Why Groupon Is Another Webvan

Groupon (NASDAQ:GRPN) looks like a grand experiment that is quickly going bad. Yesterday the company’s stock plunged 17% as a result of a restatement for its fourth quarter. Because of a surge in returns of its vouchers, revenues had to be reduced by $14.3 million, to $492.2 million, and the loss increased to $65 million, up from the original $43 million. The company also noted that there was “material weakness in its internal controls” for 2011.

According to a report in the Wall Street Journal, the Securities & Exchange Commission is looking into the matter. Of course, a slew of law firms are circling Groupon.

But the company’s accounting problems are not the real issue. Instead, Groupon’s business model is fatally flawed. Groupon looks like a Frankenstein monster that’s out of control.

Webvan’s Scary Example

Of course, this isn’t the first time this has happened in dot-com land. Webvan attempted to revolutionize the grocery business in the late 1990sby offering customers same-day delivery based on a sophisticated distribution system. Webvan had a cornucopia of offerings, such as hand-cut meats, fresh fish and live lobsters, chef-prepared meals, fine wines and premium cigars. And shipping was free for orders over $50.

Webvan had a top-notch management team. Chairman Louis Borders was the founder of Borders Books and a mastermind of logistics. The CEO was George Shaheen, who was formerly a managing partner and leader of Andersen Consulting.

Webvan also had the backing of several of Tier 1 investors, including Softbank, Sequoia Capital and Benchmark.

So why did Webvan file for bankruptcy within about two years of its IPO? Many reasons:  Webvan needed to change ingrained consumer behavior, which meant spending huge amounts on marketing. The company also had to spend substantial amounts on its infrastructure.

Webvan also grew at a tremendous pace. So as demand failed to meet its highly optimistic projections, the company quickly ran out of capital.

Runaway Growth

The Webvan case is a far from perfect comparison with Groupon. But there’s perhaps one common theme: the perils of hypergrowth.

From 2009 to 2011, Groupon’s revenues went from a mere $14.5 million to $1.62 billion. During this time, the company hired more than 10,000 employees and built operations in 44 countries.

When an organization expands at this kind of pace, it’s inevitable that problems will emerge. Perhaps the biggest is bloated costs. Is it really possible to develop an efficient platform? Probably not. There’s simply not enough time.

Another big issue is that hypergrowth usually requires entering new markets, which increases the complexity of an organization. Already Groupon has been moving aggressively into small-business services as well as high-priced vouchers, such as for Lasik surgery. However, the company’s generous refund policy could mean taking a hit from returns. This is a serious obligation for which Groupon has provided little transparency.

At the same time, the company faces growing competition. Some of the biggies include Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG) and LivingSocial.

It’s true that growth is not necessarily a bad thing. Hey, it’s key to good investing. Zynga (NASDAQ:ZNGA) and LinkedIn (NYSE:LNKD) have found ways to manage it.

But it appears that Groupon’s growth has hit unmanageable extremes.  As environmentalist Edward Abbey once said: “Growth for growth’s sake is the ideology of the cancer cell.”

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook,” “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.