What's the deal with daily deals?

Brash and quirky Groupon is arguably one of the fastest-growing Web juggernauts ever. But recent doubts about its IPO, along with soaring marketing costs, a steep traffic decline, executive departures, and a lawsuit filed against the company by its own sales reps have people questioning whether Groupon--and indeed, the daily-deals phenomenon it touched off--are showing signs of flaming out.

The sudden exit of two major social-media brands from the deals arena hasn't helped either. Facebook and Yelp both set out to create "Groupon killers" but recently scrapped their efforts. Facebook retreated after a four-month foray into the market. And after its own one-year flirtation, Yelp slashed its deals crew in half, reassigning former team members to local search and other core products. Today, with 600 Groupon-style clones crowding the space, the market is way oversaturated. Deal competition is crazy. And consumers are showing signs of frustration, with Web coupons choking their in-boxes.

And yet, despite all that, there's plenty of evidence that the daily deals and group-buying sector is red hot. Nearly three years old, the market is estimated to reach $6 billion by 2015, according to BIA/Kelsey, an industry analyst firm. Epic consumer brands like Amazon, Google, AT&T, and a host of other companies are diving in deep and investing heavily too. There have also been a spate of acquisitions, and to date, $2 billion of private equity has been infused into daily-deal type companies, according to analyst Peter Krasilovsky, a vice president at BIA/Kelsey. Daily deals are a "fast evolving" marketing platform that will remain "an important part of the way that small businesses and national advertisers will promote themselves," he told CNET.

The 'groupon' phenomenon
Daily deals are dead simple. Every day Groupon issues a discounted product or service via a digital coupon sent by e-mail, and if a certain number of people prepay for the deal, it triggers a savings. Groupon takes a cut of every deal sold. Consumers in domestic and overseas markets have been flocking to these group coupons--"groupons"--for the obvious reason: everyone loves a deal. Indeed, digital coupons on everything from wine tastings to hang-gliding lessons to spa treatments have permeated our culture in a big way. Josh Stevens, 28, demonstrated this when he lived on nothing but Groupon deals for an entire year. No cash exchanged whatsoever.

Related stories:
• Groupon postponing IPO over market chaos?
• Groupon's net loss rises to over $100 million
• Yelp trims daily deals effort
• Facebook kills deals after just four months
• Google rolls out rival to Groupon in Portland, Ore.

Local merchants and small businesses have been keen to try out this new promotional channel because there are no upfront marketing costs--unlike ads in the Yellow Pages, which cost on average $2,500 a year. Also, with phone-book ads there's no real way of telling if the ad-spend directly affects a small business or local merchant's bottom line. Groupons actually do provide such intelligence: local and small businesses, which still operate mostly offline, can now track exactly how many customers bought the e-mail promo.

For now, Chicago-based Groupon remains the company to beat in this realm, with 115 million subscribers and an estimated $20 billion valuation. But it's still just one U.S. digital dealmaker among a cacophony of clones. To critics, the flood of competitors rushing into the market underscores how easy it is to duplicate Groupon's model. What's more, since the company filed the S-1 for its mammoth $750 million IPO in June, when nearly $400 million in net losses were revealed, it has received its share of negative publicity, including claims that it's running out of cash. On top of that, Experian Hitwise came out with a report indicating Groupon's July traffic tumbled by 50 percent--whereas Living Social, the second-largest web couponer, which is also anticipating a public offering, saw a 27 percent boost in traffic. Groupon's glow appears to be fading as investors, employees, and consumers are becoming disenchanted with the company's scrappy approach coupled with a series of reckless maneuvers.

For instance, Andrew Mason, Groupon's unpredictable CEO, penned a memo to employees in late August touting the company's growth prospects and marketing prowess--in direct violation of SEC rules barring such promotional statements during a regulatory "quiet" period. The internal communique was supposedly "leaked" to the media, prompting an outcry among regulators and analysts. Shortly after, Brad Williams, Groupon's vice president of global communications, quit the firm after only two months on the job. Earlier this year there was another high-ranking Groupon defection: COO Rob Solomon. And as if that weren't enough, hundreds of Groupon's own sales staff filed a lawsuit against their employer for failing to pay overtime. Taken together, these awkward and imprudent jostlings by a company that was on the verge of going public has industry mavens, media pundits, bloggers, and even the Harvard Business Review furiously debating Groupon's viability, and the future of the daily deals market.

What's the deal?
But here's the thing: as BIA/Kelsey's Krasilovsky said, the deals market is quickly evolving. So even if it ceases to exist in its present form, it may well continue on. One-size daily deals don't fit everyone. Not even Groupon. That's why the model is morphing.

