The flameout of a perfect Internet idea

Cityspree launched its gift-certificate program in September 2000 with over $21 million in financing from Continuation Investment Partners, the equity arm of the wealthy Rothschild family, and others.

Before the launch, Cityspree CEO Anne Stanton took first place in Harvard Business School's 1999 business plan contest. At the time, her idea was called LocalRewards.com.

The winning business plan offered large profit margins. Cityspree, whose site promotes coupon deals in 41 U.S. cities, gives local restaurants, nightspots, hotels and retail shops a Web page that plays up their specials. In return, a business allows Cityspree to, for example, print batches of $30 gift certificates worth $300 per month. Cityspree then sells the certificates to consumers at a discount or auctions them to the highest bidder.

You don't have to be a genius to figure out that it doesn't cost Cityspree $300 a month to host a Web page.

But by the same token, it doesn't cost a merchant $300 to honor ten $30 gift certificates, either. By attracting new customers, both the businesses and Cityspree could make money.

The promise of this beautiful tapestry, however, has come unraveled. A provision in Cityspree's contracts with merchants allowed Cityspree to sell an entire year's worth of gift certificates within as little as a month or two. As a result, some merchants have been flooded with redemptions and are refusing to honor Cityspree certificates.

Michael Carlin worked until recently as an account executive in Cityspree's New York metro area office. He says he was laid off Jan. 26, along with dozens of other employees, and that now Cityspree has "really a bare-skeleton crew, if anything."

Carlin said a typical contract, such as one signed by the Binghamton, N.Y., branch of the Outback Steakhouse chain, promised that the eatery would make an "in-kind contribution" of $200 a month over a 12-month period. But, Carlin said of Cityspree, "within the first month and a half, they'd auctioned off two-thirds of the original package."

An Outback employee confirmed that the restaurant stopped selling certificates through Cityspree last month.

Stanton said in an interview that her company has shrunk to 25 employees from 250. Asked about certificate refusals, she said, "Out of 5,000 merchants, you'll have about 10 percent merchant issues."

She added that merchants who receive many certificates in a short period have a valid concern, but said, "We have a right to liquidate those certificates."

Jeff Kalich, the owner of Twingo's Cafe, a French-style bistro in Detroit, is one of several restaurateurs who's more than a little steamed.

Kalich said, "I've put in several calls to their offices, and unless somebody gets back to me by Monday (April 16), I'm not going to continue to take them."

Twingo's no longer participates in the program. But at press time, the Cityspree site was still selling $30 gift certificates to Twingo's for $21.

Kevin Yi, an accountant in Los Angeles, says he bought a Cityspree certificate that was honored by a merchant a few weeks ago. But when he successfully bid for a certificate more recently, it was refused on April 7 by Dalt's Classic American Grill in Burbank. A manager at Dalt's said the restaurant would no longer honor Cityspree certificates.

When someone comes up with a business model that's perfect for the Internet--matching bargain-minded shoppers with discount coupons--it's a shame when the leading example flames out. Unfortunately, if you buy a certificate at Cityspree these days, the dinner may be on you.

(Note: Yi, who was the first reader to send a tip about Cityspree's condition, will receive a free copy of "Windows Me Secrets.")

Brian Livingston's Wired Watchdog column appears at CNET News.com every Friday. Do you know of a problem affecting consumers? Send info to tips@BrianLivingston.com. He'll send you a book of high-tech secrets free if you're the first to submit a tip he prints.