In Local, Google And Groupon Are Now Competing For The Same Dollars

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Was Groupon crazy to turn down Google’s $6 billion offer, or will it be worth several times that amount a few years from now? Of course, it is impossible to know right now. But if the recent acquisition dance between Google and Groupon tells us anything, it is that local advertising is going to drive a huge amount of growth on the Web—and that it is not going to look like other forms of online advertising.

Google wants to buy Groupon not just for its phenomenal growth—Groupon is selling coupons for local merchants at a rate of $2 billion a year now—but also because Groupon follows a pay-for-performance model. Groupon only makes money when somebody buys a coupon, just like Google only makes money when somebody clicks on an ad. Groupon has cracked the code for getting local businesses to spend marketing dollars online. And increasingly, those businesses are going to choose between spending those dollars on Groupon versus on Google.

You might not think of Groupon as an advertising company, but the way most merchants rationalize offering such deeply discounted deals (typically 30 to 50 percent off) is they treat it as a marketing expense. It is a proven way to get new people into their stores, spas and restaurants. Maybe they lose money that first visit, but it is the cost to gain a new customer. Those dollars come out of their marketing budgets, which are often tight.

When it comes to local businesses, Google and Groupon are competing for the same dollars, and they are both trying to steal dollars from the yellow pages, billboards, and newspapers. The tens of billions of dollars spent in local offline advertising dwarfs the amount spent online. To the extent that a local business is advertising online at all, it can buy search keywords or it can entice new customers by offering them discounts through Groupon. This new form of online-to-offline advertising is really catching on and Google wants to have its hand in all online advertising. Local could be a huge growth area for Google.

The key to this business, however, is who controls the inventory of deals. Groupon generates these deals through its large local salesforce, distribution partnerships with other sites, and now also by letting businesses create their own self-serve deals. The more inventory of deals it can control and generate, the more ways it can figure out how to distribute these deals. (Imagine a future local ad network for mobile apps filled with Groupon offers, as just one example).

Of course, Google can introduce its own daily deal ad units, and hire a few thousand local sales people to drum up the deals, or just make it all self-serve—probably for a lot less than $6 billion. But it would take time, and Google might not get it right.

Meanwhile, Groupon will keep growing, along with the hundreds of clones following in its wake. You would think with so many clones, this would be a very competitive market, but there really aren’t many meaningful players. Even the gap between Groupon and the No. 2 daily deal site, LivingSocial, is significant—Groupon is at least two to four times as large.

The question is: How big can it get?

Logo illustration by Sean MacEntee

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