How effectively does Groupon leverage its size?

By Felix Salmon
June 4, 2011
David Sinsky has some extremely smart Groupon analysis over at the Yipit blog, using numbers from the company's S-1 to throw into question just how good Groupon is at making ever-increasing amounts of money once it has entered a market.

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David Sinsky has some extremely smart Groupon analysis over at the Yipit blog, using numbers from the company’s S-1 to throw into question just how good Groupon is at making ever-increasing amounts of money once it has entered a market.

That is, after all, the explicit rationale behind Groupon’s ever-increasing losses:

We spend a lot of money acquiring new subscribers because we can measure the return and believe in the long-term value of the marketplace we’re creating. In the past, we’ve made investments in growth that turned a healthy forecasted quarterly profit into a sizable loss. When we see opportunities to invest in long-term growth, expect that we will pursue them regardless of certain short-term consequences.

Groupon breaks out granular details for four cities in its S-1 — Chicago, its home; Boston, its second-oldest US market; Berlin; and London. The first is unique in many ways, while the last two were acquired when Groupon bought CityDeal, so Sinsky concentrates on Boston. And finds this:

Rev-per-Sub3.png Rev-per-Cust1.png

These charts show quarterly revenue per subscriber, on the left — that’s people getting Groupon’s emails — and per customer, on the right, which is people who have actually bought coupons. Both are going down, which is worrisome.

The reason to worry about these trends is that as many people including Joshua Gans have said, the daily-deal space has very low barriers to entry and is highly competitive. As such, if Groupon has a “moat” — a comparative advantage over its competitors which is very difficult to overcome — it’s its sheer size.

Size confers many advantages, not least targeting. As Kaiser Fung notes, the more new customers and fewer existing customers that a Groupon reaches, the more profitable it’s likely to be for the merchant concerned. The best Groupons target a whole new audience for the merchant in question: the S-1 gives the example of a cruise line which was doing very well with its murder-mystery cruises but much less well with its romantic-dinner cruises. By offering a Groupon valid only for the romantic-dinner cruises, the company managed to broaden its customer base without losing revenues from its existing customers.

Benjamin Edelman says that for a Groupon to be highly profitable, it should be targeted at people who are “particularly unfamiliar with a participating merchant’s services.” And it stands to reason that Groupon, with the largest subscriber base and the most sophisticated targeting technology, should be better able to target Groupons at relatively narrow classes of people than any of its subscribers.

At the same time, because the best Groupons are aimed at people who are likely to become regular customers of the merchant in question and who are well-disposed towards trying it out, sophisticated targeting should increase Groupon’s conversion rate substantially. Rather than just send the same deal out to everybody in a city, Groupon should be able to show you only those offers you’re most likely to want, and thereby increase its conversion rate.

Sinsky says that doesn’t seem to have happened in practice: “As the average purchases per customer continues to decline,” he writes, “so will overall conversion rates on personalized deals.” The trend isn’t good: Groupon’s Boston customers are less engaged, and less profitable — even as Groupon’s costs for acquiring new customers continue to rise.

That said, Sinsky doesn’t think that what we’re seeing here is a failure of Groupon’s targeting per se. Instead, we’re seeing the effects of competition. Which is where Yipit’s own data comes in:

A year ago, according to Yipit data, there were 9 daily deal services in Boston offering 15 active deals. Today, Yipit Boston shows 23 separate services offering daily deals including new successful entrants like TravelZoo and Yelp. The 23 services are responsible for creating 91 active daily deals. Worse for Groupon, there’s no sign of this ending with Google and Facebook on the horizon. Plus, successful entrants like TravelZoo are still only running two deals a week.

Realistically, what we’re seeing is improvements in Groupon’s targeting technology failing to compensate for the rise in competition (which also increases Groupon’s customer-acquisition costs.) Anecdotally, targeting technology still has a long way to go: for one thing, Groupon still isn’t remotely local enough in cities where people spend most of their money within a mile or so of where they live, and where they often get offers for merchants on the other side of town. But it’s not even clear how Groupon is going to get the kind of highly granular data about its subscribers’ income, and profession, and exact location, and other things which would help it target offers. That’s where the likes of Facebook and Foursquare have a clear advantage.

So while Groupon is still the biggest of the deal sites, the jury’s still out on the degree to which its size is going to prove an unassailable advantage over the long term. In principle, a massive subscriber base could be a huge competitive advantage. But in practice, this could be one area where Groupon finds it hard to execute.

14 comments

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What’s interesting is that a few articles I’ve come across suggest that a key reason for Groupon’s growth has been being in Chicago and not in Silicon Valley… so that they’ve been focused on growth in the sales force rather than the technology back end. They’ve had great success with the merchants and top-line revenue growth but targeting is clearly not optimal (for the third time this week, I dont want half off moisturizer!). It sometimes feels like there’s not much technological sophistication beyond a really big list of emails. Facebook is going to be hard to beat.

Posted by tomhuck | Report as abusive

Groupon’s business model is not sustainable; merchants cannot offer deals where they receive only 25% of their normal revenue (a 50% off coupon, of which groupon gets 50% of the revenue) for too long, or they will go out of business. It’s one thing to offer a loss leader, quite another to put everything on sale.

There are no barriers to entry in this market, as even small websites that are locally operated (and familiar with the merchants and community) can easily compete with Groupon, without a big investment. If merchants want to continue to offer business-killing discounts, they will have other options besides groupon.

