Collapsing Revenue Metrics - Skyrocketing Costs = Groupon's Disaster

 “We have experienced rapid growth over a short period in a new market that we have created and we do not know whether this market will continue to develop or whether it can be maintained. If we are unable to successfully respond to changes in the market, our business could be harmed.” – Groupon’s S-1 Filing

 Yeah, we’ve all bought a Groupon to get a nice(r) haircut, or a good massage…but that doesn’t mean Groupon’s IPO is something we should be excited about.

 In reality, Groupon has become nothing more than a get rich scheme for the founders and the venture capitalists backing them.  They had a first mover advantage that has completely eroded – they will soon be a lackluster business with no margins.

Here’s Why:

Quick Glance at their Subscribers and Revenue between 2008 and 2010:

	2009	2010	Growth
Revenues	$30,471,000	$713,365,000	23.4x
Subscribers	1,807,278	50,583,805	28.0x
Groupon's Sold	2,695	66,289	24.6x
Featured Merchants	1,248,792	30,296,070
Revenues/Subscriber	$17	$14
Revenue/Feat. Merch.	$11,306	$10,761
Revenue/Groupon	$24	$24

As we can see, their subscriber growth has been outstanding, growing from a base of 1.8 million in 2009 to more than 50.5 million in 2010 and 83 million at the end of Q1 2011.  I’m pretty sure this makes Groupon the fastest growing company (in terms of user growth) in modern history.  Impressive is an understatement.    Without any analysis, the revenue number looks equally impressive, showing a 23.4x growth in one year.

Red Flags Remain:

Despite this rosy initial picture, red flags are everywhere….Upon closer investigation, I have found that their “Revenue / Groupon Sold “ has remained intact at $24. (NOTE: THIS IS A CORRECTION MADE ON JUNE 6TH)  A key part of their strategy is to increase the number of merchants offering deals every day, and then targeting those deals to individuals they believe would be most interested.  They believe this helps box out other competitors from targeting those merchants, while simultaneously providing a more customized user experience for their subscribers.  What has shrunk is their revenue per merchant, showing that as their customer and merchant acquisition costs go up (with a heavy salesforce), their revenue per deal is failling rapidly.  (NOTE: Correction also added on June 6th)

Additionally, I have found that their “Revenue / Subscriber” has fallen from $17 to $14 , and as we will see below, is likely to continue to collapse.

 Subscriber to Customer Conversion Rates Falling:

				3 months ended March 31
	2009	2010		2010	2011
Subscribers(1)	1,807,278	50,583,805		3,434,610	83,100,006
Cumulative customers(2)	375,099	9,031,807		874,017	15,803,995
Featured merchants(3)	2,695	66,289		2,903	56,781
Groupons sold(4)	1,248,792	30,296,070		1,760,398	28,094,743

Above is the subscriber, customer and sales data from Groupon’s S-1 Filing, for the years 2010 and 2011. 

	3 mos. Ending March 31
	2010	2011
Subscriber to Customer Conversion	25.4%	19.0%
Groupons Sold/Subscriber	51.3%	33.8%

Taking the number of subscribers Groupon has and dividing it by its number of cumulative customers, we see that the subscriber to customer conversion is falling.  In Q1 2010 more than 25% of Groupon’s subscribers had purchased a Groupon, while only 19% of subscribers had done so in 2011.  This should worry public market investors as it indicates that each new subscriber the company acquires is less likely to make a purchase.

Subscriber Reach Out: Success?

Looking at the number of Groupons sold per subscriber, we see that in 2010 they average one Groupon for every 2 subscribers they had, and that number has collapsed to 33% in 2011, supporting the evidence cited above.

A key part of Groupon’s strategy to reach subscribers has been to eventually offer individually targeted deals. They believed that in doing so, subscribers will be more likely to convert to customers. In reality, the cost of maintaining a growing sales force of 3,500 people only causes to contribute to Groupon’s massive overhead costs. As demonstrated above, while this sales force has grown, their subscribers are less likely to purchase groupons, showing that this strategy has clearly backfired.

Furthermore, despite their subscriber base growth, their marketing expense has also been skyrocketing.  Their marketing budget has gone from $163,000 in 2008 to more than $263 million in 2010.

No Longer The First Mover

 Groupon no longer is a first mover in this market, and the low barriers to entry have made it easy for others to enter and erode their margins.  Groupon’s customers are out for the best deal, and are likely to sign up for every single discount and coupon service in existence.  Similar to the online travel search engine era of the early 2000’s, users held no loyalty towards the Expedias of the world, and instead scoured any and all sites for the best deal. The greatest weakness of Groupon is they defined the market and trained their customers to want the best deal out there, and as today has shown, sometimes that deal won’t be found on Groupon.  

Potential Saves:

The first thing Groupon could do is find a model whereby buyers are rewarded with loyalty points for going through them. If I get 10$ off every third Groupon I buy, I’d be a lot more likely to checkout Groupon’s list of discounts before I check anyone else’s.  The problem with this strategy is that it’s also easily replicated, and could perpetuate a pricing war with its competitors.  For instance, if Groupon tries to offer a $10 discount for every 3^rd Groupon one buys, it’s easy to predict that a site like LivingSocial will match or sweeten that offer.

Understanding this landscape, it becomes obvious that Groupon can survive only if it refocuses on innovation. There’s no doubt that Andrew Mason and his team have proven themselves to be visionaries, but the future of the company lies in their ability to innovate.  Groupon Now is interesting, but LivingSocial rolled out an identical product within days of Groupon’s announcement. 

Unsubstantiated Claims:

Merchant Problem:  I think merchants are finding that the exposure is incredible, but that the customers they’ve acquired aren’t.  The type of individual who pounces on a Groupon deal is one who is extremely price sensitive, and out to get the best deal.  This is particularly problematic for high end services like spas and beauty parlors, where their key differentiation is service and not price.   Over time, I believe we’ll start seeing more deals in specific verticals (like grocery stores), where they’re already competing on price, and are just trying to get more people through their doors to buy more goods.

Founder Cash Out:  Peter Kafka  correctly pointed out in his article that the vast majority of Groupon’s last round went directly to the founders as a cash pay out.  

The founders cashed out not just because they wanted what’s best for the company, but also because they realized that the company wouldn’t be worth as much as it is forever.   They are a smart team that discovered an amazing idea and executed relentlessly on it.  The problem is that Groupon’s model has no barriers to entry, and they see the writing on the wall as clearly as we do. 

The key to Groupon’s success will be to continue innovating in the space faster than their peers, which is difficult to do, at best, and impossible at worst.