Is Groupon Doomed?

Reply Thu 25 Aug, 2011 07:45 pm

Groupon Doomed by Too Much of a Good Thing
10:17 AM Tuesday August 16, 2011
by Rob Wheeler | Comments (174)

"Alright, you caught us. We're actually not making any money. In fact, we are really losing a lot of money."

This is the essence of Groupon's declaration last week that it will remove the controversial accounting metric called Adjusted Consolidated Segment Operating Income (ACSOI) from its financial statements. ACSOI essentially measures Groupon's profits before subtracting its subscriber-acquisition costs and stock option-based compensation. The metric was an attempt to put a thin veneer of respectability on what are extremely disconcerting profitability numbers for the company. In the first quarter of 2011, Groupon posted a net loss of $113.9 million. Yet, the company reported ASCOI of positive $80.1 million. In most recent quarter, Groupon's losses continued to mount as it begrudgingly abandoned the ACSOI metric amidst criticism and incredulity from the SEC.

But what is most interesting about its emphasis on the ACSOI metric is that, deep down, Groupon knows what we all know: good investments are profitable investments. It was simply not enough for the firm to report earnings and explain that it was investing for growth. Rather, Groupon felt the need to include a metric of profitability, no matter how contrived, that was actually positive.

Clayton Christensen would agree with the intuition that Groupon displays but ignores: businesses should become profitable before they become big. The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth. Such a strategy limits an early venture's funding in order to force the business to develop a profitable business model and then invests heavily in growth once such a model is identified — Christensen terms such investments "good money" for incubating growth businesses and extols the strategy for three reasons.

First, when a business is impatient for profit, managers are forced to validate their assumptions and demonstrate that customers are fundamentally willing to pay an acceptable price for the company's offering.
Secondly, expecting a business to be profitable quickly forces it to keep its fixed costs low. Because a business's cost structure determines which customers it finds profitable, keeping these fixed costs low preserves strategic options for the company when it is choosing which customers to target.
Finally, reaching profitability quickly ensures that when outside financing dries up, the venture can succeed on its own.

Groupon's fundamental problem is that it has not yet discovered a viable business model. The company asserts that it will be profitable once it reaches scale but there is little reason to believe this. The financial results of Groupon's traditional business continue to deteriorate, especially in mature markets, and new ventures such as Groupon Now also have failed to drive profits. And unlike the very few successful companies that scaled before they were profitable (think Facebook or Amazon), Groupon's business model does not benefit from significant network effects. The company's product is not more valuable to users as more people adopt the platform. If anything, the fact that Groupon is witnessing decreasing revenue per merchant and fewer Groupon purchases per subscriber in its maturing markets suggests that growth may actually decrease Groupon's value to its customers. Yet, Groupon maintains a blind faith that growth will be its salvation. As Pets.com learned in the last bubble, such a strategy works just fine until you run out of other people's money to spend on growth.

The real cause of Groupon's problem is that it had too much of a good thing. With over $1 billion of venture capital money to invest in growth, what manager has time to worry about profitability? Groupon's "bad money" — investments that were patient for profit but impatient for growth — did not instill the discipline needed to enable the company to emerge as a successful standalone venture. Now, the venture capital markets cannot supply more capital and the company must depend on the IPO market to finance its money-losing operations. Eventually, investors will be unable to sell their shares to a greater fool and Groupon will be added to the list of companies that had immense potential but died because they did not find a successful profit formula in time.

The story would be much different if Groupon did not have nearly unlimited access to funding so early in its corporate life. A successful financing strategy would have provided Groupon with incremental investments to enable the development of a profitable business model around a product that had obvious appeal to customers and merchants. In such a world, Groupon would have stuck to its home market of Chicago until it developed a business model that was profitable at scale in one market. Armed with a viable profit formula, Groupon could have scaled aggressively — confident that much larger profits awaited it.

But it is now too late. Groupon needs another $750 million to keep the lights on and to keep growing while it prays for profitability that will perpetually lay just one funding round away. Groupon's venture investors and executives need a way to cash out before everyone realizes that the emperor has no clothes. I will probably buy a Groupon every now and again — I have no problem letting investors finance my cheap consumption. But as far as an investment goes, Groupon is looking about as profitable as giving away your merchandise for 90% off.

If you have outstanding credit with Groupon, spend it.

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Reply Thu 25 Aug, 2011 08:18 pm
Groupon is stuck in an overpopulated market with Living Social, New York Mag has its own version, so does the Village Voice, Google has its own too, and 15 dozen other sources have their own version of Groupon.
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Reply Thu 25 Aug, 2011 09:34 pm
Reminds me of the DotCom boom, when companies would get venture capital and blow it all on company parties rather than anything that actually built value.

These venture capitalist angels need to provide some business savvy along with the credit line.
Reply Fri 26 Aug, 2011 05:26 am
Angel investors are usually brought in for small money and less interference with the founders' work/vision/etc. Venture capitalists (VCs) generally pay for more influence with bigger bucks but they also get a larger share of the pie. I know you may know that, Drew, but other readers might not.

Frankly, as a member of a startup, I would love to have an investor option where it was someone who could offer decent, experienced advice without making me feel like I'm being raped out of a significant share of the founders' creation. I know that these people exist, but they are few and far between.

We have a large startup community here, and the staggering lack of basic business savvy (I do thank you notes here, for God's sake, 'cause no one else can remember to do so -- and we rarely get thank yous from anyone else, or else they're impersonal and automated) is front and center. VC and angel $$ have both gotten tighter around here, and it has again devolved into a "who you know"/"what have you done for me (or investors like me) lately" mindset which makes VCs and angels around here a lot more like informal banks than people who believe in interesting, exciting ideas.

Here's an idea - with each 10% of ownership that has to be given away to an investor, could it at least buy the services of someone who has an MBA?
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