Daily Deals Is A Real, Winner-Take-Most Business

Groupon EPS and Revenue Growth

Since Groupon reported quarterly earnings, we have decided to take a look at the dynamics at play in the daily deals market.

Our conclusion: daily deals is a real, significant, winner-take-most (but not winner-take-all) business with strong barriers to entry.

What Groupon’s Quarter Tells Us
Groupon posted very strong numbers last quarter which surprised everyone:

  • Q1 2012 EPS (non-GAAP): $0.02 vs. $0.01 Wall Street estimates
  • Q1 2012 Revenue: $559.3 million vs. $530.6 million Wall Street estimates
  • Q2 2012 Revenue Forecast: $550 million to $590 million vs. $558.7 million Wall Street estimates
groupon

Most interesting was Groupon’s North American business, which came out profitable and accelerated despite lower marketing costs. As we wrote at the time, this is interesting because Groupon’s North American business is its most mature (indeed, the most mature of any daily deals business), and therefore gives us a glimpse of what a post-growth-phase daily deals business might look like, and whether it can be sustainably profitable. We think it can be, and these quarterly figures give us hope. 

Here’s why: 

  • Daily deals companies are mostly unprofitable because they spend a ton of money on marketing to grab market share
  • The question is whether they can sustain revenue while narrowing marketing spending
  • Specifically, the question is whether existing customers are buying enough Groupons to sustain revenue growth, or if the business is mostly from new customers
  • If it is the former, then the daily deals business is sustainable, because existing customers will keep generating revenue even as the business’ marketing costs go down, generating profits. If it is the latter, then daily deals are fundamentally an unsustainable business, because they require spending on acquiring new customers that exceeds revenue.

The figures from the latest quarter seem to show that it is the former, and that Groupon’s (and daily deals businesses more generally) business is sustainable. 

groupon take rate

Photo: Yipit

Groupon’s North America business had accelerating growth even as marketing spending declined.In other words, Groupon’s revenue growth came from existing customers, not from new customers who had to be acquired through marketing channels.

In other words, the most mature daily deals business in the world seems to be sustainable. Which indicates that the daily deals business can be sustainable. Which is an important thing to note as many are vociferously arguing the contrary. 

groupon goods north american billings

Photo: Yipit

Another striking facet from the quarter was increasing margins. As Yipit notes, Groupon’s “take rate,” or the amount of the deal that it keeps, has been increasing slightly (see chart), despite widespread belief that competition would whittle down margins. This suggests, again, that Groupon has significant barriers to entry.Groupon also increased overall margins because of its expanded product mix, in particular the growth of Groupon Goods, discounted excess-inventory goods that Groupon sells (see chart). As we’ll see below, traditional ecommerce is becoming an important part of the daily deals product mix.

How LivingSocial Has Been Doing

livingsocial north american gross billings

Photo: Yipit

When Amazon disclosed in a filing that its investee LivingSocial was suffering very steep losses, we wondered whether daily deals mightn’t be such a brutal business that it would be winner-take-all, with every standalone player succumbing except the one with the most economies of scale. But it doesn’t look that way after all: LivingSocial’s North American gross billings increased a striking 15% sequentially from 4Q11 to 1Q12, according to Yipit (see chart). We would be shocked if LivingSocial was profitable, but it seems its business is still moving forward. 

livingsocial north american product contribution

Photo: Yipit

LivingSocial has also been diversifying away from simply daily deals (see chart). This is similar to what Groupon is doing, but LivingSocial is probably doing more of it because it has historically sought to differentiate itself from its bigger rival with a broader service/product offering. As Yipit notes, this has taken the form of unusual businesses: 

LivingSocial created an events and experiences centre in Washington DC to host its own curated offerings. Though there are clearly many fundamental questions with the economics and scaling of such an offering, LivingSocial wants to be able to offer the best merchants in Washington DC opportunities to host supply-unconstrained experiences.

This is probably a small business, but on top of offering brand benefits it’s also a way to offer benefit to LivingSocial’s merchant customers.

What All This Tells Us About The Market
From Groupon’s successful Q1, North American and margin trends, and LivingSocial’s gross billings and revenue mix trends, we can infer a few things about the overall daily deals market.

  • YES, daily deals are a real business. Profitability is possible. It’s happening.
  • Daily deals appear to be a winner-take-most, high-barriers-to-entry business. If there are no barriers to entry to daily deals, why is almost everyone dead? There are barriers to scale, and scale effects on the internet should not be underestimated. It takes a lot to run a massive couponing operation, build a recognisable consumer brand and maintain relationships with thousands of merchants. These high fixed costs are barriers to entry.
  • Revenue diversification is an important part of the daily deals business at scale. These companies have massive consumer channels to run discounted inventory, especially when it comes to travel and commerce goods, and these are typically higher-margin businesses. It only makes sense.
  • It doesn’t look like a winner-take-all business yet, however. Groupon might be the only show on this road one day, but so far LivingSocial is hanging on.

THE BOTTOM LINE

The latest trends support our analysis: 

  • Because of this scale requirement, the market will sustain only a few “generalist” players alongside a few niche players (either hyperlocal or along specific verticals, e.g. luxury, mums…)
  • Daily deals are a new form of advertising, like the banner ad, and as such it will lead to a large market made up of these large & niche players, as well as publishers who will use it on their own as part of a diversified advertising strategy. 

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