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Bear of the Day: Groupon (GRPN)

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In the science of Biology, the relationships between different organisms are described as “symbiosis” - and there are three major types.

There’s Mutualism, in which two organisms have a relationship that benefits them both – like a bee that eats pollen and a plant that gets pollenated by the bee. The classic “win-win.”
There’s Commensalism, in which one of the organisms receives most or all of the benefit from the relationship, but the other is not harmed by the interaction. It’s basically a free-ride for one side of the arrangement.

Finally, there’s Parasitism in which one organism actively causes harm to another organism for its own gain. Generally the best strategy for a parasite is to limit the harm being caused enough not to kill the counterpart – so that it can continue reaping the benefits of the damage it’s causing without having to find another victim.

(Geeky side note: many scientists break down relationships even further and come up with 4, 5 or even 6 variations on symbiosis, but for our purposes, these three main types will suffice.)

These same types of symbiosis also sometimes accurately describe the relationship between business entities.

Obviously, most commerce is Mutualism in which one company supplies goods or services that are necessary for another company to create their own goods and services. Apple (AAPL - Free Report) didn’t manufacture most of the parts for that iPhone in your pocket – that would be overly complicated and inefficient. Instead they bought them from hundreds of other companies that have specialized in producing the individual components.

It’s a mutually beneficial arrangement and it truly benefits everyone involved – including you as the consumer.

There’s a popular economic argument that advertising is more like commensalism. If one company in an industry advertises, their competition is forced to do the same and they both end up paying a bit extra to advertising firms to sell goods and services that consumers might well have found on their own anyway.

That relationship quickly descends into parasitism when Groupon (GRPN - Free Report) is involved.

Launched in Chicago in 2008 – but quickly expanding to cities all over the world - Groupon’s bread-and-butter business is to negotiate with small businesses to offer electronic “deals” to customers who pay ahead of time in order to receive discount prices.

Groupon doesn’t disclose all of the exact terms of the agreements it has with merchants, but typically, the merchant offers a product at about half of it’s normal price and the merchant and Groupon splits that money 50/50.

Just a little quick math will tell you that in that arrangement, the merchant is netting only 25% of the normal sales price of their product. The concept is that those customers will end up buying more than just the “deal” product and/or become regular customers who come back again and again and pay full-price.

Virtually every business is seeking to attract more customers, so the Groupon premise can be very attractive, delivering a large number of new people to the store.

In reality, that hasn’t been the experience of many small businesses. There are myriad tales of small operations that run a Groupon deal, only to find themselves temporarily flooded with new customers buying goods and services below cost, but who never buy anything else.

Here’s the parasite aspect – let’s assume that supply and demand for a given product are basically constant and that there are two merchants who sell it. One of them runs a Groupon deal and sells something that normally costs $100 for $50 – and then gives $25 to Groupon. During the deal period, that merchant significantly increases market share.

The only rational choice would be for the other merchant to do the same thing – run their own deal and try to win back lost market share. Once again, Groupon gets paid $25/unit. Customers temporarily get a lower price, but unless the merchants were earning 300% gross margins prior to the sale, they’re losing money, so they won’t be able to hire new employees, make capital improvements and make a profit that they themselves could spend on other things.

The Groupon deal didn’t change the variety or quality of goods and services available. It simply facilitated trade at a lower price while earning Groupon a nice chunk of the money that was spent. From a societal standpoint, it’s parasitic.

Even before the recent pandemic forced the closure of most of Groupon’s would-be customers, merchants were already shunning the pay-for-deal model because it’s simply not sustainably profitable for them. Groupon shares have steadily declined from a split-adjusted high of over $500/share shortly after going public in 2011 to just $18.69/share on Friday.

(A 20-1 reverse split earlier in June took the nominal share price up from the $1 level.)

A huge shakeup in the boardroom, 2,800 layoffs and an ominous SEC filing detailing the significant uncertainty in future results related to Covid-19 shutdowns have the share price and earnings estimates tumbling once again.

There are companies like (JD - Free Report) and Ebay (EBAY - Free Report) – both Zacks Rank #1 (Strong Buy) stocks – who facilitate transactions in a mutually beneficial way. They’re doing quite well in the shutdown environment. Then there are parasites who can’t figure out a way to avoid killing the host. Those stocks should be avoided at all costs.

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