This analysis on Groupon’s recent S-1 filing is a few weeks old, and if we weren’t so darn busy over here we’d have posted it sooner.  The  S-1 filing allows us to take a much closer look at the nitty gritty details of the deal of the day giants’ inner workings than has previously been allowed.

The results are quite interesting.  Take a moment to read through Yipit’s case study on Groupon’s business in Boston (appended below) and while the commentary should be taken with a grain of salt, it is clear that the traditional daily deal distribution models (email marketing, display advertising and social media marketing) which led to a fantastically profitable business model, are gradually being eroded by competitive forces.

This is not a new criticism of the Groupon model.  Way back when things were just heating up for Groupon, some folks were already scratching their head about the fact that the model is very easily copied (little differentiation, lots of competition), users have very low switching costs (I don’t care who sells me the deal, I just want the best deals!) and the pool of quality businesses and quality deals in any given city is actually quite small.

What is particularly interesting is the commentary in the 2nd last paragraph of the analysis by Yipit stating that Groupon’s new GrouponNow feature of mobile local deals may actually be the savior to their problems.

The silver-lining in all of this is Groupon Now, a new mobile product from Groupon that provides real-time deals to users. With its massive salesforce and many merchant relationships, Groupon is possibly the only company capable of having enough deal inventory to make a product like Groupon Now possible. If they are able to make the business model work, then Groupon will have the eventual network effect.

We see this as promising because Clip’s location services platform allows publishers and directories to take advantage of their existing network effect and publish local mobile deals content within their existing mobile assets.  We believe that deal content (daily deal, or mobile coupons) are a new and exciting content and revenue stream for local advertising, however, at Clip we do not believe that deal content is sufficiently sticky or engaging enough to have its own content channels.  Deals are best served on the properties and apps that users already frequent to get their daily dose of news, sports, weather etc.  Yes, there will be power users who use aggregation services like OneSpout, DealRadar, TheDealMap or any number of other aggregators that keep popping up all over the place, however, they face the same CPA battles as the daily deal sites in acquiring users who just aren’t in to your brand.  Especially in the case of mobile apps, getting a user and keeping a user are two very different things.

In the meantime, publishers continue to struggle with how they are going to monetize their newly launched digital media assets.  Over the coming years, eyeballs are continually going to shift away from newsprint to digital sources.  Publishers have the tough job of figuring out how to get paid in digital the same way they did for print (advertising based on subscription).  Display ads still kind of suck on both web and mobile in terms of user engagement and the economics behind them.  At Clip, we feel that personalized and localized (read: relevant) deal content is something mainstream news readers are asking for, and would actually be willing to pay for.    In this very interesting commentary on the problem with newspaper paywalls, digital media scholar Alfred Hermida, argues that news headlines have always been a commoditized market, but people were willing to pay for “the wrapper” that a newspaper came in.  The fact that it showed up at your doorstep every morning, as well as all the add-ons you get beyond the headlines ie. the sports, obits, classifieds and real estate sections.  Try taking the “done deals” section of the Friday Globe away from my mother and you will see what I mean.

Please feel free to chime in below with any comments on the Groupon Analysis or thoughts on the Clip approach to the daily deal economy.  We’d love your feedback.

- Dave Offierski

Groupon S-1 Reveals Business Model Deteriorating in Oldest Markets

by yipit on June 3, 2011

While no one has ever doubted Groupon’s impressive topline growth – the question has always been around the defensibility of a business that has so few barriers to entry.

In its long awaited S-1, it’s clear that Groupon has impressive topline growth. However, when looking at its oldest markets, it appears that their business model is deteriorating.

Groupon’s Network Effect?

• On the consumer side: “Increased relevancy enables us to offer several daily deals, which we believe results in increasing purchases by targeted subscribers, thereby driving greater demand for Groupons.”
• On the merchant side: “Increasing our merchant base also increases the number and variety of deals that we offer to consumers, which we believe drives higher subscriber and user traffic, and in turn promotes greater merchant interest in offering deals through our marketplace, creating a network effect.”

However, when looking at the data for their Boston market, it does not appear that that Groupon has achieved this virtuous cycle.

The Boston Case Study

While Groupon is relatively opaque for most of its filing, it provides case studies of four of its major cities. We look at Boston since Chicago, the other US city, is Groupon’s home town.

Despite being one of Groupon’s oldest markets, Boston had demonstrated impressive growth: revenue, subscribers and customers have all tripled in the past year. This topline growth has been aided by the launch of personalized deals in Boston in Q3 2010: Groupon started running multiple deals per day in Boston through its targeting/personalization initiative.

Deeper analysis of the Boston case study, however, shows that despite impressive topline growth Groupon’s business model peaked around Q3 2010 and has been deteriorating ever since.

