|YIPIT: The Reports of Groupon's Death are Greatly Exaggerated|
The Reports of Groupon’s Death Are Greatly Exaggerated
by Vinicius Vacanti on June 5, 2011
Since Groupon filed its S-1 on Thursday, there have been hundreds of negative articles written about Groupon (including one of our own).
While some of the concerns brought up about Groupon are legitimate, many of them are unfounded.
Unfortunately for Groupon, since they just filed their S-1 with the SEC, they can’t publicly respond to these concerns (this period is known as a quiet period).
As part of our work on building Yipit as a daily deal aggregator of over 500 services, we’ve talked to hundreds of daily deal sites, big media companies, white label providers, local merchants, journalists, daily deal users and daily deal non-users. Throughout that process, we’ve learned a tremendous amount about how the industry works, its legitimate challenges and its unfounded concerns.
Here are the some of the most widely circulated concerns that are largely unfounded:
1. Local Merchants Don’t Like Daily Deals
Based on our Yipit data product, 44% of daily deals run in May were run by businesses who had already run a daily deal. If they really had a bad experience, why would so many merchants be doing it again? Also, if local merchants didn’t like daily deals, how was Groupon able to increase the number of merchants they work with in a mature market like Boston by 60% in just the last three months.
Even though Yipit aggregates deals and doesn’t work with merchants directly, we still get 20 unsolicited emails a day from merchants wanting to run a daily deal on Yipit. I would guess Groupon gets 2,000 unsolicited emails a day from merchants wanting to run daily deals.
This perception of local merchants not liking daily deals largely comes from the observation bias that the only stories you read about are the ones where merchants had a bad experience. It’s the same way that if you watch the nightly news, you would assume there’s a murder on every block.
2. Local Merchants Can’t Effectively Discount More Than 10%
The Knewton Blog, in a post entitled “Groupon is a Straight-Up Ponzi Scheme”, stated that the “The vast majority of local merchants can’t discount more than 10 percent.” I have no idea where they pulled that statistic from but it’s completely unfounded.
From the S-1, only 9% of Groupon’s deals are for traditional retail businesses that typically feature high variable costs. The other 91% of Groupon’s deals are for spas, salons, restaurants, events, activities and other services. These merchants all have a large fixed cost based, perishable inventory and considerably lower variable costs. Accordingly, their marginal cost on an addition customer is low enough allowing them to discount aggressively. That’s why businesses have been having 50% off sales and large group discounts for hundreds of years.
3. Groupon Insiders Are Cashing Out
Of course Groupon insiders have cashed out a portion of their shares (approximately 20%). No matter how confident they are in the business, it would be financially irresponsible for them not to cash out a portion of their shares given the multi-billion dollar valuation they were being offered as part of earlier rounds. The vast majority of their wealth is still completely tied-up in the success of Groupon.
4. Groupon is Not Building a Moat
In a widely circulated post, 37signals co-founder David Hansson pointed out that Groupon is not building a moat like Amazon did. Based on our observations, Groupon may not be a completely untraversable moat, but they are building a moat.
While LivingSocial has become a strong number 2, just ask the 400 other independent daily deal sites that have launched since Groupon. While they have been able to get traction and are building strong businesses, only a handful have scaled to a million users and none of them have scaled to double-digit millions of users. User acquisition has become too competitive and thus too expensive.
While there’s no barrier to entry in the space, there’s now a barrier to scale and Groupon has scale. Over time that scale will allow them to develop a better experience on the user side and merchant side (think relationships with credit card companies, partnerships with nationwide brands).
But what about the threat from existing media companies that already have millions of users like TravelZoo, Gilt, Google and Facebook?
Groupon is building a bigger moat: a massive local salesforce of over 3,500 people. Why do you think Google and Facebook just launched in a few markets? That’s because they couldn’t launch in more markets since they don’t yet have the necessary local salesforce and it will take time for them to build it.
This salesforce could become an even more impressive moat if Groupon Now, a mobile real-time deals product, takes off. For a product like Groupon Now to work, you need thousands of active deals in each city which only a very large salesforce can make happen.
5. Groupon’s Trying To Trick Us By Emphasizing a New Accounting Metric
One of the most talked about issues with Groupon’s S-1 (see Forbe’s critical analysis) is their emphasis on a metric called adjusted CSOI which is their operating income excluding online marketing expense, acquisition costs and stock-based compensation.
The big figure in that calculation is the online marketing expense which when backed-out, implies that Groupon is profitable ($81.2 million in the first 3 months of 2011, or $325 million annualized). The main issue people have with backing-out this expense is that without online marketing Groupon’s business would collapse. That’s unfounded.
Even if Groupon completely stopped marketing, they would still be able to grow their subscribe base. Based on conversations with industry insiders, I would guess that almost half of all users Groupon signs up are non-paid users which are probably better Groupon users than paid users. That being said, if you consider CSOI, you have to significantly discount their current revenue and revenue growth expectations.
Groupon is using CSOI to point out that they are investing aggressively in the growth of their business at the expense of current profitability.
6. Groupon is Effectively Insolvent
A widely circulated post on Minyanville argues that Groupon is effectively insolvent because they owe a net $230 million in accounts payable and are currently burning $100 million a quarter. This is completely unfounded.
First off, $100 million a quarter is a non-cash number. Their cash flow from operating activities in 2010 was a positive $86 million and a positive $17 million in the first 3 months of 2011. They aren’t actually losing $100 million a quarter.
Secondly, a business with negative working capital is actually a strong business. It means that Groupon can effectively use its working capital to fund operations. Most businesses are in the unfortunate position of having positive working capital and thus need to pay out funds faster than they are able to collect.
While many of the concerns brought up have been unfounded, there are some real concerns:
Groupon Stores, their attempt at self-serve, did not work
Groupon Now is unproven and a very different business. I’ve used Groupon Now in New York and it may need at least 10 times more deals to really be effective
As we reported yesterday, it appears that increasing competitive pressures are causing Groupon’s business model to weaken in its older markets
Groupon’s shareholder structure makes it so that public market investors will have very little say in the company
Groupon faces serious competition from LivingSocial and bigger media companies
Like any other company Groupon faces several challenges; but, like Mark Twain once said after reading his obituary, the reports of Groupon’s death are greatly exaggerated.