Daily deals site Groupon has enjoyed a meteoric rise in popularity as one of the most recognizable new media brands and, until recently, was highly praised by consumers and media pundits alike as the single fastest growing company in history. The tide of public opinion seems to have shifted, however, as the company has come under fire since going public with claims of the company being everything from just another overhyped tech startup to an outright pyramid scheme.
Some of the criticism subsided after Groupon’s IPO, which valued the company at an eye-popping $12 billion dollars, but the substance of the criticism surrounding the company remains: Groupon, at its core, is a fundamentally flawed business model and just another train wreck in slow motion that merchants and investors should steer clear of.
Groupon’s flaws, in order of importance, start with a strikingly poor, totally unsustainable value proposition for its merchants. The company has also developed a reputation for a “churn and burn” sales culture that is particularly concerning for longer term investors. Groupon also suffers from an almost complete lack of innovation, a frighteningly narrow scope of offer applicability for merchants and consumers, low switching costs for consumers and enormous operational challenges, including soaring customer acquisition costs and rapidly declining margins.
Poor Value Proposition for Merchants
While great for consumers looking for “one-off” sales discounts, Groupon’s model is not profitable for most of its merchant partners, and is an awful (some would argue predatory) value proposition for low-margin businesses in particular. A typical “daily deal” arrangement with Groupon would require a merchant coupon of 50%, providing, for example, $50 of food for just $25. Groupon’s cut of revenue from these daily “deals” is typically 50%, leaving the restaurant with a 25% cut out from $50 in fully priced revenue. Question: How can a restaurant sell food at a 75% discount? Answer: It can’t because the math doesn’t work. Reports of Groupon sales people encouraging merchants to use the product as a promotional tool to first “drum up new customers” which subsequently drives repeat business have also been highly criticized. An example:
Jewelry company owner, Andres Arango, sold 80 Groupon coupons — $35 of jewelry for $15 — in two days getting only $7.50 in revenue per sale, resulting in a huge loss on the deal. What about repeat or return customers? “They never came back,” Arango said. For most merchants, and low margin businesses in particular, Groupon’s daily deal model simply won’t work as a legitimate source of meaningful revenue.
The fact that merchants simply will not be able to continue offering discounts through the company for a sustained period of time may prove to be the seismic jolt that will cause its collapse. Merchants cannot sustain offering effective discounts of 50-75% on their products and services for extended periods.
Offer Applicability, Switching Costs & Deal Fatigue
Another huge weakness of Groupon’s is the very limited applicability of its offerings. Most of its offerings are targeted mainly at females, offering deals on non-essential, luxury and discretionary purchases such like spa packages, manicures, and travel packages. These specialty offerings comprise an inordinate share of Groupon’s offerings, which have a lower overall market demand.
Another problem for Groupon is the lack of switching costs for customers and merchants who are free to use competitive services like LivingSocial, Amazon Local, or Travelzoo’s Local Deals. There is simply no gain or advantage from using Groupon repeatedly for customers, who often subscribe to multiple daily deal email services. Experts have argued that “the value of the deal and the quality of the merchant drive the transaction–not the company that emails the offer.”
Even more problematic for the industry in general is so-called “deal-fatigue”. With the low barriers to entry and the plethora of daily deal offerings flooding the marketplace, the avalanche of deals has become a huge distraction for many customers, many of whom have started tuning out the offerings entirely.
Lack of Innovation
One of the biggest red flags in Groupon’s business model is its lack of innovation. The best arguments that could be made with respect to Groupon’s innovation are Groupon Getaways and Groupon Goods. Sadly, however, these are merely retreads of product categories that were established more than a decade ago. While some would argue that Groupon doesn’t need to be a technology innovator, the low barriers to entry and flood of competition from literally dozens of deal sites requires innovation to remain viable. Tom Peters infamous “innovate or die” quote could never be more applicable in this comet-like industry.
Churn and Burn Sales Culture
In its early days, Groupon was simply looking to help people find interesting things to do in their hometown city of Chicago. CEO Andrew Mason also pushed the idea of pitching Groupon offers to local businesses as a way to help bolster their cash flow at a time when banks were not lending money. The company rapidly succumbed to early investors and co-founder Eric Lefkofsky’s desire for rapid growth. In a leaked internal memo, Lefkofsky pushed hard to rapidly scale the business, no matter what it took. “[Lets] take this thing to the extreme… if we get whacked on the ride down – who gives a $#!+. The time to get radical is now … we have nothing to lose.” In its early days, the company became a very lucrative place for young college students and early twenty-something’s to go to work for. An early employee of the company confirmed reports of entry-level sales people making well into six figure salaries. “Their [base salary] was thirty something [thousand dollars per year], [but] they were making a ton of money.” These massive pay days for “entry level” employees angered older executives who resented the windfall compensation. That would all change in May 2010 when Groupon bought German Groupon clone MyCityDeal, owned by Marc, Oliver and Alexander Samwer, a trio of German born brothers. The hard charging Samwer brothers brought with them a very shrewd, results-oriented, take-no-prisoners operational style to the Groupon sales force. Some employees were relieved at what seemed to be a much-needed shift to a more traditional, professional sales organization. Referring to it as the “The German Way”, other Groupon employees were stunned at the dramatic cultural shift, which seemingly overnight became an incredibly cut-throat, sharp elbowed and ruthless place to work. Sales people started to be pressed hard to use pushy and underhanded telemarketing sales tactics to close deals. “It’s a total boiler room sales culture [now]. And it’s really hardass. It’s pretty hardcore.”
