Mr. Vacanti

When we saw Groupon's amended filing this morning pledging to stop squandering funds on marketing--since, you know, it didn't actually get them new users anymore--we knew just who to hit up for some perspective: Vinicius Vacanti, co-founder and CEO of Yipit, the daily deals aggregation and recommendation engine, whose company has been supplying the data on the industry trends inside the market. Thankfully the star of the small screen had some time to gChat.

He talked to Betabeat about when the window to profitably acquire new users from online marketing closed, why fears of a daily deals bubble may themselves be inflated, and the key to giving the Internet coupon fad some legs.

Mr. Vacanti said today's filing was to be expected, as increased competition changed the economics of acquiring customers.  "As we've written before, per subscriber economics had been deteriorating and the cost to acquire users had been going up.  Now their efforts will be focused on re-engaging with their current users and getting their happy users to tell their friends."

Those diminishing returns from marketing were a long time coming, noted Mr. Vacanti, "The window that appears to have closed is the ability to effectively acquire users via online marketing. That's how Groupon and LivingSocial grew their business. Honestly, that window had closed for all new daily deal sites 9 months ago. Other than Groupon and LivingSocial, no other daily deal sites had been able to acquire users effectively."

While amending their IPO filing draws attention to Groupon's marketing spend, Mr. Vacanti said, "Every daily deal site was probably spending around the same neighborhood to acquire a user. [Groupon] definitely spends more,  but probably not on a per-user basis."

So what would help acquiring customers? "Higher quality deals make a difference," he said.

As for how the amended filing might affect Groupon's planned IPO, Mr. Vacanti said the decision not to spend on marketing with diminishing returns would be positive from a short-term profitability standpoint, but noted that long term, "From a revenue growth perspective, it will be negative. But that might not even be fully reflected for a year."

To those sounding the death knell for the daily deals market, he advises taking another look at the August numbers. It was "a very successful month for the industry," due to new travels deals like Groupon Getaways and LivingSocial Escapes. In fact, Mr. Vacanti sees this as a maturing industry getting closer to saturation. "Over time, people will get more and more comfortable using daily deals. More people will redeem using their smart phones. Daily deal sites will get smarter about what offers work when."

Mr. Vacanti also points out that the daily deals space is missing one key ingredient to make a bubble. "VCs have not actually been funding many daily deal sites. Of the 600 daily deal sites that have launched, less than 20 have been VC funded."

But he did see some flaws with the media companies attempt to pile on. "I do think media companies who launched daily deal services did so without putting as much thought into as they should have." He pointed to Facebook pulling out of the market and Yelp focusing on fewer, higher quality deals and dedicating an actual sales team to building its product, with 15 people now devoted exclusively to selling daily deals.

Yipit benefits from the proliferation of daily deals sites whether or not the big players succeed. As Mr. Vacanti notes, "What matters to Yipit is that there are many great companies creating interesting offers for consumers. There are over 400 active daily deal sites doing just that and that number keeps going up."

Yipit co-founders Vinicius Vacanti and Jim Moran

Daily deal aggregator Yipit just raised a $6 million B round led by Highland Capital partners with participation from previous backers RRE, DFJ Gotham and IA Ventures.

"We are hoping to expand in three ways," says co-founder Vinicius Vicanti. "One is on the data side, where we will be analyzing and packing all the information we are collecting on the daily deal market." Right now the sale of this data to hedge funds and daily deal sites is generating half of Yipit's revenue.

"The second area is the consumer interface. When we started there were so few services that a daily email made sense as a delivery mechanism. Now we want to create a great set of tools on our site so people can really engage and get custom recommendations."

To do that Yipit is looking to expand the company from 7 to 30, hiring a mix of engineers, developers and product managers. Guess some space will be opening up at General Assembly soon.

The company is currently culling together deals from 335 services in 32 cities. Yipit has grown ten fold in the last year and now reaches 250,000 people each day, and Vicanti says international expansion is next on their list.

