On Groupon’s warpath toward a $20B IPO, the company is spending $2.3M a day on consumer marketing – roughly twice as much as Target. On Wednesday the SEC rightly criticised Groupon for removing this marketing expense from their profit equation. Accounting should be the least of their concerns. According to the company’s S1, Groupon is paying for their momentum by spending more on marketing than the same consumers are worth to Groupon.
Daily Deal companies use every available marketing channel to grow their subscriber base. Ads on Google, mobile banners, radio and TV commercials… you get the idea. More emails not only drive more sales, they also make up for the “leaking bucket” problem: every day some percentage of Groupon’s existing subscribers turn off their newsletter, subscribe to a competitor or stop making purchases all together.
Groupon spent $5.65 for every new subscriber they acquired in 2011, a 152% increase from the price paid in the first quarter of 2010. At this rate Groupon would now be paying over $7. Why the huge increase? As hundreds of Groupon clones began to compete with Groupon for the same consumers, advertising became more expensive and less effective.
So is an inbox worth $7 or even $5.65 to Groupon? In 2010, the company generated $61M in adjusted profit, a value of $1.20 per subscriber. Hmm… That doesn’t look good.
Groupon believes the value is much higher, as they’re likely to profit off each subscriber long after the year they were acquired. Daily Deal marketers use three assumptions to calculate each consumer’s lifetime value:
- How often does a subscriber make a purchase? In Q1 ’11, Groupon subscribers purchased at an annualized rate of 1.35 deals per year.
- How much money do we make when someone purchases? Groupon’s average price point in Q1 ’11 was $23. At their adjusted profit margin of 13 per cent, Groupon walks away with $2.98 for every transaction.
- How long will a consumer remain a subscriber? Groupon doesn’t give us this one. Let’s conservatively assume .1 per cent unsubscribe each day.
Plug these numbers into a Google Spreadsheet and you get a lifetime value of $4.86 for Q1 ’11, a 64 per cent decline from Q2 ’09. Insiders refer to declining lifetime values as the ‘tragedy of the commons’: the value of an inbox depreciates each time a subscribers adds a competing service. Groupon’s most active consumers now get five to 10 daily emails from a competitor.
The resulting CPA vs. lifetime value chart is something Groupon is unlikely to bring to their road show. Groupon is on track to earn a negative 52 per cent return on every dollar they spend on email marketing in Q3 2011.[i]
So why is Groupon lighting cash on fire? The company has dozens of strategy and marketing executives who could run this analysis. Groupon’s seemingly irrational marketing spend is driven by a combination of three factors:
- Groupon believes the actual consumer lifetime value is far greater than it is today
The company’s working on a number of initiatives to better monetise consumers and merchants – notably deal personalisation and Groupon Now! This would require a significant change in trajectory; lifetime consumer value has decreased for six of the last eight quarters despite multiple product releases.
- Email marketing is a sacred cow
Email marketing is in Groupon’s DNA. Dozens of employees spend millions of dollars daily. Analysts are discouraged from approaching their exceptionally wealthy bosses with a presentation that calls for mass layoffs and slowed trajectory.
- Groupon believes markets are irrational
LinkedIn’s 554x P/E ratio is proof that public markets now value momentum more than business fundamentals. Groupon could shut off their marketing spend and be “profitable”, but slower growth would have a significant adverse impact on their valuation.
My company, Signpost.com, disengaged consumer marketing in January ’11. We subscribe to a Warren Buffet framework: in every market cycle, there are innovators, imitators and idiots. In the daily deal space, innovators like Groupon and Living Social gained traction in 2009. Imitators quickly bid for share in 2010. As for 2011, well… let’s just say there are a lot of daily deal companies.
[i] Assumptions not noted here: Discount rate of 9.8 per cent based on a WACC analysis of comparable companies listed in their S1. Subscribers decrease average purchase rate by .093 per cent daily based on Groupon’s average lifetime purchase decline.