Consumers Buying Fewer Groupons

On the consumer side, we just need to answer one question:

Does Groupon’s ability to send targeted/personalized deals to subscribers (thanks to its large merchant base) drive increased demand for Groupons?

If this were true, it would imply that activity and revenue per subscriber metrics would increase right along with Groupon’s increased deals per day.

However, Groupon’s quarterly revenue per subscriber is declining Boston.

Groupon’s business model is predicated on the idea that the company can stomach the ever-increasing customer acquisition costs since an acquired customer should generate a steady flow of high margin revenue.  However, this relies on existing customers purchasing several subsequent deals.  While existing customers are indeed purchasing subsequent deals, they are doing so at a declining rate, despite Groupon’s recent targeting efforts.

Far more worrisome for Groupon is the fact that its existing customers (those 20% of subscribers who have ever bought a Groupon) are also becoming less engaged. The Boston Case Study reveals purchases made from existing customers by removing the impact of purchases made by new customers each period:

Frequently when you see this deterioration in a company’s existing customer base it is because the average customer is getting “older” and these “older” customers tend to be less active.

However, due to the exponential growth in customers, the average “age” of Groupon’s customer base has been roughly the same since Q1 2010. In other words, the average customer isn’t getting older.

As Groupon begins to reach saturation in Boston and its customer base inevitably ages as a result, reversing the decline in participation from its existing customer base will only become more difficult.

Groupon’s Customer Acquisition Costs are Rising

And of course, right when Groupon’s customers are becoming less engaged, and therefore less profitable – Groupon’s costs to acquire customers are skyrocketing.

Given the recent entrance of well-financed competitors such as Google, Facebook and Microsoft its hard to believe Groupon’s customer acquisition costs will slow anytime soon. Along with declining engagement from existing customers, this does not bode well for the future of Groupon’s margins.

Groupon Selling Fewer Deals per Merchant

The second question is whether Groupon’s industry-leading subscriber base will attract merchants willing to pay a premium to run with Groupon and preventing other players from effectively driving down gross margins to compete on cost.

According to Groupon, merchants are willing to pay a premium for their reach.

However, Groupon’s targeting/personalization strategy is leading to a decline in the number of Groupon’s purchased per deal as the number of deals Groupon is running per city far outpaces the growth in subscribers.

Should personalization increase conversion rate per deal, this may offset decline in reach – Groupon could presumably increase total merchant satisfaction by satisfying more merchants more efficiently. However, as the average purchases per customer continues to decline so will overall conversion rates on personalized deals.

Groupon’s decision to rapidly increase the number of deals per metro has allowed competitors to credibly tell merchants that they deliver more customers than Groupon can in major cities such as Boston. Based on the Yipit Data Product, which features nearly 20,000 offers per month across major US metros, both Travelzoo and LivingSocial now average more vouchers sold per deal than Groupon in most major North American cities.

Several other players such as OpenTable, WagJag, DealFind regularly sell as many or more vouchers per deal as Groupon in major markets as well. This calls into question any network effect that Groupon thinks it may have by having the largest subscriber base in the industry.  Merchants won’t pay a premium for total subscribers if Groupon can’t deliver more new customers than the competition.

If Groupon can’t charge a premium for its larger subscriber base, what competitive advantage or network effect does it have on the merchant side of the market?

Groupon Operating Margins Declining

While Groupon is experiencing rapid revenue growth, we believe operating margins are declining because, as we’ve shown above:

• Revenue per Groupon customer is declining
• Cost to acquire those customers are increasing
• Sales costs are increasing as it needs to run smaller deals with more merchants to personalize the experience

While Groupon doesn’t reveal costs in Boston, by taking company-wide customer acquisition costs and SG&A costs (allowing for some opearating leverage) you see significantly declining operating margins.

Why Is This Happening? Competition Has Arrived

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.

“Groupon Now” May Be the Answer

The silver-lining in all of this is Groupon Now, a new mobile product from Groupon that provides real-time deals to users. With its massive salesforce and many merchant relationships, Groupon is possibly the only company capable of having enough deal inventory to make a product like Groupon Now possible. If they are able to make the business model work, then Groupon will have the eventual network effect.

What Does This Mean For the IPO?

As one of Groupon’s oldest markets, Boston offers a glimpse into the future as the rest of Groupon’s business matures. Declining revenue per user, increasing customer acquisition cost, and declining operating margins do not bode well for the company’s core business.  Given all of this, Groupon’s IPO valuation may come down to how investors perceive the prospects of Groupon Now. Since Groupon only recently launched Groupon Now in a few test markets and has not yet provided data on those launches, it remains unclear how investors will value Groupon Now.

Follow @YipitData on Twitter for the latest industry trends and analysis by the Yipit Team.

David Sinsky, Jim Moran and Vinicius Vacanti contributed to this post. David runs Yipit’s Data Product, which provides past offer detail and competitive intelligence to the Daily Deal Industry.