GroupOn and self-fulfilling panics
Groupon bears a lot of similarity to the subprime mortgage crisis:
Leaving aside the issue of whether GroupOn has an inherently flawed model, what we are left with is a classic example of the Diamond-Dybvig model. In short, you have a feedback system where -
- No one knows how much value is out there in outstanding Groupons. No one has kept track. Groupon is working to improve this, but many Groupons are still tracked by pen and paper or not tracked at all.
- Groupon issues big checks to merchants without any credit check or due diligence. Groupon is taking on a lot of risk of merchants not honoring their obligations. See my earlier VentureBeat story on the challenges that relying on small businesses poses for Groupon.
- It’s impossible to tell with certainty who will owe money to whom if Groupon fails.
- Banks don’t fully understand the risk they are taking on.
- Groupon merchants don’t fully understand the service that they are buying. Groupon is pitched to merchants as a “no risk” way of reaching consumers. There may be no money down, but running a Groupon has a lot of long-term risk, including losing money on poorly targeted customers and damaging your Yelp ratings.
- Much like housing market models that relied on housing prices to continue to grow, Groupon’s model relies on continued revenue growth. With the latest S-1, we saw that once Groupon slows investment in marketing, revenue growth slows down substantially.
for a bank - any rumor of difficulties will create a self-fulfilling panic.
Picture it - if you feel that the bank is unsound, you run to get your money out first (since only the first 10% will get their money back). Since everybody does the same thing, you have an automatic self-fulfilling panic.
The solution for banks was the FDIC - since you now know that your money is assured by the FDIC, you don't rush to the bank to get your money back. In fact, nobody does, squelching the panic.
The solution for GroupOn? Something similar, i.e., they need somebody with large enough pockets to guarantee the major parties involved - the consumers, merchants, and the credit-card companies.
I'm fairly certain that we're not going to have a FGIC (GroupOn Insurance Corp?) anytime soon. What GroupOn could do, however, is buy insurance on this risk - a GroupOn Default Obligation (GDO if you will!). Let the market price this risk - let Chicago bear what Chicago created (for the Econ types out there, the Efficient Market Hypothesis came out of Chicago too). If the insurance is too expensive, then, well, we're back to the original point about GroupOn having an inherently flawed model!
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