Can Groupon crack the China puzzle?

February 23, 2011: 4:06 PM ET

The leading daily deals site has everything going for it domestically, but that means nothing when it comes to avoiding the scrap heap other high-flying U.S. Internet companies have been tossed onto in China.

When Groupon China finally, officially, goes live, again, it will have some 1,700 local "tuangou" sites to compete with. Yes, if anything sums up the hurdles Groupon is facing in China, it's that the language of the country it's trying to take by storm already has a single, specific word to describe its business model.

According to Chinese sources, Gaopeng.com, Groupon's local venture with Internet portal Tencent, went live for just 24 hours earlier this month before getting pulled down. Groupon's local staff supposedly jumped the gun, and Tencent "took emergency actions" to shut down the servers, a possible sign that two companies may be in a joint venture, but aren't exactly warm and fuzzy partners just yet.

"Shutting down the web site shows the desire by Tencent to control this venture," wrote the Southern Metropolis, a local Chinese newspaper. "Tencent is sending Groupon a little warning: 'on Chinese turf, you listen to me.'"

For budding Western startups like Groupon, China represents a lot of untapped potential. The country holds 450 million Internet users, a number that will grow to become 42% of all global Internet users by 2014. And according to the Wall Street Journal, the Chinese group-buying search engine Tuan800.com claims such daily deal site transactions will pass $2.4 billion in sales by the end of the year.

"Groupon has a lot of pressure to grow," says Forrester analyst Sucharita Mulpuro, who points to sites like Amazon (AMZN) and eBay (EBAY), which each report that half their revenues come from outside the U.S. "They don't need to be the top player in any international market. They just need to have a presence."

Groupon as Henry Ford

Groupon's first business move into China started with the acquisition of CityDeal last May. The German startup's management was absorbed into Groupon and eventually put in charge of its China initiative, which involves using funds from the company's recent $950 million investment, from Venture Capital firms including Andreesen Horowitz and Digital Sky Technologies (DST), towards hiring up to 1,000 employees by next month. Groupon reportedly offered to pay job candidates as much as $30,000, more than quadruple what its Chinese competitors are paying. The huge wage increase is clearly meant to attract China's brightest to the company, but building a competent staff won't be quite that easy.

In fact, local media outlets have reported that the company's rapid expansion is proving somewhat problematic. (And here it's worth noting that all media in China is state controlled, and likely has interests besides objective reporting of the news to consider.) Groupon's marketing director for the China region, Ren Xin, resigned recently and if the site launch brouhaha is any indication, the company's newly-minted relationship with Tencent could already be souring. Whereas Groupon apparently wants to launch and expand quickly, Tencent seems to prefer a much slower approach.

If Groupon wants to succeed on the Chinese front, it must build a formidable sales-force, like the one it has developed in the U.S. Clearly it intends to meet that goal, at least partly, by hiring those 1,000 employees, but if a recently-posted university jobs posting is legitimate, the company may be placing too much emphasis on academic credentials and consulting experience and not enough placed on knowledge of the local terrain.

"If you hold a Masters degree from an internationally leading university, have working experience from a reputable bank/consultancy, have startup experience, you will be able to join the management team, otherwise we will also find a suitable position for you," reads the post.

Having a strong salesforce, one that's in-the-know when it comes to that up-and-coming restaurant in Shēnzhèn or the cool new lounge in Wǔhàn, is essential, but many of the company's senior managers appear to be foreigners or ethnic Chinese who were born in other countries, thus perhaps lacking that ground-level knowledge that is part of Groupon's magic elsewhere in the world.

Another big concern for Groupon will be ensureing that local companies are legitimate. While content censorship is strictly enforced in China, business practices aren't. Big, effective organizations like the Better Business Bureau, which gather information on a company's transactions and report fraudulent activity, do not have Chinese equivalents, says analyst Mulpuro. Many smaller businesses operate illegally in some way, an issue that most recently came to a head when Alibaba.com CEO David Wei and COO Elvis Lee resigned over controversy that some 2,000 small-business vendors had defrauded Alibaba's customers, with the help of around 100 Alibaba employees.

Once Groupon has a sales-force in place and its staffers develop relationships with local businesses, the party will just be getting started. Groupon will then be running up against that tuangou competition. Sheer quantity of competition aside -- including Meituan, reportedly backed by Sequoia Capital – a number of competitors have vowed to make Groupon's Chinese expansion as difficult as possible. In mid-January, according to Chinese media reports, the heads of several local sites including Lashou.com, Manzuo.com, and Ftuan.com held an emergency meeting and formed a defensive alliance, declaring Groupon as their biggest rival due to its huge cash reserves and Tencent partnership. One of the harshest stipulations they agreed upon was to never hire a former Groupon employee, in an attempt to negate the high salaries Groupon is offering new hires.

There are other practical issues to consider, like how to build an effective email database of users when so many Chinese citizens use numerous aliases, or deploy an online payment system for a country that still pays predominantly with cash. It's obstacles like these that may have led Google China co-founder Alan Guo to Twitter about what he saw as Groupon's arrogant Western attitude, and predict that the venture would likely fail.

If Groupon did fail in China, it certainly wouldn't be the first company to do so. Groupon would just be the latest in a long line of Western companies -- like eBay, Yahoo and Google -- to make a spectacular, troubled exit from the white-hot Chinese Internet scene.

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About This Author
JP Mangalindan
JP Mangalindan
Writer, Fortune

JP Mangalindan is a San Francisco-based writer at Fortune, covering Silicon Valley. Since joining in 2010, he has written on a wide array of topics, from the turnaround of eBay to the evolution of net neutrality. A graduate of Fordham University, Mangalindan has also written for GQ, Popular Science, and Entertainment Weekly.

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