Did Zipcar Go Too Far?

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News outlets in Washington, D.C., reported that about halfway through LivingSocial's two-day deal on Zipcar (NAS: ZIP) memberships, consumers had bought a whopping 3,000 memberships. The deal was 75% off the regular price of a membership and $30 in driving credit, which may give investors pause. Are all the new memberships worth the deep discounts' hit to the bottom line? Or is this a brilliant way to gain a leg up on the competition?

Join the club
Wholesale giant Costco (NAS: COST) is a perfect example of how lucrative companies with a membership-based business model can be. Jim Sinegal's company draws nearly all of its profits from membership fees:

Year

Total Net Income

Membership Fees

2010$1.3 billion$1.7 billion
2009$1.1 billion$1.5 billion

Source: Company annual report.

The numbers don't lie. Costco keeps razor-thin margins on the goods it sells, relying on products' low cost to entice customers into buying annual memberships.

Zipcar, however, is no Costco. Right now, Zipcar only generates 12% of its revenue from membership fees; the other 88% comes from car use. Discount deals like LivingSocial's will not do much to drive that number higher in the short term, but if the company can control costs and limit churn year-over-year, that number should grow. In the meantime, the company must encourage all its new Zipsters (hip slang for members) to make use of their memberships.

Zipster forever?
Though Zipcar is the dominant player in the car-sharing business, owning 50% of the market share in North America right now, competition is growing from traditional car rental companies like Hertz (NYS: HTZ) and Avis Budget (NAS: CAR) . These companies are reinventing themselves to fit the car-share model with programs like Hertz on Demand.  

D.C. is one of Zipcar's four major markets (New York, Chicago, and San Francisco are the others), and competition issues here can highlight challenges the company might face on a greater scale nationwide.

Take, for example, parking spots. Zipcar used to be able to rent premium spots from the District for $200 annually. Those days are over; those premium spots now command as much as $3,600 a year. As a result, Zipcar's number of curbside parking spots dropped this summer from 84 in the District to 12. Who was among the other companies interested in bidding for the same spots? You guessed it, Hertz.

Foolish takeaway
If Zipcar wants to continue to dominate, it has to snatch up as much of the market share as possible, as soon as possible. Though it may take an initial hit on its bottom line with this LivingSocial deal, it now has more than 3,000 customers who will probably not sign up with Hertz or a similar competitor in the next year.

Zipcar is humming right along after its IPO this year, but there are more great ideas out there!Click herefor the Motley Fool's special free report "The Hottest IPO of 2011."

At the time this article was published Fool contributorAimee Duffyhas had a Zipcar membership for two years, but shedoesn't own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Hertz Global Holdings, Costco Wholesale, and Zipcar.Motley Fool newsletter serviceshave recommended buying shares of Costco Wholesale, and Zipcar. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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