The truth behind Yelp and Facebook bailing on deals

August 31, 2011: 9:43 AM ET

Conventional wisdoms says the two major sites dropping out of the deal is good for Groupon and Living social. Conventional wisdom is wrong.

FORTUNE -- When Facebook announced that it was ending its experiment with daily deals after less than four months, Reuters, like many, claimed the move "may ease some competitive pressure on industry leaders Groupon and LivingSocial."

Not even close. Competitive pressures are precisely why Facebook is abandoning deals and why Yelp is now scaling back on the feature too. Their exit from the market won't ease anything. There are still hundreds of companies offering deals, and there will likely be more because the barriers to entering the market are very low. That means margins will keep falling. Facebook and Yelp are getting out of what is, for them, a bad business.

That doesn't mean it's bad for everyone, though. There will likely always be a market for online coupons. But the ease of market entry and the fact that most deal services aren't differentiated from each other makes for a toxic combination for companies like Groupon and LivingSocial hoping to dominate the market. Customers have no compelling reason to stick with, for example, Groupon; they can easily go to Living Social or any other such service without losing anything. When Groupon came on the scene, it was called "the next eBay." But eBay works because that's where all the sellers are. With deals, the sellers are all over the place, each of them just a click or two away.

True, Amazon (AMZN) is getting into the game with its AmazonLocal service. But that only proves the point: Amazon is tying its deals alongside its core business by offering subscribers discounts on goods Amazon already sells. That will likely boost the company's revenues and, more importantly, give customers a reason to stick with Amazon for deals. That doesn't mean the experiment will work for sure, but it gives Amazon a distinct advantage.

Groupon, meanwhile, is gearing up for its IPO. It lost $420 million last year and $220 million in the first half of this year. It's hard to imagine how things will get much better for the company as competitive pressures inevitably continue to mount.

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