The following is an in-depth analysis of Groupon’s business in one of its oldest markets, Boston, by the folks at daily deal aggregator Yipit.
The entire piece is worth reading, but for the TL;DR crowd, here is the breakdown. Groupon’s costs to acquire customers is skyrocketing, while its revenue per customer is plummeting. Along with shrinking margins and a lower number of Groupon’s sold per deal, Yipit sees serious warning signs in the company’s financials.
While no one has ever doubted Groupon’s impressive topline growth – the question has always been around the defensibility of a business that has so few barriers to entry.
In its long awaited S-1, it’s clear that Groupon has impressive topline growth. However, when looking at it’s oldest markets, it appears that their business model is deteriorating.
Groupon’s Network Effect?
Groupon argues it’s reached a virtuous cycle in its public filing: the larger one side of its market grows, the larger the other grows since scale in one provides for scale in the other.
On the consumer side: “Increased relevancy enables us to offer several daily deals, which we believe results in increasing purchases by targeted subscribers, thereby driving greater demand for Groupons.”
On the merchant side: “Increasing our merchant base also increases the number and variety of deals that we offer to consumers, which we believe drives higher subscriber and user traffic, and in turn promotes greater merchant interest in offering deals through our marketplace, creating a network effect.”
However, when looking at the data for their Boston market, it does not appear that that Groupon has achieved this virtuous cycle.
The Boston Case Study
While Groupon is relatively opaque for most of its filing, it provides case studies of four of its major cities. We look at Boston since Chicago, the other US city, is Groupon’s home town.
Despite being one of its oldest markets, Boston had demonstrated impressive growth: revenue, subscribers and customers have all tripled in the past year. This topline growth has been aided by the launch of personalized deals in Boston in Q3 2010: Groupon started running multiple deals per day in Boston through its targeting/personalization initiative.
Deeper analysis of the Boston case study, however, shows that despite impressive topline growth Groupon’s business model peaked around Q3 2010 and has been deteriorating ever since.
Consumers Buying Less Groupons
On the consumer side, we just need to answer one question:
Does Groupon’s ability to send targeted/personalized deals to subscribers (thanks to its large merchant base) drive increased demand for Groupons?
If this were true, it would imply that activity and revenue per subscriber metrics would increase right along with Groupon’s increased deals per day.
Groupon’s business model is predicated on the idea that the company can stomach the ever-increasing customer acquisition costs since once a customer has been acquired they will generate a steady flow of high margin cash. However, this relies on existing customers purchasing several subsequent deals. While existing customers are indeed purchasing subsequent deals, they are doing so at a declining rate, despite targeting efforts.
Far more worrisome for Groupon is the fact that its existing customers (those 20% of subscribers who have ever bought a Groupon) are also becoming less engaged. The Boston Case Study reveals purchases made from existing customers by removing the impact of purchases made by new customers each period:
Frequently when you see this deterioration in a company’s existing customer base it is because the average customer is getting “older” and these “older” customers tend to be less active.
However, due to the exponential growth in customers, the average “age” of Groupon’s customer base has been roughly the same since Q1 2010. In other words, the average customer isn’t getting older.
As Groupon begins to reach saturation in Boston and its customer base inevitably ages as a result, reversing the decline in participation from its existing customer base will only become more difficult.
Groupon’s Customer Acquisition Costs are Rising
And of course, right when Groupon’s customers are becoming less engaged, and therefore less profitable – Groupon’s costs to acquire customers are skyrocketing.
Given the recent entrance of well-financed competitors such as Google, Facebook and Microsoft its hard to believe Groupon’s customer acquisition costs will slow anytime soon. Along with declining engagement for existing customers, this does not bode well for the future of Groupon’s margins.
Groupon Selling Less Deals per Merchant
The second question is whether Groupon’s industry-leading subscriber base will attract merchants willing to pay a premium to run with Groupon and preventing other players from effectively driving down gross margins to compete on cost.
According to Groupon, merchants pay a premium for their reach.
However, Groupon’s targeting/personalization strategy is leading to a decline in the number of Groupon’s purchased per deal as the number of deals Groupon is running per city far outpaces the growth in subscribers.
So what is happening in Boston? Groupon’s subscriber base has increased an astonishing 300% in the last year, but the number of deals Groupon ran in the area actually grew faster. This, along with the declining engagement of its customer base has led to the inevitable conclusion that the number of Groupon’s each deal sells is declining quickly.
Should personalization increase conversion rate per deal, this may offset decline in reach – Groupon could presumably increased total merchant satisfaction by satisfying more merchants more efficiently. However, as the average purchases per customer continues to decline so will overall conversion rates on personalized deals.
Groupon’s decision to rapidly increase the number of deals per metro has allowed competitors to credibly tell merchants that they deliver more customers than Groupon can in major cities such as Boston. Based on the Yipit Data Product, which features nearly 20,000 offers per month across major US metros, both Travelzoo and LivingSocial now average more vouchers sold per merchant than Groupon in Boston and many other major North American cities.
Several other players such as OpenTable, WagJag, DealFind regularly sell as many or more vouchers per deal as Groupon in major markets as well. This calls into question any network effect that Groupon thinks it may have by having the largest subscriber base in the industry. Merchants won’t pay a premium for total subscribers if Groupon can’t deliver more new customers than the competition.
If Groupon can’t charge a premium for its larger subscriber base, what competitive advantage or network effect does it have on the merchant side of the market?
Groupon Operating Margins Declining
While Groupon is experiencing rapid revenue growth, we believe operating margins are declining because, as we’ve shown above:
- Revenue per Groupon customer is declining
- Cost to acquire those customers are increasing
- Sales costs are increasing as it needs to run smaller deals with more merchants to personalize the experience
While Groupon doesn’t reveal costs in Boston, by taking company-wide customer acquisition costs and SG&A costs (allowing for some opearating leverage) you see significantly declining operating margins.
Why Is This Happening? Competition Has ArrivedA year ago, according to Yipit data, there were 9 daily deal services in Boston offering 15 active deals.
Today, Yipit Boston, shows 23 separate services offering daily deals including new successful entrants like TravelZoo and Yelp. The 23 services are responsible for creating 91 active daily deals. Worse for Groupon, there’s no sign of this ending with Google and Facebook on the horizon. Plus, successful entrants like TravelZoo are still only running two deals a week.
“Groupon Now” May Be the Answer
The silver-lining in all of this is Groupon Now, a new mobile product from Groupon that provides real-time deals to users. With it’s massive salesforce and many merchant relationships, Groupon is possibly the only company capable of having enough deal inventory to make a product like Groupon Now possible. If they are able to make the business model work, then Groupon will have the eventual network effect.
What Does This Mean For the IPO?
As one of Groupon’s oldest markets, Boston offers a glimpse into the future as the rest of Groupon’s business matures. Declining revenue per user, increasing customer acquisition cost, and declining operating margins do not bode well for the company’s core business. Given all of this, Groupon’s IPO valuation may come down to how investors perceive the prospects of Groupon Now. Since Groupon only recently launched Groupon Now in a few test markets and has not yet provided data on those launches, it’s unclear how investors will value Groupon Now.
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