Are cracks starting to show at Groupon?

Last week wasn't a good one for Groupon. On February 6th, the company launched a series of television ads (its first) on the Super Bowl broadcast in the U.S. The ads started by describing some major problem (the situation in Tibet, deforestation in the Amazon, or threats to whales) and then turned into a pitch for a great deal at a restaurant, a salon or a boat trip. They were intended to be funny, but they ended up offending many viewers. Company CEO Andrew Mason defended the ads on a company blog, but said that their endings would be changed to put more emphasis on the problems that the ads were supposed to be about. However, rather than pulling the original ads until the revised versions were ready, Groupon continued to run the original ads, and the complaints continued. Last Thursday, Mason announced that the ads would be discontinued entirely.

The same day that Groupon called it quits on its television ads, it ran a deal with FTD, a flower distribution service in the U.S., offering $40 worth of flowers for $20. According to CNNMoney.com, almost 3,330 people took the deal, which required them to purchase the flowers through a special Groupon/FTD website. The problem was that some customers compared the prices found on the Groupon/FTD site with FTD's own website, and learned that the prices for the Groupon promotion were marked up anywhere from $10 to $20 more than they were on Groupon's own site, meaning that the Groupon deal offered little or no discount from the true prices.

In addition, some buyers found that the flowers wouldn't be delivered until February 15th, the day after Valentine's Day. Groupon and FTD were forced to rescind the deal, agreed to refund money to any customers who wanted it, and offered the discounts on the prices of flowers on the FTD.com site, not the Groupon/FTD site, for those customers who still wanted the deal.

Groupon's portrays itself as a fun company, but the "fun" might be disguising a level of immaturity on the part of the company's top managers. This is certainly not the first time that a startup has made highly public mistakes. Facebook is a prime example of repeatedly making gaffes (intentional or otherwise) when it comes to its users' privacy. A few years ago, Amazon was caught offering different prices on the same products to different customers, and was forced to both change its pricing policies and refund the difference to customers who purchased at higher prices.

However, while Amazon's Jeff Bezos was decisive in taking responsibility for the company's pricing gaffe, Groupon's Mason looks wishy-washy. Take the ads: First he denied that there was a problem, then said that the company would change the ads (without actually doing so), and then he withdrew the ads. Or consider the FTD situation: Did no one within Groupon take the time to compare the prices listed on the Groupon/FTD site with FTD's own site to make sure that customers would get the deal they were buying? Or did Groupon know that the prices on the Groupon/FTD site were marked up and figured that customers wouldn't know the difference?

Looking at Groupon's rapid growth, it's beginning to look like an engine that's revved up so high that parts are flying off. Problems like the ones that Groupon had last week are "red flags". The company should learn some lessons from its gaffes, and consider bringing in more experienced managers to prevent them from happening again.

Is Groupon subject to network effects?

As virtually everyone with a computer knows, Groupon turned down Google's acquisition offer, said to total $6 billion, last Friday evening. Parties who claim to have been close to the negotiations say that Groupon didn't want to risk its culture as part of Google, and that the company believes that it's following in the path of Facebook, which turned down several acquisition attempts. (For that matter, it's following in the path of Google, which tried to sell itself to Excite in 1999 for $1 million, without success.)

Critics of the Google/Groupon deal say that it's easy to create a "daily deals" service, and in fact, there are dozens of them in the U.S. alone. The technical barriers to entry are very low. The same was true in the 90s, when eBay became the dominant Internet auction site. There were dozens of other auction sites, some of which focused on vertical niches, and others that took eBay head-on. However, eBay became dominant because it took advantage of network effects, where the value of a product or service increases as the number of people using it increases. (Bob Metcalfe argued that the value is roughly the square of the number of users.)

In eBay's case, as more people used the service and more people posted products for sale, it generated a "virtuous circle" that made it more popular and gave users ever fewer reasons for using other auction sites. Groupon, however, is a different animal. Most Groupon users don't go to the site to find deals; instead, they get daily deals via email. Groupon's value comes in cornering the market for daily deals, and there are simply too many retailers out there for that to happen. Even Groupon realizes that it can't add enough salespeople to grow its business fast enough, so it's implementing a service that enables merchants to post their own deals.

Groupon may get to the point where consumers no longer pay attention to other daily deals and merchants no longer bother to post deals with other services, but it's not there yet and may never get there. That doesn't mean that Groupon won't continue to grow and won't be successful enough to eventually IPO, but it does mean that the "low barriers to entry" argument is credible. It's far too early to say whether Google dodged a bullet or Groupon made a brilliant decision, but either way, Groupon is no eBay.

Episode 5 of the Feldman File videoblog is live!

This week's episode of the Feldman File videoblog is live on YouTube! If you can't see it here, click here to view it in your browser. Here are the stories in this week's show:

• Google's $6 billion offer for Groupon is rejected, but it acquires DRM specialist Widevine
• Verizon Wireless fires up its LTE broadband network and launches its first devices
• Comcast extends its agreement to acquire NBC Universal and contends with complaints from Level 3 and Zoom Telephonics
• Adobe releases the first beta of Flash Player 10.2
• The U.S. Justice Department is forced to drop charges against an accused Xbox 360 modder
• Flipboard adds HTML5 support and advertising

Go where the talent is

TechCrunch wrote today about two companies opening new geographic outposts: Facebook is planning to open an engineering office in Seattle, and Chicago's Groupon has acquired mobile application developer Mob.ly, which is currently based in San Francisco, and will move it to a new Groupon Silicon Valley office in Palo Alto. In Facebook's case, the company is probably looking to tap into engineers that work at MySpace's Seattle offices, as well as talent from Microsoft and Amazon. Groupon's CEO Andrew Mason made it clear that has company has had difficulty getting talent to relocate to Chicago from Silicon Valley, so Groupon will go where the talent is.

Opening up satellite offices is hardly a new tactic; Google has had a Chicago office ever since it purchased Feedburner, and has large operations in New York, Pittsburgh and other cities. Microsoft's Silicon Valley engineering center is in Mountain View, a couple of miles from the Googleplex. Amazon's A9.com search engine operation is headquartered in Palo Alto, and it designs its Kindle hardware at its Lab126 in Cupertino, not far from Apple's headquarters. The point is that all these companies found it easier or more cost-effective to find the talent they needed in cities other than their headquarters.

You don't have to have a billion-dollar valuation to play at this game. Chicago's 37signals is perhaps one of the best at using virtual offices to get the talent it needs without relocation expenses or physical offices. Probably half of 37signals' team is scattered across the U.S. and Europe; they use the company's own tools to communicate and keep in sync.

VCs often demand that startups relocate to Silicon Valley, New York or Boston so that they can be close to investors and talent. However, it's far more cost-effective to create outposts where the talent is than it is to move everything to a region that quite often has much higher costs of living and doing business.