Groupon’s challenges in China. What does this mean for its Expedia partnership?

In this article, Timothy O’Neil-Dunne and I raise potential issues for Groupon and Expedia in China and ask what it could mean for their travel partnership – if China is in the plans*

Last week, various media reported that Groupon let go a large number of staff and is closing up to 41 offices of its Gaopeng.com joint venture in China.

While it is not surprising a foreign company is experiencing challenges entering China, and Groupon’s PR professionals position its actions as normal strategic adjustments after entering a new market full-bore, the scale and immediacy of Groupon’s actions are noteworthy given that it entered the market with such force and pulled back so quickly.

Its issues may lie in the hard knocks many foreign companies, including Expedia, had already experienced, chief among them underestimating the foreign investor-averse and government forces just underneath the surface-level opportunity of China’s potential market size and support of capitalism-style commerce. The constraints of China’s foreign-investment, labor, and media policies, as well as promising but still immature online and mobile transaction markets – all critical for Groupon – are a few indicators. For other hard lessons, just ask Google and Best Buy.

The seemingly simple, yet complex lesson heard over again? China is different. And though whatever segment of China’s projected US$486 Billion in domestic travel spend in 2014 (source: WTTC), of which US$78 Billion may be online spend (source: iResearch), is attributable to group and/or daily deals, it’s bound to be a sizeable market. And it’s in a land grab that can enable irrational capital investment decisions, just as it is elsewhere.

Which brings us to our Groupon-Expedia-China questions. How does this affect plans for the Groupon-Expedia partnership in China – if there even are plans – and why do we question it?

Well, a number of reasons (though to be clear, our observations are primarily hypothetical for now), including an intriguing mix of Groupon’s challenges and controversial race to IPO, Expedia’s new approach in China and history with partnerships, and the potentially conflicting role of a powerful Chinese investor/partner/competitor common to both Groupon and Expedia.

First, does Expedia-Groupon extend to eLong?
Expedia is a strong brand for Groupon to exhibit on its IPO roadshow as a sign of its travel-related focus and potential, though institutional investors less familiar with the travel industry specifically may not perceive the slow weakening of Expedia’s position in it. And expansion plans for Groupon Getaways from the US to Europe may well prove productive, but how far does the Groupon-Expedia partnership really extend? Does Groupon’s deal include a legally-specified partnership or separate contract with eLong, rather than a general Expedia deal open to interpretation (and potential conflict) later?

Seems a simple question, but with Groupon’s hyper-focus on growth, the complexities of the Chinese market, and Expedia’s perceived history of one-sided partnerships and mixed results with joint ventures, it’s a fair one.

If not, China may never have been part of the deal, even as Expedia expands its commitment to China for the longer term with another sizeable investment into eLong.

Second, what is Tencent’s role?
If you’re not familiar yet, Tencent is one of the three huge Chinese internet powers along with Baidu (investor in Qunar), and Alibaba Group.

With roughly 700 Million active accounts, its recent investment of US$84 Million to buy 16% of eLong gave eLong – or at least its languishing stock price and valuation relative to the well-connected Ctrip – a welcome boost, though its initial spike from $12 to $26 in May has retreated to $18, and market value continues to be a small fraction of Ctrip’s.

Interestingly, Tencent also happens to be Groupon’s primary JV partner in Gaopeng.com.

So on the surface, would this be positive for a Groupon-Expedia partnership in China – if eLong is the legal partner? Would it smooth the way for eLong and Gaopeng to market travel deals through their own sites, and perhaps Tencent’s vast reach itself?

Not so fast…
Tencent also has its own daily deal business through its QQ service, which happens to be the largest daily deal business in China, through one of the biggest internet and mobile properties in China in general.

QQ sample deal page screenshot

So while those 700 Million Tencent accounts, QQ’s reach, and its established mobile commerce base for virtual goods are understandably attractive, how does the nature of Tencents’s JV with Groupon compare to Tencent’s own QQ service, and does it really support Gaopeng?

Rumors (repeat, Rumors – though stated in this Financial Times article), even suggest Groupon has to cut staff and markets because Tencent has slow-played its cash investment into Gaopeng, which apparently does not have a non-compete with Tencent, either.

This could create a competitive conflict with its own investor, though from Tencent’s perspective, such a hedge can be a viable strategy. From Groupon’s, it’s riskier.

Back to travel…
While Tencent’s QQ competes directly with Groupon/Gaopeng, Tencent does not compete directly with eLong and surely desires a piece of the potential travel market due to Ctrip’s capital markets success and to keep step with Baidu’s huge investment of over $300M in Qunar. Tencent had already bought a 30% share of 17u.com.

So while the risk of Tencent’s potential conflict with Groupon does not appear to translate to Expedia, would Tencent allow eLong to market travel deals in China through Groupon/Gaopeng? Or Gaopeng travel deals through eLong?

And if Tencent objects, could Expedia push to honor a commitment to Groupon since Tencent owns only a minority 16% of eLong? Expedia-eLong and Tencent may very well have a good relationship now, though we have seen ventures in China fall apart over far less. If it comes down to it, who holds the real power – Expedia or Tencent?

Experienced foreign investors in China would likely argue the latter, and while Expedia is better positioned than most other OTAs, many in the travel industry observe that its leverage may be declining, largely due to competition – primarily Priceline and supplier-direct – and suppliers’ growing collective pressure on Expedia’s tactics.

Finally…
Expedia’s economic model may also become more compressed after it spins off TripAdvisor to return capital to institutional investors (and Barry Diller), who have long coveted Priceline’s equity return performance. In short, Expedia is becoming more vulnerable and may be more motivated to protect its own business rather than truly value a long-term partnership with Groupon, even if Groupon is providing its most valuable resource to Expedia – the information about its customers and their travel and experiential interests.

In addition, contrary to industry froth about Groupon and LivingSocial, I happen to believe both can truly be transformative for the travel industry – if they can evolve beyond the daily deal model of today. Neither needs an Expedia in the medium or long term, and remember, Amazon didn’t just sell books forever.

For China specifically, this all makes for a pretty fascinating and dynamic situation, where we suspect Expedia-Groupon may face real challenges in getting off the ground. If more concrete information emerges, we will happily adjust our assessment if necessary. Regardless, the entire opportunity may end up moot, of course, if Groupon itself cannot survive in China.

*We need to state that we have not received privileged access or legal insight for our views. It is based on our observations and perspective alone.

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