

For a further in-depth look at Facebook's prospects as an investment, including four key areas you must watch and three reasons to buy and sell now to help you reach your own decision, check out our brand-new premium report on the social network. The report also comes with free critical news updates for one full year, so grab your copy of our Facebook report today.

Fool contributor Dan Newman actually has bought a Groupon and would buy another. He holds no position in any of the above companies. Follow him on Twitter, @TMFHelloNewman.

The Motley Fool owns shares of Facebook and
Motley Fool newsletter services have recommended buying shares of General Motors, Facebook, and We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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10/27/2016 4:00 PM
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