3 Things to Watch With Groupon

Can it get better for Groupon (NAS: GRPN) ? The daily-deals pioneer has been one of 2012's worst investments, but investors are beginning to see signs that the company is repositioning itself. Groupon's future is, to say the least, a little murky -- but answering a few key questions would go a long way toward clearing up the haze. Let's take a look at three big issues facing Groupon now, and maybe we can start to see its future more clearly.

1: Can daily deals work in a crowded marketplace?
Groupon was really the first company of its type, but any seemingly successful niche never stays lonely for long. Internet giants Google (NAS: GOOG) and Amazon.com (NAS: AMZN) are now competing in basic daily deals, and there are plenty of private and sub-niche (think travel) companies doing essentially the same thing. As things get crowded, margins drop. Groupon's gross margins have been contracting for a long time, even as net income finally trends into positive territory:

GRPN Revenue Chart
GRPN Revenue Chart

GRPN Revenue data by YCharts

The primary barrier to entry to daily deals isn't technology; it's marketing. Groupon's insane employee growth rate was built almost entirely on an expanding web of salesmen, who sold small businesses on the benefits of Groupon and thus established a local presence from which to sell deals.

The Google and Amazon brands are undeniably stronger than Groupon's in the public consciousness, which should (at least in theory) allow the two companies to attract better deals with less legwork. The increasingly public negative backlash against Groupon promotions should also have the long-term effect of winnowing down the small businesses that continue to work with daily deals. My Foolish colleague Dan Newman recently pointed out that many small businesses suffer declines in their Yelp (NAS: YELP) ratings when running Groupon promotions. Some business owners may decide the long-term reputation hit is simply not worth a Groupon-generated boost in traffic.

Will Groupon be able to maintain profitability as competition intensifies? Perhaps, if there's enough growth left. That leads us to the second issue.

2: How much more growth is possible?
Growth estimates for 2013 expect Groupon's bottom line to grow by triple digits, but next year's revenue is expected to grow by only 20%. That's a good sign in the short term, as many bears doubted that Groupon might be able to improve its margins. Margins can't increase forever, so when will Groupon be "mature"? The same problems plague Facebook, which was already suffering declining growth rates when it went public.

Between competitive pressure pushing gross margins down and market saturation pushing growth rates down, Groupon looks set to smack into a growth wall sooner rather than later. To overcome that problem, we look at the final issue.

3: Can Groupon diversify effectively?
Groupon's already moving into a new niche with Groupon Goods, an online retail operation that puts it in direct competition with (who else?) Amazon. If Jeff Bezos didn't have a bull's-eye on Groupon before, he probably does now. Shareholders already have to contend with potentially dodgy accounting regarding the retail segment, which is a pretty inexcusable fumble from a company that's been dogged by accounting problems since its IPO filing.

Accounting issues aside, does Groupon really think it's wise to go head-to-head with not only Amazon, but also deep-discount money-loser Overstock.com (NAS: OSTK) Did Groupon not learn its lesson from all those cautionary tales of small businesses losing their shirts by selling Groupons for things (maybe their shirts) for what amounted to a quarter of their normal price? If you want to know what happens when you run sales all the time, look at Overstock. Its bottom line finally poked its head into positive territory a few years ago, but it saw its shadow and went back into hibernation. Going up against Amazon with sale items isn't going to work.

I don't doubt that there are ways to diversify. Many top tech companies have. However, Groupon Goods doesn't look like the best way to do that. What else is up CEO Andrew Mason's sleeve?

Amazon might hold more sway over Groupon's future than anyone else, thanks to its position in daily deals and its online retail dominance. Stay on top of Jeff Bezos' next big move with the Fool's premium research service. It might not be as fun as a half-off spa treatment, but it's a whole lot more valuable. Subscribe today.

The article 3 Things to Watch With Groupon originally appeared on Fool.com.

Fool contributorAlex Planesholds no financial position in any company mentioned here. Add him onGoogle+or follow him on Twitter,@TMFBiggles, for more news and insights. The Motley Fool owns shares of Amazon.com and Facebook.Motley Fool newsletter serviceshave recommended buying shares of Amazon.com, Facebook, and Google. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days. The Motley Fool has adisclosure policy.

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