The Bankwatch

Tracking the consumer evolution of financial services

Groupon promise of ability to scale is weak

There has been a fair bit written about the Groupon IPO and while some have touched on it, there is one key point that needs to be made.  I remain sceptical about online advertising and affiliate marketing in terms of long term sustainability, and yet that is the basis of Groupons model, and that they can improve their margins by scale.

Groupon is not any kind of testament to whether we are in a dot com bubble or not.  Groupon is a classic case people becoming muddled by large numbers, and I will explain that in a moment.  The others that somehow Groupon  became associated with, Linkedin, FaceBook and Twitter are completely different.  Linkedin have gone public, and they have a potential profit story.  The other two have not tried to go public so there is nothing to defend there.

Groupon is a different story.  This from the SEC S-1 filing.  The story here is whether they can scale, and I do not see it.

image

 

First a brief explanation of the business model.  Groupon sells coupons to consumers, and pays 50% of the proceeds to the business that offers the coupon.  The first thing we notice is that the gross margin say in the 2011 3 months result is not $322 (50% of the revenue) but $52 million less.  There must be sufficient operational costs associated with getting the 50% back to the merchants, or from acquiring merchants, that it eats up almost 20% of the Groupon share of the revenue.

Next and sticking with the March 2011 results, we can look the marketing costs of $208M which all but wipes out the gross margin.

Revenue              $644

Cost of revenue  $375

Marketing           $208

Surplus               $  62   9.6%

A 9.6 % contribution to operational expenses is not good.  This company is just churning money.

image

If we boil the numbers down to their product, groupons, here is how it shakes out.

Revenue $644,708,000
Gross revenue $270,000,000
Marketing $208,000,000
Groupons sold 28,094,703
$23   Revenue per     groupon
$10   Gross revenue per groupon
$7    mkt cost per     groupon
$62,000,000 Total contribution to operational costs from Groupon sales

While the number that gets the attention is the $644M in 3 months, that is not the story.  The story is the gross contribution per groupon after acquisition costs, is less than $3.  The cost to acquire each groupon is what matters, and to what extent can the company reduce that cost with scale, a claim that is throughout the S-1.

To return to the point made at the beginning.  Groupon is not a story of internet companies.  It is a company based on extremely high marketing costs.  It is not clear why with scale of 5 times more groupons sold, or 5,000 more groupons sold, that the individual marketing costs of acquiring the consumer for each groupon will change.  That would require Groupon re-invent marketing beyond the current framework represented by typical online marketing (from S-1 – (online marketing initiatives, such as search engine marketing, display advertisements, referral programs and affiliate marketing).

The thing about FaceBook is that they have developed their own eco-system of users.  This can potentially open up new customer engagement and revenue opportunities that would not be available to others.

I don’t see that with Groupon.  This is a company based entirely on customer acquisition using the commodity that is standard online advertising, and commodity advertising  just get more expensive, not less.  The owners and investors might do well on this IPO but I see little in terms of benefit to others.

 

Written by Colin Henderson

June 4, 2011 at 20:22

Posted in Uncategorized

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  1. […] Groupon promise of ability to scale is weak (thebankwatch.com) […]

    Oh Goodbye Days…

    June 19, 2011 at 04:41

  2. […] Groupon promise of ability to scale is weak (thebankwatch.com) […]


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