Singing the praises of the group buy

Groupon‘s (NASDAQ:GRPN) run up to its IPO this morning has been over a pretty bumpy road. Questionable accounting metrics that failed to take marketing costs (one of the company’s largest expenditures) into consideration raised flags at the SEC and among tech journalists. A significant amount of the $1.14 billion the company raised from angels and venture capitalists went towards buying out early employees, leaving Groupon with more liabilities than cash on hand or assets to cover them should growth stall. And to top it off, top talent from Yahoo and Google never lasted more than a few months at the head of the company. Originally expected to reach a valuation of $30 billion, it’s expected that today’s IPO will value the company at less than half that amount – $13 billion. Insert your own joke about 50% off coupons here.

So why would anyone still want to put group money behind the group buying startup? It really comes down to just two reasons: demand and traction.

Groupon’s been touted as both a small business killer and savior. The reality is that it comes down to the person running the business, and their ability to come up with a pricing formula that allows them to cover costs while presenting an attractive introductory offer, as much as it does to Groupon. Some business owners will miscalculate the amount they can afford to discount, and have a bad experience. Others won’t though, and by all accounts Groupon still has lists of merchants in countries in the US and around the world who are lined up, waiting to give it a try.

And the fact is, aside from LivingSocial – the 2nd most popular daily deals site on a global scale, there isn’t a single company who has the type of scale to satisfy local merchant demand in as many cities, to as many subscribers as Groupon does. Newspapers? Radio ads? They’ll always have a base with car dealers and real estate agents, but businesses are finding that nothing gets new customers in the door like a group coupon. In fact, the one thing fueling much of Groupon’s competition is the fact that Groupon doesn’t have enough deal supply to satisfy merchant demand. Which seems to indicate healthy, sustainable at the very least, consumer demand.

Which leads us to competition and traction.

Google Offers might become a nice lead generation tool to get local merchants advertising on search terms, but the reality is that getting consumers to think of a site as the best place to go for local deals is a full time endeavor. It’s why Facebook and Yelp threw in the towel on their deals products. In Facebook’s case, the deep pockets are there, in Yelp’s case the local merchant relationships are there, but neither on its own is enough to gain serious traction. Groupon’s sales heavy 10,000 strong employee roster (estimates put sales staff at 4-5,000) isn’t a challenge that can be overcome through better algorithms, and as smaller competitors consolidate (BuyWithMe was recently sold at a fire sale price to Gilt), it’s become obvious that it’s no longer a challenge that can be overcome by buying or acquiring to growth.

Groupon is probably nearing the top of their hockey stick growth – blame it on everything from competition to deal fatigue, but the fact is that they grew faster in 3 years than some companies have in 30. Percentage wise, they aren’t growing like they once were, but you can’t discount the fact that they’re still growing on hundreds of millions of dollars in sales.  And those much maligned marketing expenses? They may have taken away from profits, but they also created a barrier to entry significant enough that only one other company has been able to truly compete thus far.

While smaller players will undoubtedly carve out a niche and see some success with group buying, Groupon has become the 800 lb. gorilla of local/small business advertising. A few monkeys, who have a fraction of their attention and an even smaller fraction of their resources, on their back may slow them down, but won’t be what brings them down.

There will be a lot of Groupon fatcats pretty soon.

We won’t hold our breath for a 50% off deal, but if you haven’t burned all of your investment dollars in RenRen or the (in our opinion) better positioned LinkedIn or Yandex you’ll be happy to know that Groupon will officially be going public. Until GRPN shares officially start trading, the company’s value will remain fluid, but suffice it to say the market cap is likely going to be much more than the $6 billion Google offer that Groupon turned down. The last widely quoted estimate placed Groupon’s value at $25 billion, but we’ve seen with LinkedIn that pent up interest can quickly balloon to figures many times more pre-market estimates.

That being said, we learned a bit from Groupon’s S-1 form: here are a few of the most interesting financials and figures.

$750 Million the amount Groupon expects to raise from its IPO

$713 Million Groupon’s 2010 gross revenue

$645 Million Groupon’s gross revenue for Q1 2011 alone

60% Groupon’s Average “Cost of Revenue” in 2010- that includes things like paying merchants. That’s down from 63% in 2009 and a much more generous 95% in 2008 when Groupon first started.

