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Merchants think socially, act locally

The newest trend in e-commerce: Social media meets local networking.

Social commerce site Groupon offers daily deals to nearly two million subscribers in 27 U.S. cities.

When David Morton, owner of the Pompei chain in Chicago, signed up with an Internet startup to offer a coupon online, he expected to sell a few thousand at most. Instead, during the 24 hours the coupon was posted on November 22, more than 9,000 local consumers purchased an offer that got them $10 worth of pizza for $5.

The coupon was an all-time sales record for Chicago-based Groupon, a hot startup that brings the buying power of the masses to the social web. After launching with local merchants in its hometown one year ago, Groupon today offers deals to nearly two million users in 27 cities in the U.S. including New York, Charlotte and Austin.

Here’s how it works: Groupon sends a daily email to subscribers with a deal, or “Groupon,” for a local business or event, like a salon, restaurant, class or concert. If they want in, users then sign on to Groupon’s site to pay by credit card and have a year to redeem the coupon.

Before “the deal is on,” however, a minimum number of users must agree to buy. This spurs buyers to post the deal to social networks like Facebook and Twitter (or go the old-fashioned route: email) so the quota will be met. Many of Groupon’s offerings also tend to be social in nature, like attending a class or an event or checking out a new restaurant, making them ideal for rallying Facebook friends.

“Groupon layers nicely on top of the social graph that’s developed over the last few years,” says Groupon CEO Andrew Mason.

The site shows nearly one million Groupons sold, claiming to have saved users over $42 million. The company, which takes a cut of the deals it sells, is profitable and predicts revenue of $100 million over the next 12 months.

Investors get their Groupon

These numbers caught the eye of exalted venture capital firm Accel Partners, which led a $30 million investment round with New Enterprise Associates, announced last week. The infusion will go towards hiring, investing in technology, growing the customer base and expanding geographically.

Accel, an investor in Facebook, doesn’t need to be convinced of the social web’s potential: Another portfolio company, Playfish (it makes “social games” for Facebook and other social media platforms) last month sold to Electronic Arts (ERT) for $400 million.

“We’re in the middle of another transition, of search to the social web,” says Accel’s Kevin Efrusy. “Just as Google [through its search business] enabled a whole new crop of businesses, the social web is enabling a lot of things that just weren’t possible before.”

Groupon’s model is appealing to investors in part because of is its operational efficiency. There is no need for inventory or shipping–users simply print the Groupon and take it to the vendor. And unlike other group buying sites, because most of the offers are services or experiences, there’s a nearly unlimited supply. (Some offers do need to be capped though, as Mason experienced when the company sold 4,000 Groupons for a nail salon with only two technicians, which was booked solid for months after).

Groupon might not the best idea for impulse buyers on a budget. But much of what the site offers are things you might do anyway: get a haircut, go out to eat, attend a sports events. And Groupon claims a high threshold of quality. “We knew that if we did bottom of the barrel, that would be self-fulfilling, we would be bargain basement, cheap stuff site,” says Mason, referencing past Groupons for James Beard award winning-restaurants and the Art Institute of Chicago.

Word-of-mouth, Facebook-style

For all Groupon’s promise and buzz, it’s still early days for the space and not everyone is convinced. Forrester analyst Nate Elliott points out that buying clubs and word of mouth marketing have been around for years. “Look at Avon, Tupperware, Amway—these are five to ten billion dollar companies. Marketers have long understood the power of influence marketing.”

But Groupon’s advantage seems to be its ability to harness the power of local communities online. “Groupon really cracked the code because they realized it was about local business,” explains Efrusy. “Local has been difficult to make money on since beginning of the Internet. How do you find out about yoga, a hair salon, a spa? Word of mouth.”

In addition to being an untapped source of ad revenue, local businesses are an attractive target for Groupon because they are highly relevant to users, who enjoy discovering new places and events in their hometowns.  This also helps create the perception that Groupon’s deals are more about content and information, rather than advertising.

“We’ve been a Chicago institution for 100 years, but we thought this was a way to reach new customers,” says Pompei owner Morton. “It’s much more powerful and direct than traditional media.”