Groupon Following Yahoo-esque Strategy – A Bad Move

In June of this year, Groupon filed their S-1, ending speculation about their IPO plans. However, since then, not only has the company been impacted by unfavorable news, but the present volatile market conditions has also raised doubts on the feasibility of an IPO that was expected to raise $750 million at a valuation of $20 billion. Groupon’s IPO was expected in the fall of this year.

Goupon’s Financials
According to recent results, Groupon’s growth is still going strong. The number of email subscribers in North America increased to more than 40 million compared with 37 million subscribers in the previous quarter and a mere 6.9 million subscribers one year ago. The number of international subscribers grew to 75.5 million in the recent quarter compared with 52.4 million last quarter and 3.5 million a year ago.

Groupon generated $878 million in gross revenues for the quarter, compared with $644.7 million a quarter ago. Groupon’s international business has grown big. Revenues from international operations are now $535.1 million, while revenues from North America stood at $342.9 million for the quarter. The company reported a net loss of $102.7 million for the quarter, more than double the previous year’s $36.8 million loss.

A Declining Merchant Pool
Groupon’s merchant pool also fell – from 20,233 last quarter to 20,041 this quarter. The declining merchant basis is a reflection of merchants’ reactions to Groupon’s revenue model: Groupon charges almost 50% of revenue share on a deal. Many businesses believe it to be a big price to pay for a coupon that already encourages deep discounts. According to a study of 150 businesses conducted by Rice University’s Jones School of Business, 32% of the businesses found the Groupon deal to be unprofitable and more than 40% of them said they would not run a campaign again.

For Groupon’s growth to continue, the company needs to continue to add new merchants. In general, they do not have long-term arrangements with merchants and need to spend significantly on marketing to attract and retain merchants to increase revenues.

Groupon’s Accounting Policy 
Last year, Groupon spent $263.2 million on marketing compared with $4.5 million in 2009. Marketing expenses as a percentage of revenues rose from 14.9% in 2009 to 36.8% last year. To account for these high expenses, Groupon has created their own financial metrics that are not compliant with generally accepted accounting principles, or GAAP. Groupon uses “adjusted consolidated segment operating income” a metric that excludes marketing and acquisition costs, when reporting financials. This metric allows them to show an operating profit even though they had a net loss of $413.4 million last year and $113.9 million this quarter.

Such accounting practices are being reviewed by the SEC and until a decision is made by the authority – one is expected next month – Groupon may not be able to move ahead with their IPO.

A Better Path for Growth
Meanwhile, I have a few observations about the company’s strategy. One, I think they should stop chasing new subscribers and focus on servicing their current customer base better. I have a Groupon account, and most of what shows up there is crap. Why not go deep into each region or city in which Groupon has large concentrations of customers and serve them well? I live in Menlo Park, California. I would like to receive really interesting offers from the Menlo Park-Palo Alto area, not offers from San Francisco or San Jose – both cities are more 25 miles from where I live.

Second, losing merchants is very bad news. Groupon needs to adjust its business model so that it can preserve the revenue-sharing dynamic but not drive merchants into the territory of unprofitable transactions. That would be tantamount to killing the proverbial golden goose. Remember, Groupon doesn’t have a product to sell on its own. It makes money when the products of those merchants are sold.

I suspect that Groupon, if it focuses on serving its current subscriber and merchant base better for a couple of years and spends less on marketing to grow internationally, the company will have a much more robust P&L, and it will no longer find it necessary to cook up funny accounting principles.

As it stands, Groupon is following a bad strategy of expansion at ridiculous costs without enforcing the discipline of monetization. If it continues down this path, an excellent role model could be Yahoo, once the Web’s largest site. Even today, traffic isn’t Yahoo’s problem. Monetization is. The company has been consistently lousy at monetization.

Groupon isn’t lousy at monetization, but it needs to be better at it, and it needs to not kill the golden goose: the merchants whose revenue the company relies on to grow in the short term and to survive in the long term.