.The Achilles’ Heel of Gilt & Groupon: Long-Term Volume

I would expect any reader here would know about the two red hot new categories on online commerce – private product sales and group coupons – both becoming very popular by offering time-sensitive deep discounts to large Internet audiences. Gilt Groupe and Groupon are respectively the best known in U.S., but grand-daddies like France’s Vente-Privée towers over Gilt, and new competition is coming on fast and fierce. The growth in these sectors is for good reason. These models generate a huge amount of upfront revenue for the provider who only later pays the actual manufacturer or service provider their cut.
But the success of these business will also be their Achilles’ heel. There’s a rumor (I have not been able to verify) that Todd Sawicki found the news that Gilt Groupe has been so successful at selling top-notch unsold clothing inventory that the well items intended for retail is drying up. It’s said that They are doing direct deals with manufacturers to produce lines explicitly to be sold on Gilt. It is estimated that 35-40% of Gilt’s women’s clothing sold will have been acquired direct from producers, even though the implication is that everything is high-end liquidized inventory. While it’s a great score to buy a $2,000 suit for $380, it’s another to buy a good looking, but poorly made $380 suit for $300 dollars. People on the private sales sites are not there to get decent deals on low and medium quality goods, they are there to get great deals on high quality goods. When the quality drops, so will the customers, when the realize they could get the same item’s elsewhere at the same price without being forced to make the purchase in the site’s short time frame.
Silicon Alley Insider did some good comparative research on other companies (such as overstock.com) selling unsold inventory at deep discounts. Since these businesses were all premised on relieving markets of excess inventory, they all bump up against a very firm ceiling once excess inventory is gone. This isn’t to say they aren’t great businesses, they are, but it does mean it will be very hard for Gilt to have enough inventory to match the demand it creates. Add to this equation there presence of 5 or more fast-follow competitors in almost every vertical and we should expect to see quickly shrinking margins as newcomers bid up what’s left of the inventory.
For the coupon sites there is a different but similar Achilles’ heel related to volume. At first I was stunned that businesses were offering services at 25%-33% of retail cost, and moreover making this offer to hundreds or thousands of people. These are local businesses not factory production lines. More customers mean more work. Detailing a car, whitening teeth, or giving helicopter lessons does not get cheaper because you suddenly have 500 new customers. In many ways it gets more expensive because you’re obligated to service huge volume over a short period. But businesses aren’t doing it tactically to increase short term sales, they’re spending marketing dollars to land long-term customers at a short-term loss. This is reasonable (if they actually on top of their marketing/ROI game), but makes it very unlikely they’ll make such an offer again now that they’ve built a huge new pool of leads.
In this very forthcoming review by a helicopter pilot training schools the problem is made quite clear. The school wanted to do a Groupon as a marketing campaign to get more student. They certainly got people’s attention, but likely too much. They are now obligated to give 2,400 introductory lessons at such a cheap price the instructors have to do them all voluntarily. One can assume it will be a very long time before they agree to doing another Groupon, and when word gets out other businesses might try and estimate the true cost in advance instead of listening to a pitch that says “how could you lose by getting more customers then you can handle”. So like Gilt and the private sellers, the success of Groupon and the coupon sites means they are draining a pool they can’t refill.
It will be very interesting to watch. Will these businesses be able to adjust their models to allow for reduced short-term sales, but ensure their long-term success? Will hyper competition make this a race to the bottom and if so, who will get caught holding the bag? The start-ups? The companies that acquire them? The companies that give them their inventory?


.
.
.
.
.
.
.



.

.