Prior to its much-ballyhooed IPO, daily deal industry site Yipit released an in-depth analysis of Groupon’s S-1 filingwhich revealed startling operational cracks in its business model. Yipit’s analysis showed stunning weaknesses in Groupon’s business that included the following:
- Top line growth peaked around Q3 2010 but has been deteriorating ever since.
- Revenue per customer is steadily declining.
- Customer renewal rates are declining.
- Soaring customer acquisition costs. 500% increase year over year from 2010 to 2011.
- Number of Groupons sold per deal rapidly declining.
- Operating margins declining and face enormous downside pressure from competitive forces.
- Revenue per Groupon customer is steadily declining
Can someone say dead-man walking?
To add a cherry to the sundae, Groupon had to remove their very controversial accounting metric called Adjusted Consolidated Segment Operating Income (ASCOI) from its financial statements prior to its public filing because of criticism from the Securities Exchange Commission. The fact is that ACSOI measures profits BEFORE subtracting customer acquisition costs and stock-option compensation. In Q1 of 2011, Groupon posted a net loss of $113.9 million but reported ASCOI “profits” of $80.1 million.
Groupon’s use of ACSOI was a thinly veiled attempt to put lipstick on a pig prior to its public stock offering. Bottom line, Groupon has NEVER been profitable and simply used the ACSOI metric to feign profitable respectability, which it clearly doesn’t have. The SEC tends to frown on make believe accounting terminology that attempts to demonstrate profitability without actually being profitable.
While the SEC never officially dubbed the ASCOI metric as “irregular”, investment professionals like CNBC’s Jim Cramer and the investment community have special consideration for accounting irregularities in particular: “Accounting irregularities equals sell.”
To paraphrase, if a high profile stock suddenly announces a restatement of earnings due to “accounting irregularities”, you should immediately sell that stock. Groupon looks about as profitable of an investment as giving away your merchandise for 90% off.
The bottom line is that any time a fledgling company has to invent an accounting metric to prove that it’s profitable, doesn’t that tell you everything you need to know about what the company already knows about itself?
If it walks like a duck and talks like a duck, it’s not a cute puppy.
Bogus Business Model
Groupon’s real problem is that it has yet to discover a practical, viable business model. The company has not achieved profitability and some analysts predict that profitability won’t happen until late 2013 or early 2014, that’s if it arrives at all. The company claims that it can reach profitability once it “scales” but there’s no evidence that Groupon actually has the “network effect” that it claims will drive its scalability.
At the end of the day, the poor value proposition for merchants and operational vulnerabilities will be Groupon’s ultimate undoing. The limited offer applicability and low switching costs will continue to bait new competition into the marketplace putting even more downward pressure on margins as Groupon’s costs continue to soar. One industry analyst estimates that selling, general, and administrative (SG&A) expenses at the company of more than 50% of projected full-year revenue in 2011. And while their corporate culture is undoubtedly fixable, a technology company that lacks innovation will accelerate Groupon’s undoing.
The fact that Groupon quickly swelled from a small start-up to a burgeoning multinational enterprise with over 10,000 employees is very worrisome. History has shown time and again that exponential growth in companies that operate in unproven and non-traditional industries lead to strikingly quick implosions (Pets.com, eToys). Many industry pundits believe that Groupon is little more than a house of cards that will come tumbling down just as quickly as it was built.
Compounding these worries are the aforementioned internal problems at the company, which has had a very hard time keeping a Chief Operating Officer (COO) on board, and many of the company’s early employees are demanding extravagant pay raises because they feel entitled to share in its incredible but possibly short-lived success. The company’s founder and board members have also been accused of jeopardizing the long-term viability of the company for opting to take a $900 million cash payout that could have been reinvested in the long-term growth of the company. Finally, the Securities and Exchange Commission (SEC) has been probing the company’s finances, only to find that Groupon’s leaders are reluctant to open their books to external, impartial auditors.
At one point, Google offered $6 billion to take over Groupon and to add to its stable of Internet properties. The company balked at the offer, and when the Initial Public Offering (IPO) of the company’s stock was first announced, Groupon was valued at $25 billion. However, that figure has since been revised to less than half the original valuation.
Consumers continue to use the company’s offerings because, for them, it’s a no-risk proposition offering significant savings. They have everything to gain and nothing to lose. However, the same is not true when it comes to potential investors, who were initially salivating at the prospect of being part of the fastest-growing company in history but are now exercising caution. Due diligence suggests that caution is indeed a wise approach, and that outright avoidance may be even wiser.Bill Hazelton is CEO & Founder of Credit Card Assist, an industry leading credit card comparison site, offering advice and tips on balance transfers, cash back rewards programs and all things credit-related. You can also find him on Google+, Twitter and Facebook.
Editor’s note: Guest posts are published when ideas are well written and thought provoking. Publishing does not equal endorsement.