Groupon’s monumental revenue growth has certainly made the company a preferred choice for private investors in the last 2 years. However, this growth has come at the expense of Groupon burning cash quickly to fuel its marketing expenses. We take a quick look at how Groupon has fared in its revenue and expense growth so far, the factors responsible for it and what the consequences it can have on the company in future. From this we believe that Groupon will need to slow its growth to focus on profitability per customer otherwise customer acquisition costs will weigh on its growth outlook and ultimately its valuation.
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A bulk of Groupon’s operating expenses are directed towards its marketing initiatives, with total marketing expenses already crossing $610 million for the first nine months of 2011 alone. Groupon’s strategy has consistently been to grow the number of subscribers in its mailing list under the assumption that this rapid expansion in subscriber base would ultimately lead to more Groupon buyers who will be retained by the company in future.
The statistics however portray a relatively worrisome picture of Groupon’s marketing expenses. Figures from Groupon’s own S-1 filing show that its getting increasingly expensive to acquire a new subscriber. Given the easy duplication of the daily deals business model and the hundreds of Groupon clones already in the market, this trend could get worse for Groupon and slow its growth over time.
Groupon has always justified its marketing expenses under the assumption that these would eventually become “loyal” customers, after which Groupon will stop expanding, hence drastically cutting down its marketing spend. However, loyal users mean that each customer acts as a long-lasting revenue stream for Groupon, which has unfortunately not been the case as the numbers reveal.
The above 2 trends lead to an alarming conclusion: Groupon is increasingly spending more to add each new subscriber. However, these subscribers do not prove to be long-standing with their revenue contribution steadily declining over time.
Overall, the above two trends are not a big surprise in the daily deals space. Given the intense competition, marketing expenses can keep increasing relative to per capita revenue as Groupon continuously battles against more and more competitors. Additionally, daily deal users would also consist of bargain-hunters who are simply looking for the cheapest deal rather than being loyal to one particular discount provider. This lack of loyalty leads to the declining per capita revenue as shown above.
Solution: Tap the Brakes on Growth to Improve Profitability
While the marketing vs. revenue issue might not spiral out of control for Groupon yet, we expect that it could soon trigger a change in the company strategy. Groupon’s growth that made it wildly popular can very well act as its biggest problem in future, and the company needs a re-think of its business model. The first steps it can tap the breaks on marketing expenses and focus on further monetizing existing subscribers. The challenge would be to keep Groupon’s existing customer base happy, whether its through better personalization or bigger discounts.
Additionally, Groupon may need a better filtering process for its merchant base. High variable cost businesses such as restaurants might see Groupon as a raw deal. The key would be prioritize businesses which have low variable costs (such as spas) and hence can afford to run Groupon deals on a regular basis. That can provide an upside to the total deals sold, hence increasing per capita revenue.
We recently launched coverage on our analysis of Groupon with a $8.6 billion valuation estimate.