$263 Million the amount Groupon spent on marketing in 2010 that’s up from a measly $4.5 million in 2009. Marketing spending in the first quarter of 2011 is already $208 million, so prepare for some eye-popping numbers next year.

$456 Million Groupon’s 2010 Net Loss. That’s right, even with $713 million in top line revenue, Groupon actually lost money. Get comfortable with it: despite critics predicting that the company’s model won’t last, CEO Andrew Mason is in for the long haul, even if that means losing money.

“We spend a lot of money acquiring new subscribers because we can measure the return and believe in the long-term value of the marketplace we’re creating. In the past, we’ve made investments in growth that turned a healthy forecasted quarterly profit into a sizable loss. When we see opportunities to invest in long-term growth, expect that we will pursue them regardless of certain short-term consequences,” he says in the filing.

43 the number of countries where Groupon offers deals

83 million the number of Groupon subscribers at the end of March 2011. That’s a pretty impressive email list.

15.8 million or 19% – the number who actually bought a Groupon. It may not sound like a lot, but 19% is actually pretty great as far as conversion rates go.

28 million the number of Groupons sold. That’s about 1.8 Groupons per customer, meaning that most customers try Groupon at least twice, and that’s only for the first 3 months of this year.

7 the number of expected Groupon billionaires. They are:

• Venture capital firm Accel Partners (their 5.6% will be worth an estimated $1.4 billion)
• Former president Rob Solomon (who maintained 6.8% of the company, estimated to be worth $1.7 billion)
• Brad Keywell (an early minority investor and co-founder, his 6.9% stake is estimated at $1.7 billion)
• CEO Andrew Mason (owns 7.7%, worth an estimated $1.9 billion)
• The Samwer brothers (who sold a German clone to Groupon, and ended up with 10.3% of the company, estimated to be worth $2.6 billion)
• New Enterprise Associates (an early investor that owns 14.7%, valued at $3.7 billion)
• Eric Lefkosky (the co-founder who provided most of the initial capital owns 21.6% of the company, valued at $5.4 billion) {BusinessInsider}

If you’re feeling a bit bad for Andrew Mason: don’t. In addition to the fact that he’ll still end up worth more than $2 billion, he and Lefkosky both own 41.7% of the voting shares in the company, meaning he still has a big say in the direction of the company.

Still we have to say that Rob Solomon, who didn’t even stay on as President for a full year, made one of the better deals. The Samwers are a very close second. Cumulatively, they came out with more, but individually (there are 3 brothers) their stakes are worth a little less than a billion each.

Travel is the new fashion, it seems, judging by the number of websites jumping into the space lately. Today Groupon became the latest site to strike out into the discounted travel space with Groupon Getaways (a partnership with Expedia).

After Gilt and Hautelook demonstrated near immediate success with the daily fashion sale model, it seemed a new company following the exact same model appeared every week faster than you could say 70% off. Gilt was the first of those sites to bring travel deals into the mix with their Jetsetter website; but today there’s the American Express backed Vacationist and Exclusively.in (a Gilt style site targeted towards Indian fashion and design), who recently expanded to include Asian focused travel deals.

Unlike fashion, there’s no Vente Privee (who American Express also recently partnered with) – that is an established behemoth who’s been making money off the model for a while. That’s the good news, now the critical look.

While startups like Airbnb are having success as an un-hotel travel coordinator for the value conscious, we do have to wonder if discount travel will eventually run into some of the same issues of discount fashion: luxury fashion sales bounced back, brands got smarter about manufacturing which means less inventory to discount in the first place and a focus on full priced sales. Make no mistake, while Gilt and others continue to do brisk business in discounted apparel, the leading US flash retailer is looking for growth in retail at regular price.

According to Pegasus, a hotel reservation system provider used by 90,000 hotels around the world, hotels in the US and around the world are seeing growth in spite of regional crises.

“March global bookings and revenue reached the second highest growth pace over the last twelve month period, increasing by +10.8% and +15.5%, respectively, over prior year.” {the Pegasus View March 2011}

While we have no doubt that Groupon’s massive audience will buy into the travel deals, and those seeking travel deals will buy into Groupon’s regular offerings, we wonder how long it will be before the same discounted dates are bouncing around on the various sites. What’s wrong with that? Limited inventory plus three different options for filling it means that the discounts may get to be less attractive over time.

