Groupon's Coupons Become the New Advertising Model

In just two years Groupon has become one of the fastest-growing companies on the Web. And the amazing thing is that it all kind of happened by accident. Andrew Mason, the 30-year-old guy who started the company, built a Web site in 2007 called The Point, where people could join forces and work together for causes they cared about. But Mason noticed that some were using his site to form buying groups and get discounts on products. That's when the lightbulb went on in Mason's head. In 2008 The Point pivoted to become Groupon, a site that is on track to generate as much as $500 million in revenue this year, according to a Morgan Stanley report.

For the uninitiated, here's how Groupon works. It finds a merchant in, say, Boston— a nail salon, perhaps —that will offer a 50 percent discount on a manicure-pedicure, but only if at least 100 people sign up. Groupon broadcasts the offer to its subscribers in Boston, and rounds up the participants. For its matchmaking services, Groupon gets half of whatever revenue the merchant brings in. The numbers in this example are hypothetical; discounts vary, and so does the cut that Groupon collects from merchants. But on average, merchants end up collecting only about 25 percent of what they would normally make, since they cut their price in half and then give up half of what they collect. Yet merchants are falling all over Groupon because they view these deals as a new form of advertising, one that has a very big advantage over the old-fashioned kind: it actually works.

Mason didn't set out to reinvent the advertising business. But almost by accident, he's solved the puzzle that's had lots of people—ad executives, publishers, and even hotshot Web companies—scratching their heads. At some point it became clear that traditional advertising doesn't work on the Web. That's why advertisers won't pay very much for online ad space. It's also why old-guard media companies are in such trouble, and why even newcomers like Facebook can't demand very high rates for ads. What needs to change is the nature of advertising itself. That business hasn't really evolved since the days of Don Draper. Facebook and Twitter have talked in fuzzy terms about inventing new ways to reach consumers, but so far they have failed to come up with anything revolutionary.

You get the sense that the Groupon guys can't really believe what's happening to them. Four months ago, Groupon had 13 million subscribers; today the number is approaching 30 million. And the company, which last year had about 100 employees, mostly in Chicago, now has 2,900 people in 31 countries, delivering deals in 300 markets. "It's pretty mind-boggling," says Rob Solomon, a Silicon Valley veteran (he worked at Yahoo and later as a venture capitalist) who joined Groupon as president and chief operating officer earlier this year. "Very few companies have scaled like this."

There's no special technological wizardry involved in what Groupon does. For that reason, hundreds of copycats have popped up, including one in China that calls itself Groupon and designed its Web site (Groupon.cn) to look al-most exactly like Groupon.com. Solomon says Groupon has the advantage of being first in the market and bigger than its rivals. Just as Amazon dominates e-commerce even though there are hundreds of other e-commerce sites, so Groupon can dominate the space it has created, he says.

But won't Groupon have to slash its take on deals in order to keep winning merchants away from other group-buying Web sites? Won't merchants get sick of giving up half the revenue from Groupon offers? And when that happens, won't Groupon's margins take a hit?

Solomon insists that competition isn't hurting his business. "In fact, it's quite the opposite," he says. One way Groupon hopes to gain an edge is by using software to learn about its members, so it can deliver more relevant offers: my wife will get the -manicure-pedicure deal, but I'll get an offer on fly-fishing lessons. The key now is execution—delivering great customer service and keeping everybody happy on both sides of the transactions.

Perhaps the most remarkable thing about Groupon is that this opportunity was staring all 0f us right in the face—at least those of us who are old enough to remember getting a Sunday newspaper that was actually printed on paper. Coupons?! Good grief.