For example, Groupon is already moving into mobile and near-instant deals with its Groupon Now service. Specialized daily-deals sites have been attracting investments and growing rapidly. Gaypon (gay-friendly) and Kabiela.com (aimed at auto enthusiasts) and deal aggregator Shopperlike.com are recent specialty entrants. "Flash"--or instant--sales are a hit with consumers: they help retailers sell inventory more efficiently by offering deals during a limited window of time--when business is slow, for example, or when a retailer has too much inventory. Gilt City, Bloomspot, and iDeeli make use of flash sales and focus on discounted high-end luxury goods and clublike exclusivity via a "members only" approach. With 3.5 million members, Gilt City parent Gilt Groupe says it's on track to reel in $400 million in revenues this year. In August, Gilt Groupe introduced a Facebook page devoted to exclusive recurring deals from retailers like Vera Wang.

Yelp, the San Francisco-based local reviews service, which draws over 50 million monthly unique visitors, has a new "self-service" deals product for business owners. Local merchants who are Web savvy can visit a special page on the site to upload discounted offers to their Yelp page. When a deal is sold via the automated service, Yelp takes a 30 percent cut. For any refunds Yelp sends to customers, businesses must pay 70 percent back to the company. Yelp says the two-month-old free tool is gaining traction--"several thousand businesses have posted deals," it reports. (It's unclear how many small-business owners will take advantage of the service, though, given that most aren't even online and that two-thirds of small businesses still rely on ads in the Yellow Pages.

The closers
Long-term, of course, the winners and losers in all of this have yet to be determined. "There are lots of good businesses with lots of different angles," says analyst Krasilovsky. But observers say it can't hurt to be an early entrant with a known brand, deep pockets, and a massive sales force.

Online retailing giant Amazon has pumped $175 million into Living Social. Just two years old, Living Social has 43 million members and operates in 575 daily-deals markets globally. The Washington, D.C.-based company boasts that it's hiring six new staffers a day and anticipates $1 billion in revenues this year.

In July, AT&T Interactive--which according to the company is the world's largest publisher, by revenue, of print-based Yellow Page directories--launched its own daily-deals site: YP.com. The plan, reportedly, is to take daily deals nationwide in every local market where AT&T has a presence--and that means quite a few.

Google is another one to watch. Though the company started with a measured approach, it's picking up speed and aggressively investing in local deals. Groupon's rejection of Google's $6 billion takeover offer last December may have spurred the search giant to move ahead more briskly. In recent weeks, Google has gone on a buying spree: the newest acquisition is Zagat, publisher of the respected series of guidebooks to restaurants, hotels, and other local destinations. By snapping up Zagat, Google is going head-to-head with Groupon, Living Social, and every other major player that's after local deals and advertising. The ultimate prize, after all, isn't digital coupons or daily offers per se--those are merely vehicles or shortcuts to get to the $100 billion local advertising market. More than half of all ad buys are local, according to market analysts at BIA/Kelsey in Chantilly, Va. The firm is projecting local advertising to hit $144 billion by 2014. No wonder Marissa Mayer, Google's point person for local, maps, and location services, called Zagat "a cornerstone of our local offering," in a blog post.

"Google is betting big," confirms a person familiar with the firm's daily-deals strategy. The company sees massive opportunities to tie together local advertising with real-time, geo-targeted discounts sent directly to consumers' mobile phones. Google will instantly deliver the best and closest deals to consumers no matter where they are. Then, Google intends to "close the loop" by enabling on-the-spot payments thanks to "Google Wallet," a soon-to-launch mobile payments service.

Other new local deals acquisitions from Google: Zave Networks, a digital coupons and loyalty rewards company; Dealmap, a smart, location-based daily-deals aggregator; and WhaleShark Media, a profitable company with a suite of coupon and discount sites. And Google Offers, another strategic weapon against Groupon, began testing prepaid daily deals in Portland five months ago. As of last week, Google Offers has expanded to five new markets: Austin, Boston, Seattle, Washington, D.C., and Denver. The beta service is also available in the San Francisco Bay Area and New York City.

Finally--and last but not least--industry insiders expect Facebook to stay in the game, despite recent media reports.

"I don't think anyone thinks they're going away," one source familiar with the daily-deals market told CNET. "This business requires reaching hundreds of thousands of merchants. It's a very competitive space from a sales perspective. Facebook was just nibbling around the edges at this. They didn't have a clear strategy." Apparently, Facebook doesn't have the "feet on the street" to pull off a group promotions and social buying program at scale. The company described its four-month deals efforts as a "test" and went at it with only a limited number of partners signed. But with Facebook Credits, Places, and check-in deals still in place, the company could easily surprise with its next deals move.

Sure, Groupon and its CEO might seem flawed, loud, and messy in the way they go about business, but they deserve credit for ushering in today's crush of digital discounts, and linking small and local businesses, most of which still operate offline, with online consumers.

Going forward, it's anyone's guess as to which daily-deals companies will have staying power. But when all is said and done, consumers are getting deep discounts on products, services, and the like delivered right to their in-boxes. And "merchants are saying it's a good model," according to Andrew Weinstein, Living Social's communications director. "If it works for the businesses and the consumers, then it works for us."

At the end of the day, everyone just wants a good deal.