The one advantage Groupon may have though is their international reach. Groupon Getwaways is starting in the US, then Canada with an international rollout after that. Unlike fashion, in addition to there not being a clear behemoth there aren’t any sites outside the US who’ve successfully developed travel flash sales.

You already know how the group buying thing has worked out for Groupon (ridiculously well), but restaurants, spas and yoga studios aren’t the only ones who find a little bit of peer pressure beneficial in driving sales.

IMVU, the creators of a virtual world where users can buy clothes and accessories for avatars, recently tested a group buying promotion for in-game currency that brought in $112,000 in 3 days. {VentureBeat} Not quite the millions of dollars that Groupon or competitors like Living Social have taken in on special national promotions, but not too bad for what amounts to pixels. Also, unlike Groupon and LivingSocial, there aren’t any physical products to deal with at any point so the profit margins on those promotions are probably quite impressive.

Virtual currency purchases amount to $40 million a year for IMVU. The company has 6 million items in its virtual catalog, and 7,000 user generated items are added every day.

We don’t doubt the power of a group buy or time limit in prompting people to spend money (the time limiting has worked well for Gilt, Hautelook and other sample sale sites), but do have to wonder if the promotion would have worked just as well without the group component. The first group buying deal was for 50% off the price of 200,000 credits if 300 people signed up. The discounted price was $99, and in the end more than 1100 users signed up.

From the VentureBeat post, it isn’t clear if the limited time 50% off promotion had been tried before without the group component. It’s doubtful that it hurt anything, but limited availability + saving money isn’t exactly a new discovery. If we had to guess, we’d put our money behind those two things making the promotion successful rather than the power of the crowd.

Either way, let’s give a “well played” to IMVU for coming up with a fresh spin on a somewhat established promotional tactic.

According to Bloomberg, Groupon has held talks with banks about an IPO that would give the company a valuation of no less than $15 billion, and as much as $25 billion.

Groupon’s eye-popping growth hasn’t slowed since the Google offer fell apart, and despite solid efforts from LivingSocial (the closest competitor) and a Super Bowl ad campaign that rubbed some people the wrong way, they now have 70 million users in 500 markets – up from 300 markets when the Google talks were under way.

Google was rumored to have their eye on BuyWithMe – a much more distant competitor who is fighting with most of the other group buying sites for third place (earlier coverage here) – but decided to get into the group buying game with their own product.

Facebook also reportedly has their eye on the group buying market, but Groupon’s massive sales force and first mover advantage haven’t been easy for Google to catch up to, and we’re pretty sure Facebook will have similar challenges.

Why? It’s not totally about the size of the audience – although 70 million users is really, really impressive. Having the audience is one part, but the success of Groupon is also due to their significant sales force. The Groupon page on LinkedIn shows 1,353 employees, with 43% in sales and marketing. Google and Facebook, while incredibly valuable companies in their own right, are much more tech heavy. For comparison, the Google page on LinkedIn shows 26,899 employees with only 13% in sales or marketing functions. Facebook has 2,540 employees, with 23% in sales and marketing.

While Google and Facebook battle each other out over top tech talent, Groupon is building themselves up on sales talent. For small businesses, that’s important. The vast majority of small business owners aren’t sales or marketing geniuses. They may be fantastic chefs or wonderful masseuses, but that doesn’t make them online marketing experts. So when Google or Facebook present self-serve options, they may be technically perfect, but without the human touch of someone to help walk the business owner through the process and explain things to them those self-serve option will continue to underperform when compared to a company like Groupon that’s driven by sales people rather than engineers.

So far Groupon’s been using the massive amounts of money they’ve raised to acquire companies with local sales teams, and hire additional sales and marketing people. Google and Facebook largely used the massive amount of money they have to acquire new tech talent, and while that’s serving their core businesses well, it’s very difficult to change the culture of a company from tech led to sales led overnight. Google and Facebook find their strength in ideas, Groupon finds its strength in execution. No, their business model isn’t completely original, and yes, there are many other companies doing the same thing. The thing is, none of those companies are doing it better.