This gives Yipit a broad perspective on the industry, and they have not been afraid to point out some of the ugly realities of the daily deal business. After Groupon announced its plans to IPO and released its S-1 to the SEC, Yipit wrote a long post about how Groupon's business is decaying in its established markets.

Groupon's upcoming IPO is perceived by many as a litmus test for the daily deal industry, but Vicanti says its all relative. "If they open as just a $5-1o billion dollar company, that may be perceived as a failure by the public markets. But building a business of that scale in three years is a great accomplishment." The daily deal industry still has room to grow, thinks Yipit, and they want to build the best aggregator with the best consumer interface and data analytics, both in the U.S. and around the world.

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.

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David Sinsky, Yipit Blog

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.

Follow @YipitData on Twitter for the latest industry trends and analysis by the Yipit Team.

David Sinsky, Jim Moran and Vinicius Vacanti contributed to this post. David runs Yipit’s Data Product, which provides past offer detail and competitive intelligence to the Daily Deal Industry.

This afternoon Yipit announced it was giving users the option to receive "hyper-local" deals aimed at both their home and work addresses.

Yipit can do this kind of targeted offering because it aggregates from 485 different deal services, meaning it routinely has more than 100 offers per day in New York.

A source Betabeat spoke with today speculated that the explosive growth in the daily deal space was part of the motivation for Foursquare's new funding round.

At roughly 60 employees, Facebook is way out out-gunned when it comes to sales staff sourcing local deals. Luckily they have eight million users as an incentive for merchants.

Yipit, on the other hand, is in a great position. As the number of deals increases their ability to funnel and curate them becomes more valuable.

If a user is logged into iGoogle, there is no log in process. Just select your location and an email pops up in your inbox. Unlike Groupon, it doesn't ask a bunch of questions off the bat, maybe because Google has already crafted a fairly detailed profile on me. The initial email also doesn't contain any offers.

The choices for subscribers so far are limited to Manhattan: uptown, midtown or downtown. "Google really doesn't have the salesforce in place right now to offer a big variety," says Vin Vicanti, of deal aggregator Yipit. "And what makes a deal work is the specificity, something that is close by and fits my taste."

Vicanti says Google does have some advantages it could leverage, such as integration with Gmail and Google Maps. "If you could purchase the deal directly from within the email, and later be able to navigate to it on your phone simply by calling up the email, that could really differentiate Google Offers from competitors."

But for now, says Vacanti, it seems like the Google Offers group won't be able to tap those resources. "My sense is that they are in a  silo of marketing and sales, cut off from engineering. They are going to need to prove themselves first."  If that is the logic Google is operating on, it's a shame, because on its own this product is unlikely to have the personality or momentum of its established competitors.

We come bearing coupons.

As Vinicius Vacanti, co-founder of daily deal aggregator Yipit pointed out, the New York Times ran three separate stories today on the explosion of companies in this industry.

In a piece for the Dining section, restaurant owners express their shock and awe at the number of deal sites, groupon clones and coupon brokers beating down their doors. They describe being pitched in person, on the subway and in a relentless barrage of email. The article, without citing a specific source, claims a dozen daily deal sites are being born each week.

No one, it seems, is really digging out a broad picture to give a sense of whether or not this trend benefits restaurants, an important factor if Groupon's incredible growth is to continue leading up to an IPO.

Instead we're left with back and forth anecdotes.

"After Ed Brown, of Ed’s Chowderhouse in Manhattan, gave a few luxe deal sites a spin, he concluded that “the discount doesn’t bring any more money to the bottom line.” He added, “There is no way you’ll ever make money on them, and we didn’t.”

“Think of how much it would cost you to hire public relations people, though you’re never sure what media will be interested,” Mr. Massari (of Piccolo Cafe) said. “But Groupon gave us a massive marketing campaign that a small business like ours would never be able to afford.”

One clear beneficiary? Sites like Yipit that have a flood of new sources to draw on each day for deals and don't interact directly with merchants or their bottom line.