Groupon spends way too much on customer acquisition, most of whom don’t even use the service. It might work if there was a guaranteed recurring revenue stream (like a 2-year wireless contract), but there are no penalties for cutting back on your groupon spending when you’re short on cash.

The Groupon IPO will add to the debate on the latest dotcom bubble, and their failure will hopefully accelerate the popping of the bubble, so resources (human, capital, and time) that are being squandered on unnecessary and overhyped websites can be more efficiently utilized elsewhere.

Posted by KenG_CA | Report as abusive

KenG – I don’t disagree with you, but what if 25% of their “normal” revenue via Groupon is better than 0% of their normal revenue via unsold merch?

Posted by KidDynamite | Report as abusive

KD, I guess if most of what they sell via groupon deals are unsaleable, then a 75% off fire sale makes sense. But that just reinforces my first point, that it’s not sustainable, either for the merchant or Groupon. If they have lots of unsold merchandise, they’re not going to last long anyway, and it’s unlikely they will restrict the fire sale to just groupon customers. And if it’s just a little inventory, then it won’t generate much business for Groupon. And it certainly won’t work for restaurants, unless they’re selling day-old bread or leftovers.

Posted by KenG_CA | Report as abusive

Business overlap between different deal-a-day sites is inevitable; the only question is, whose coupons are better deals for the end user? (After all, if all deals are equal, there will be little incentive towards switching, and Groupon wins by default.) This requires one simple rule: smaller margins.

Google Offers utilizes Google Checkout for payment processing, enabling Google to shrink its margins but still gain a profit from one end or the other. In very short order, one would expect Google to use its Android base to streamline the process of utilizing mobile Offers via Checkout. That is a powerful thought.

Yes, barriers to entry are very low. But with Amazon and Google entering the ring, it’s no longer the barrier to entry that matters, but economies of scale and quality of coupons / simplicity of coupon buying, that will determine the survival of any given site. (Proof: Dell Marketplace…few people use it, because it’s a convoluted process to get in on a coupon.)

Posted by GRRR | Report as abusive

Felix & readers might find this one interesting:

http://www.knewton.com/blog/knewton/from -jose/2011/06/03/groupon-is-a-straight-u p-ponzi-scheme/

Posted by KidDynamite | Report as abusive

I live in suburban Connecticut, where Groupon does not yet have local merchants (closes is 45 minutes away in Hartford). However, there are a number of local imitators. I signed up for one, and was getting the “daily deal”. None really interested me, but I started checking out the details on a few of them. Inevitably, the same “deal” was available, in many cases a better one, on the merchants website. I also checked with two local merchants I know who initially signed up. Both said that the deal was unprofitable for them, and that they had no intention of continuing. So, no deal for the customer, and a bad deal for the merchant. Sounds like a sustainable business model to me.

Posted by bff426 | Report as abusive

We’re told almost daily that the American economy is suffering from a huge demand shortfall that is affecting businesses’ ability to make money and create jobs. The economists tell us to use government spending to stimulate job creation. On the other hand, we have companies like Groupon whose business model seems to be extracting a fee and creating even more pricing pressure on the same struggling businesses who won’t hire anyone. Here’s a thought… go shopping and pay full price. Won’t that be a much better stimulus?

Posted by silliness | Report as abusive

To draw in new people (the reason merchants make the offer), you have to attract the people who don’t usually patronize the place.

To interest consumers, you have to offer a place that people are naturally inclined to patronize on a whim, but will come back to on a regular basis at less of a discount.

Jessica Bloody Hagy could illustrate the sustainable Groupon market, but no one would believe it. The only thing that makes it sustainable is the pretense that Groupon e-mails are not spam, and those revenue levels suggest that more and more people are treating them that way.

Posted by klhoughton | Report as abusive

KD, I hadn’t seen that link you provided to Knewton, but if I had, I would have done what you did and not spent all that time writing my comments.

In addition to Felix and us readers finding that interesting, I would think would-be buyers of Goupon’s IPO shares would find it interesting, as would any merchants who are considering using Groupon.

Posted by KenG_CA | Report as abusive

These comments miss the point about Groupon’s business model. Businesses using Groupon don’t actually want to make a sale. Yes, they want to sell PRE-PAID vouchers that EXPIRE in a short time frame, but they don’t actually want customers to show up at the door. If you actually look at what’s on offer at Groupon, it’s usually services that can only be offered at a measured pace to a few customers per day (in my local area, Groupon appears to specialize in discounts on colonic irrigation). Combine this with vouchers that expire within three to six months and the end result is that there are going to be a whole lot of pre-paid, but unirrigated colons out there where the merchant (and Groupon) make a whole lot of money for doing nothing. This is a mug’s game for consumers, which they’re clearly cottoning onto.

Posted by RichBerkshire | Report as abusive

It doesn’t help that they have loopholes. Users register multiple accounts to earn $10 commission!

http://blog.just2us.com/2011/07/how-to-a lways-earn-10-for-each-groupon-deal/

Posted by samwize | Report as abusive

On a merchant capital project we tried this and people signed up with multiple accounts just to receive the $20 commission we were offering on one of the big commission sites, cj.com.

Posted by MerchantMaster | Report as abusive

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Posted by traducator romana daneza | Report as abusive