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Groupon’s Struggle: A Lesson On Chinese Market Cycles

2011 was a pretty intense year for the E-commerce industry in China. A total investment amount of US$4.6 billion in the industry accounted for 92 public investments. In just one year, this amount is more than 2 times that of total investments in the 5 year period of 2006-2010. The rapid consumerism and growth in E-commerce also fueled traditional brands such as Suning, Guomei to step out and extend their presence in the online arena. Interestingly, 80% of this total investment went to firms providing B2C services.

Groupon Cheers, Tuanbao Nowhere Near

This morning (9th Feb, Beijing time), Groupon announced their first post-IPO financial report for the fourth quarter of 2011. Revenue in 2011 Q4 was US$506 million, a growth of 194% compared to the same quarter in 2010. Net loss was US$42 million, a stark improvement from 2010 Q4’s net loss of US$379 million. Groupon’s performance in Q4 was better than expected, especially when quite a lot of attention was given to speculations on the potential consequences of its IPO late last year. Based on Groupon’s 2011 Q4 performance, a common stock shareholder would have just made a loss of US$0.08 for each share that he held when the market closed for the year.

Back in China, the group buying market continues to shrink in numbers, from 6,000 firms at its peak in mid-2011, to about 2,500 firms left standing. Public and investors’ confidence in the industry is also far from encouraging. Many investors are now unwilling to take risks to invest in the group buying market. China’s Tuanbao (not to be mistaken as Groupon’s division in China) is one of the top 10 group buying firms by revenue in China, and it has been plagued by financial troubles of late. Just a day ago, employees have only received their pay for the month of Dec’2010, with many other merchants of Tuanbao still awaiting their delayed payments. Analysts commented that Tuanbao spent too much on advertising, and was seriously lacking in efforts to retain their customers. In 2011, an amount of US$87 mil was spent on advertising only, and they are not alone.

Pace of the Chinese Market

The Chinese market moves extremely quickly. One of the common tactics Chinese companies, especially bigger players, constantly engage in – is to force competitors out of the market. The cycle that can be observed at least for the group buying market is this. Firms enter the newly created market, and the market will experience exponential growth in the number of firms providing similar services within a short span of weeks. Firms start getting investments, and the race to gain market share begins. One bigger player decides to escalate competition and pressure others to exit, by spending massive amounts on advertising. But at the same time, other players follow suit, and the market is now engaged in robust competition, causing the industry boom that we have all witnessed.

Eventually, the expansion becomes too rapid, resulting in job cuts, delayed IPOs, less investments and shrinking market numbers. The intense competition also means that profit margins are decreased. With profit margins of about 40% for US group buying firms in 2011, the corresponding profit ratio of 10% earned by their Chinese counterparts seem somewhat meager.

Looking ahead

Previously, we discussed the need for firms to diversify. Something has to be done to stay relevant; be it raising prices or cutting down on costs, which firms such as Amazon have started practising.

Yes, China is definitely a hotbed for startups and investors – this market is too exciting to be missed. Investors are aplenty, and they play significant roles in the rapid growth of the market. However, as in the case of Tuanbao, once the investment bubble in the group buy scene had burst, even relatively larger firms started having cash flow problems and now face a potential exit. Who’s next in the line?

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