@gordonbowman

The Groupon, Angie's List and Yelp IPOs Proved One Thing: Local Is Really, Really Hard

That's the one thought I'm left with after reading through the S-1's of Groupon, Angie's List, and Yelp.

Let's dig into the numbers. Here's a look at the losses and revenues for each:

• Groupon 
  • FY 2010: a loss of $456M on revenues of $713M. 
  • Q1 2011: a loss of $146M on $644M in revenue.  
• Angie's List
  • FY 2010: a loss of $27.2M on revenues of $59.0M. 
  • First six months of 2011: a loss of $25.8M on $38.6M in revenue. 
• Yelp
  • FY 2010: a loss of $9.51M on revenues of $47.7M. 
  • First nine months of 2011: a loss of $7.6M on $58.4M in revenue. 

And what's the main driver of these losses? 

• Groupon
  • $208M spent on marketing in the first quarter of 2011 and another $178M on sales people and the rest.
• Angie's List
  • $48M spent on marketing (of which $35 million was on TV ads) and $22M on sales.
• Yelp
  • $38.5M, or nearly two-thirds of its revenue, spent on sales and marketing.

So a very large contributing factor to the losses for each of these companies comes down to marketing and sales. The marketing side of this is pure customer acquisition (read: advertising). And the sales side is simply feet on the street. Or warm bodies hitting the phones.

As Rocky Agrawal noted in his analysis of Yelp, there is very stiff competition in the small business advertising market so earning and keeping their business is difficult and expensive. 

Of course, there is a good reason why these companies are putting so many bodies behind the phones: the local advertising market is massive. So massive in fact that when I tried to find a number for the size of the local advertising market I came across a range from $14 Billion all the way up to $130 Billion. Companies realize that "to the winner go the spoils" so they're dedicating lots of resources to local in order to get out ahead of the competition. 

Indeed, local advertising is such a big market that my own company Pandora is aggresively going after it as well. Although it's a slightly different market in that we're going after local radio dollars specifically -- an area where I think we're well primed to gain market share in.

There are of course many strengths in all of the above businesses. The rate that each of them has grown revenues is no easy feat and should be applauded. I am personally a huge fan of Yelp the product. It's by far the most comprehensive source of reviews out there and the best place to go when I want to find a new restaurant. I am no longer a Groupon subscriber because the emails got to be too much but I've been impressed by their efforts with personalization. And I've bought deals through Groupon Now a couple of times too and been happy with the experience. Marc Andreessen nailed it when talking about Groupon recently in his predictions for 2012:

I've always felt that the criticism of Groupon has been unwarranted. People have really underappreciated what Groupon has done, which is they've created a way for small businesses that aren't online to spend money online and be able to dial up customers on demand. That's a really big deal. 

But investors have to look for the strengths AND the weaknesses of a company. One weakness (if big enough) is enough to cripple even the best company despite its many strengths.

The question, that we've asked before, is can these companies get their marketing and sales costs down even in the long term? I'm of the opinion that a more automated solution is the answer. I know it might be sacrilege for a salesperson to say so, but if a local advertiser wants to book $1,000 worth of ads, should they have to go through a sales rep in order to do so? At some point it is just not scalable.

More importantly, the question gets put back startups: is there a better way to do things in local?

Also: Two Opposing Views on Groupon

Two Opposing Views on Groupon

Given all the news, I have been thinking a lot about Groupon's business model. When they initially released their their S-1 back in June it generated a lot of dicsussion on the long-term viability of their business model. I would say that most of the comments were negative, with one even going so far as calling Groupon a “Ponzi Scheme.”

However, I was most struck by two opposing views/analyses.

The first was from David Heinemeier Hansson who said to pass on this deal. Hansson argued that it is costing Groupon $1.43 to make $1.00 with no signs of getting any cheaper:

" ... They’re currently losing a staggering $117M per quarter, despite revenues of $644M, they’ll be burning through that cash almost as soon as it hits their account.

... The S-1 tells us the reality is far from that ideal. Groupon had to spend $208M on marketing in the first quarter and another $178M on sales people and the rest. Surprise, surprise — it’s costly to buy enough ads to reach the volume of consumers needed to produce such staggering revenue numbers. Likewise, hiring an army of 7,000-and-counting employees to cold-call every small business owner in the world costs a pretty penny, too.

... Groupon has a great tagline in “the fastest growing company in history,” but don’t underestimate how incredibly risky an investment it still is. There’s a very real chance Groupon will never figure out how to tune the revenue machine enough to produce even a penny of profit. They’re asking the public to value them at an alleged $25 billion (or 1/12th of AAPL, a company that generated $6 billion in real profits last quarter) on a hope, a prayer, a song, and a dance about fantasy metrics.

Buyer beware."

(via shortlogic.tumblr.com)

On the other side, there was Steve Cheney who argued that Groupon is worth $25 Billion. Cheney proposed that Groupon will be the centerpiece for the future of daily deals, a real-time bidding system for remnant inventory at places around you:

" ... And that’s the exact issue in question that people are puking over. Those reading the S1 believe this merchant to customer link is very weak, because Groupon left out key metrics for effective customer acquisition cost and merchant churn. 

That would be a sensible conclusion IF today’s email-based daily deal world were to remain static…  if that were the case all this would be extremely worrisome. But things are changing. We’re entering the next phase for daily deals, something Groupon has been public about: real time bidding on remnant inventory at places around you. 

... So the real end-goal for daily deal sites is in assembling a marketplace and exchange that has enough inventory and users to support these types of new online to offline behaviors at massive scale. And if Groupon doesn’t figure it out, someone else will. There is way more money to be made in offline commerce than there is in online commerce. Everyone knows that by now.

... The reality is we’re in inning 2 or 3 of deals and local commerce. We’re moving away from these static one-time deals toward a marketplace for your attention in the physical world. And someone is going to make a lot of money off of it." 

(via stevecheney.posterous.com)

Both have very good points. Time will tell who is more prescient here. One thing is clear, in going from founding to IPO in under three years, Groupon is the fastest growing company we have seen in a long time. But with all this growth comes lots of losses too:

(via businessinsider.com)

Summary. Is Groupon's business model sustainable? Time will tell. Certainly competitors are coming from all angles: LivingSocial is right on their heels and coming on strong, Google is pushing hard into other markets and national deals, and many are focused on certain niches (Lot18 for wine, CoupTessa for women, etc.). Combine all of these and you only get higher customer acquisition costs and tighter margins. The key will be if these customers become loyal repeat customers or not.

I am with Vinicius Vacanti on his great Yipit follow-up post that it is far too soon to tell.

We should however take a moment to reflect on what they have accomplished in such a short period of time. As Henry Blodget reflected, it is nothing short of remarkable and America does need more companies like Groupon.

I love reading S-1s by the way. You can talk all you want, but the GAAP numbers don't lie. Everything is laid out for all to see. 

Know of any other interesting analyses? Feel free to email any I might be missing. Just shoot me a note or comment below.

Also: In This Market, What's An Intelligent Investor To Do?