In case you’re just tuning in, Groupon filed their S1 forms yesterday to raise $750 million through a public stock offering. They’ve opened up the books and the public can now see how they’ve been faring. At first glance, it’s disconcerting and the blogosphere is exploding with criticism. I’d like to weigh in with a small comment.
About two years ago, Groupon launched an amazing service that grew like wildfire. They caught the imagination of early adopters with a solid business model that quickly enlisted a huge following and grew a large revenue stream. With $645 million in revenue from 83 million subscribers in Q1 alone, Groupon is on track to earn an incredible annual average of well over $30 per user, making it possible to spend huge amounts to acquire users and still maintain profitability.
So why am I concerned? Because Groupon is burning through margin to earn revenue.
Groupon’s business model has been to pre-sell local merchandise at a discount. As a price for the service, Groupon has been taking 50% of the remaining margin from local businesses. Similar to a high interest, short term loan, the business gets a huge check on day one and then has to pay off the loan through merchandise as buyers return with their Groupons. This 50% service charge has proven untenable for many businesses who are already giving their customers a huge discount. With already low margins, for many businesses, the math just doesn’t make sense. For Groupon, however, inventory is essential. Every deal they can acquire through their massive sales force is worth a huge amount of revenue to them. The rumors now abound that in order to maintain inventory, Groupon is now negotiating it’s 50% cut. I can’t cite anyone on this, but it’s not surprising. There’s a ton of lash back (see here, here, and here) against daily deal sites, and Groupon needs the inventory. Cutting margin is an easy way to maintain inventory.
The Groupon business was an amazing discovery. Putting together struggling local businesses with hungry deal seekers was genius. Unfortunately, there’s very little defensible about this model. Unlike Google or Apple, there’s no amazing technology that keeps competitors from creating clones: an email system is easy to create and not all that difficult to scale. As a customer, you don’t have anything on the site that ties you to Groupon; there’s no Facebook-ish social graph or eBay-like buyer profile. No, Groupon defends itself with a salesforce and business relationships, but they’re far from the only company with those relationships. A successful business model always attracts cloners and Groupon clones abound. Companies like Scoutmob, Thrillist or the SF Chronicle have created daily deal clones to monetize their existing business relationships. As the clones have emerged, acquisition costs have skyrocketed. Search terms that were once cheap have skyrocketed in value as competitors enter a spending war. The daily deals land grab has left Groupon paying exorbitant costs to acquire a user, and the number isn’t going down. Competition is also driving up the cost to acquire inventory, creating the need for Groupon’s roughly 4,000 salespeople and all the costs associated with a team of that magnitude.
Revenues abound for Groupon, yet the company is still deep in the dark red as their margins are being squeezed on both sides. Not only is Groupon giving up margin to acquire inventory, their cost of acquisition is increasing. In Michael Mace’s article on RIM, Mr. Mace illustrates how the death kiss for RIM is a similar downhill margin treadmill. RIM, hoping to go “mainstream”, decreased their prices to accelerate growth, reducing margin and losing profit to maintain a consistently growing revenue stream. Eventually, this process burns out and revenue plummets. The key factors that really matter are not revenue growth or subscription rate, both of which can be manufactured, but the cost of acquiring and maintaining revenue. In this article, David Sinsky presents an investigation of Groupon’s situation in Boston based on their S1 filing. My key takeaway is the falling revenue per customer. Groupon is on a spending treadmill and the figures point to the situation only getting worse.
An indefensible business model is dangerous, especially with massive growth. As soon as competitors smell the revenue, they attack like hounds, tearing away at margins and increasing costs. For Groupon this has lead to increased costs both to acquire inventory and to acquire customers. Groupon is now in a tough situation, hemorrhaging money to keep the revenue stream growing. I’m certain that Groupon’s IPO will be successful, largely due to the huge amount of hype behind the company, however, I’m eager to see how it all plays out in the end. Perhaps Groupon is building a moat that will defend them against their competitors, however, from my first experiences, I don’t think Groupon Now is it.
Just read another great article on the topic. Well worth the short read.