Groupon and It's Future

Synopsis:

Who doesn’t like to enjoy a good deal on dinner in a nice restaurant? Groupon allows it’s subscribers to experience discount deals on daily group coupons with merchants, get aways and experiences, and discounts on services and goods. Groupon’s goal is to serve as a marketing conduit between the merchant and Groupon’s subscribers. The merchant doesn’t have to pay Groupon anything unless the merchant is actually making money on deal presented. Basically, When a Groupon deal happens, Groupon gets a cut of the revenues from the retailer that offered the deal. Each coupon on the site has a predetermined minimum. If not enough people sign up for the deal to take effect, neither Groupon nor the business makes any money. Groupon has become an alternative to traditional advertising, where business owners pay up front and hope for the best.  In the Groupon platform, these promotions are like a whole new form of local advertising, where merchants only have to pay for real result. From the Groupon subscriber point of view, Groupon is a free service for everyone to join. Each day, Groupon will send an email announcement to its subscribers, describing the daily deal in the subscriber’s area. Commonly, the deals are 50% discounts at a restaurant, or 50% discounts at a specific store. If you like the daily deal, then you purchase an electronic coupon directly from Groupon. You print that coupon, take it to the restaurant or store, and redeem it for Groupon’s value. Groupon has used this business formula to grow within 16 months from 5000 local Chicago subscribers to 36.8 million registered users worldwide in.  (Page 501)

Groupon started as a reaction to poor service. Groupon’s founder Andrew Mason was having difficulty with cancelling a cell phone contract and out of his discontent, he thought about how he could leverage the power of a large group of people to utilize a theoretical tipping point. A tipping point is when there is enough pressure brought on by enough small changes, (people’s attitudes and reactions) that significant change could occur. Mason took his concept and with Eric Lefkofsky started a website called The Point. What they discovered was that the most successful campaigns undertaken on The Point involved consumers aggregating their buying power to lower purchase prices. They then decided that they could capitalize on that effect and use the group as an engine to generate group purchasing power. They were able to convince local merchants that they had enough of a subscriber base to drive marketing campaigns to their subscriber base and drive the group’s buying power to the merchants. They switched from The Point and Groupon was born in October 2008. Groupon’s first deal was a buy on get one free deal from a pizzeria in it’s own building. From there Groupon grew to being a $1.6 billion dollar company (in revenues) with 150 markets in North America, 100 markets in Europe, Asia, and South America and had 35 million subscribers. In November of 2011, Google made an offer for Groupon of US $6 billion dollars, which Groupon rejected. Instead Groupon decided that it would go public with a $700 million offering. While the initial public offering was considered successful, the stock has not been the shining star everyone expected. From the 2011 initial public offering to August 31, 2012, a period of only 10 months, Groupon stock fell 84% from $26.11 to $4.15. One of the reasons for Groupon’s free-fall in the it’s stock market price is that Groupon has not made any operating income from it’s start in 2008 through 2011. Groupon is very good at cash flow though, in that it collects funds immediately for the daily deals, while paying merchants in 60 days. Groupon’s stock market share was also affected by having to restate it earnings  “to correct for error in its presentation of revenue” in its March 31, 2011 financial statements. Revenues were states as 54% higher than they actually were.

Groupon’s business model was easy to understand but hard to restrain. Groupon has outlined five distinct strategies for its mission. They want to grow its subscriber and customer base. They want to grow the number of merchant partners it features. Groupon want to position itself to benefit from technological changes that may affect consumer behavior. Increase the number and variety of products through innovation. They want to expand with acquisitions and business development partnerships. In realistic practice though, Groupon is very good with customer service, but very hard to nail down on business fundamentals.  Groupon brings local merchants who have tangible goods and services in touch with people who are internet savvy and want high value. Groupon also has a model for how it works with its merchants. Groupon is very customer focused and promises that “If the experience using your Groupon ever lets you down, we’ll make it right or return your purchase.” (Page 490). Deals are presented to subscribers and if insufficient interest is unavailable, then the deal is removed from offer. Groupon also is very careful whom it picks as a merchant and there is a selection process that vets out any undesirable partners. Only on in eight merchant applications are accepted. This helps insure that the Groupon promise is kept. Groupon’s basic business fundamentals on the other hand do not seem to have the same high standards. The overstated revenue issue was already discussed earlier. Another issues is that Groupon does not use common business metrics in judging itself and this leads to further confusion and possible scrutiny. For example, Groupon used metrics such as adjusted consolidated segment operating income, free cash flow, and gross billings rather then net income. (Page 502) Consolidated segment operating income is defined as “the consolidated segment operating income before new subscriber acquisition costs and certain non-cash charges.” (Page 502) Groupon felt that this metric was closer to its operating philosophy in that it did not include expenses unrelated to future operating expenses. Free cash flow is defined as cash flow reduce by purchase of property and equipment, and gross billings are defined as the gross amount collected from customers for Groupons sold. Gross billings did not include merchant revenue and this way the metric could be used to measure growth. The use of obtuse metrics was common in Groupon and the argument can be had that Groupon is a unique company, but these types of financial obfuscations can only lead to market distrust. From a customer service side, Groupon does well, but from an internal financial controls and measurement, Groupon leave much to be desired.

Finding of Fact #1:

Groupon’s financial statements are subject to The Sarbanes–Oxley Act of 2002 for a publicly traded firm and Groupon has shown that they are compliant. But in order to truly understand their financial position they need to drop the creative metrics and focus on establishing a positive net income.

Recommendations:

        Groupon is very good at cash management in that Groupon collects cash at the time of service and pays out its costs 60 days later to merchants. This is highly desirable for any business enterprise because basically you are getting paid before your suppliers. Where Groupon needs to look deeply is how it measures itself financially so that it had a clear perspective of its financial performance. Rather than be creative with financial metrics such as adjusted consolidated segment operating income, free cash flow, and gross billings, it needs to address it’s core issue of negative net income. A company can survive on cash flow for a long time at long as it’s able to cover fixed costs and most variable costs, but it’s a slow death without profit. Groupon needs to be clear on it’s fundamentals, such as net income, gross margin, and actual expenses. Once these are laid out, then it can have a direction on what to cut back and where to apply resources to get stronger. Areas that they need to look at for net income correction are marketing and SG&A. SG&A is Sales, General and Administrative expenses. Whiles revenues have been increasing, Marketing costs are not aligned with sales, so how can you tell if your marketing effort is yielding the effects needed. In 2010 marketing costs were 93% of revenue, in 2011 marketing costs were 77% of revenue, but in 2009 marketing costs were only 35% of revenue. In the years 2009-2010 revenue grew by a multiplier of 21 times or from $14,540,000 to $312,941,000, but in 2010-2011 revenue grew only a 5 times pace. Groupon needs to scale back and address how to market effectively for about 40% of revenue, similarly as it did in it’s earlier years. Marketing should be considered a variable cost that it tied to revenue generation. There is s similar situation with Sales and General Administration (SG&A). As a company starts to mature, SG&A should decrease due to efficiencies that naturally occur. You develop momentum and standards of practice and are able do tasks in more repetitive and efficient ways. Groupon is at 51% SG&A cost after 4 years. This is too high and needs correction. Sales cost is variable to sales generation and revenue creation, but needs to be addressed on its return of investment.  Groupon spent significantly more money on SG&A in 2010 than 2009, without the same percentage of growth in revenue. They decreased back to a little better more than 2009 in 2011, but revenue growth was actually negative after the restatement of financials. Fundamentally, Groupon needs to address how it spends it cash to drive net income to profitable. Their cost structure is out of whack and needs to be addressed rather, rather than just chase top line sales.