Crowds are growing for Groupon's discounted offerings.

“Bubble or no bubble?” That’s the question being asked about Groupon given its expected $20 to $30B stock valuation. Two and one-half year old Groupon is the pioneer of daily discounts for members from local service providers. Its revenue from 83 million users across 43 countries surged in 2011 to $644M just in its first quarter, versus $44M for the same quarter of 2010. Despite this rapid growth, it’s in the red.

Groupon reminds me of a hearty perennial bulb, bound to break through the crusty earth come spring because its time has come. Increasingly powerful purchasing agents have pounded B2B suppliers for discounts since the 1980s. Big-box retailers have demanded excruciating discounts from consumer goods companies like P&G and Kraft. So why shouldn’t service providers have to discount more? Enter Groupon. Now local services like fine dining sell for huge discounts from list prices, with Groupon pocketing half of whatever its members spend.

Case in point: Harbor Athletic Club (Madison, WI) offers one month of unlimited hot yoga classes for $25 on Groupon, a $49 value for Harbor Athletic Club members and $69 value for nonmembers. For $59, Groupon members get a two-month membership with no initiation fee, plus two months of unlimited tanning and a one-hour personal-training consultation, a $215 value. This is the kind of deal Groupon hopes will make them the go-to source for local discounts, in fact for all discounts. A successful GAP clothing promotion demonstrates Groupon’s ability to sell discounts for national retailers as well.

Service providers have to be smart to use Groupon. If they sell unused capacity, they’ll make money. But offers like Harbor’s may lead current customers to get steamed when hot yoga classes are full, creating a net membership loss.

What about investors? The answer boils down to scalability and advantage, which Groupon argues it has owing to first-mover advantages. Building the largest base of members will make it the most attractive partner for companies offering discounts. Marketing the most attractive coupons will make it the go-to site for consumers, or so the pitch to investors goes. Both will lower Groupon’s costs per customer and discounter, thereby creating profitability.

On-line retailer Amazon had first-mover advantages in book sales. It built distribution facilities not easily matched by me-too competitors. Members inform other members about the value of different books through their on-line critiques. Insightful Amazon software creates informed recommendations of other books each customer might like. Unlike Groupon’s experience, reaching booksellers was very affordable for Amazon at its founding, as the publishing market was highly consolidated. And, the more Amazon penetrated book buyers, the more publishers became reliant on it as a distribution channel. Furthermore Amazon’s infrastructure created an entirely new business — renting space on its infrastructure. And the company backward integrated into E-books.

These advantages and opportunities don’t apply to Groupon, however. For Groupon, the only potential advantage is numbers. Yet, from a network perspective, it has no obvious advantage over Google, Facebook, or Amazon, the number one spots for Internet searching, social networking and goods buying. All of them could move into Groupon’s market. If, however, consumers segment which sites they use for different activities and “finding discounts” emerges as a new category, Groupon might have a network advantage as first-to-market. If not, Groupon will become the MySpace or Yahoo of 2011.

A more interesting question is whether Groupon can uniquely benefit companies with higher returns from discounting than those reaped from newspapers, flyers, city magazines, their own websites or Groupon copycats? Therein lies Groupon’s opportunity, or its pitfall. If all Groupon offers is the size of its network, it will be caught up in pricing wars if Google, Amazon, or Facebook enter Groupon’s market. Other future competitors include niche companies like Open Table, a go-to site for restaurant reservations and Expedia for hotels, car rental agencies and airlines. Niche companies might not have as large a network as Groupon’s, but highly motivated purchasers make these sites attractive places for service providers to offer discounts.

Google’s model shows Groupon the way. Google replaced banner ads with search-based ads while making their site easy and fun for members to navigate so that it remained sticky for users. Google’s advertising innovation and user experience resulted in a $172B company capturing half of the US’s online advertising spend and a number one rating among Internet search sites. Groupon must be similarly innovative if it does not want to be the poster child for 2011 bubbles.

Groupon hopes to differentiate itself through clever writing. But Groupon is already angering writers who must promise in the application process not to work for any Groupon competitor, whether or not the applicant even lands a Groupon job. Any corporate founders this greedy will gladly take money from investors mistakenly investing in a bubble.