How Groupon could turn a profit

Groupon’s prospectus for an IPO valuing it as high as $30 billion stirred controversy around the company’s explosive growth and huge losses. Silicon Valley wants Groupon to look like a technology company, but right now the company is basically in the Yellow Pages business, and until it starts successfully using data gathered from its sales and massive customer base to offer better personalization and targeting, profits will be scarce.

Groupon revenues grew from zero to $713 million in three years — and $645 million in 2011’s first quarter — but it lost $456 million last year and $147 million in the first quarter of 2011. Aside from international acquisitions, the big expenses driving those losses are staffing, especially in sales, and marketing spending. According to its S-1, Groupon has over 3,500 salespeople and over 900 editorial staff writing up its clever, quirky offer emails. It spent over $250 million on marketing in 2010 and a whopping $208 million in this year’s first quarter.

Looking at Groupon’s quarterly data, I see a flat to slightly down trend in deals sold and total revenues per subscriber. Meanwhile, marketing spending per new subscriber added is more than doubling. With competition increasing and the novelty of daily deals wearing off, customer acquisition costs will only go up.

While the cost of entry to any single daily deals market is low, the cost of scale across cities and countries is enormous. Groupon’s spending on growth hasn’t produced any economies of scale nor network effects. It has yet to show that adding additional consumers or merchants increases more than proportional value to its network, or that it can lock in either type of customer.

Groupon needs to increase its revenue per customer, both on the consumer and merchant side. Its 83 million subscribers have bought 28 million Groupons from nearly 57,000 promoted merchants. Number two daily deal player LivingSocial has 28 million subscribers. So Groupon should be better able to achieve a network effect by analyzing all of its data on consumer interests and purchases to craft better, personalized offers and deliver them to targeted audiences. That should generate more purchases per customer. Groupon’s data analysis should lead to better marketing insights on customer habits and preferences that it could deliver as a service back to its merchants.

But deal aggregator Yipit interprets declining sales per customer in a mature Groupon market as signs that Groupon’s personalized offers aren’t working well yet. Groupon needs to shift some of that customer acquisition spending towards big data analysis to make sure its network effects kick in. It’s about to face big, data-savvy competitors.

How the competition stacks up

Groupon’s business is not for the faint of heart, or, really, for new startups. Its competitors are the big guys, each of which has a major differentiator or two, balanced by a weakness:

  • Google has buying intent data from search and the analysis skills to apply it to offers. Google can also supply a variety of other marketing and advertising services to merchants along with daily deals. That’s why I thought a Google-Groupon merger made sense, because Google has only a small local sales force.
  • Amazon, which has an investment in LivingSocial and is testing reselling deals, is also wise in the ways of data. Of course, Amazon is the dominant force in e-commerce. But so far, daily deals are more about marketing than buying, and Amazon only dabbles in advertising.
  • Facebook has a distribution channel for deals but no local sales force. So it is aggregating deals from other companies and focusing on entertainment-oriented offers that appeal to groups of friends rather than deep discounts.

What’s next?

In addition to dialing up the data analysis, Groupon needs to add more services for its sales force to sell. But unlike Gilt Groupe, which is getting deeper into online retail (a business that scales less efficiently than technology-driven marketing), Groupon should add products for its merchants. Just like Yellow Pages companies such as YP.com and Superpages, Groupon should buy search and display advertising for its merchants: The company is well equipped to do the targeting analysis that would baffle a local small business.

Groupon should also help its merchants with their customer retention and loyalty programs with “brick and click” points and check-in programs. The company is testing mobile offers, but why not just buy Foursquare? Groupon could maintain the brand and probably triple Foursquare’s audience while adding its local sales force to Foursquare’s budding national advertiser business. By adding data-driven products and services for both its consumer and merchant customers, Groupon should be able to squeeze healthy profits out of its massive sales.

Question of the week

How can Groupon cut its losses?
Relevant Analyst
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David Card

VP Research Gigaom Research

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4 Comments Subscribers to comment

  1. I never got groupon. Coupons are age old concepts. Barrier to entry in this business is low for large players with established distribution networks. Groupon puzzles me till date!! I agree – it needs some technological leverage.. maybe Groupon Now or FourSquare can add the missing spice ?

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    1. Vishal: 3,500 salespeople is a fairly big barrier to entry, even for Google ;->

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  2. David, 3,500 salespeople may look like an asset now when no one is paying attention to how Groupon is bleeding cash. Its adjusted CSOI metric doesn’t capture its customer acquisition, marketing costs. I don’t see how the company will turn cash flow positive. It is not a technology play, Facebook and Google are and once they get into the deals business, which they have started to, they can totally undercut Groupon’s business. Most of us still get to services/products through search engine or social networks.

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    1. I don’t think daily deals will be replacing search anytime soon myself. Groupon needs to turn itself into a marketing services company for its merchants. That could be a great business, if not nearly as profitable as search or social technology platforms.

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