For the tech giants it’s going to be very difficult to add on that culture fast enough to pose an immediate threat to the group buying leader. For competitors, if Groupon is snapping up the top local sales talent it will be expensive to compete with them, and in the group buying space, it’s near impossible to outspend Groupon.

Yup, just like that, things are going to be a lot more interesting for current group buying leader Groupon.

First, the details on Google’s planned competitor.

Image via Mashable

Mashable received a confidential fact sheet spelling out the merchant benefits of Google Offers, “a new product to help potential customers and clientele find great deals in their area through a daily email.” From the fact sheet, we learn that Google will provide writers to write up offers (just like Groupon), promote the offer on the Google Offers website and through email to local subscribers (just like Groupon).

Right now Living Social is Groupon’s closest competitor, and even with a national promotion that topped Groupon’s national promotion (their 50% off Amazon giftcard deal ended up pulling in a little more than $13 million), they’re a distant second. Here’s why competition from Google will be unlike anything else that Groupon’s had to deal with so far:

1. Google knows Groupon’s secrets

Even though an acquisition never happened, Google surely had plenty of time during due diligence to examine Groupon’s operations inside and out. They know their strengths, but more important they know their weaknesses in a way that other copycats don’t.

2. Google knows a lot of Groupon’s secrets

Even beyond anything they learned in due diligence, Google runs what is arguably the largest ad network on the internet. Perhaps you’ve heard of a little product called AdWords, or a small acquisition that did happen called DoubleClick. Google will offer some church and state separation assurance that they aren’t looking into specific advertisers campaigns, but let’s be honest – Google’s seen a lot of things on Groupon that they can’t unsee and we’re pretty sure that includes ad data.

3. Google made $8 billion last quarter

Groupon recently raised $1 billion and is rumored to be going for a $15 billion IPO. They also do approximately $2 billion per year in revenue – as much or more than Facebook pulled in, on a smaller user base. Google made $8 billion in one quarter. And they own millions of email addresses through Gmail. And they own the ad network that runs ads to those users. And they could afford to keep pace with Groupon’s spending, even if they didn’t.

Uh oh.

Lest we seem to be all doom and gloom about Groupon’s prospects, there are a few things to keep in mind. First is that the companies have different DNA, and if Google was willing to buy Groupon in spite of that – or perhaps even because of that, it’s a sign that email addresses and an advertising budget may not be the end all be all of dominating the space. As a company, Google is probably the smartest guy in the room but Groupon is the life of the party.

When it comes to local business, that may make a difference. When it comes to your search results, or your phone doing cool new things, you probably want the smartest guy in the room. When it comes to trying new things, you probably don’t want that guy telling you what’s fun, even if it’s algorithmically correct.

That life of the party, witty promotion is central to the type of community spirit that got users hooked on Groupon and the businesses they promote in the first place, and will be what keeps Groupon in the fight as much as billion dollar investments.

Starting with the biggest billions first, Apple now has a market cap of more than $302 billion, which is more than Microsoft ($239 billion), Walmart ($194 billion), Google ($193 billion) and pretty much any other huge, publicly traded company that you can think of besides Exxon Mobil ($375 billion).

Looks like Meizu has a few more M9s to go before they pose a serious threat. Still, it will be interesting to see how long it will take for Android pushes Google’s company value ahead of Microsoft, when they’ll officially become the biggest threat in Apple’s rearview mirror. While Apple has a head start with the iPad, if Android tablets can experience the kind of growth Android phones have enjoyed it’s something which might not be far off.

Apple and Facebook are officially having the best January (of 2011) ever!

On to the not yet public companies, Facebook raised $500 million from Goldman Sachs and previous investor DST (a Russian investment firm) at a $50 billion valuation which makes the company worth more than eBay ($37 billion), TimeWarner ($35 billion) and Yahoo ($21 billion). The company is resisting pressure to go public, which most people suspect is to avoid having to answer to shareholders.

Questions Facebook may wish to avoid are on how it plans to add the level of revenue which would justify such a massive valuation. Groupon, who famously rejected Google’s multi-billion dollar buyout offer, recently raised $500 million – DST was the lead investor there also – at a valuation of almost $5 billion. Which is still a lot of money, but considering that Groupon has revenues estimated to be around $2 billion and Facebook has revenue estimated at… $2 billion (as of September). {TechCrunch}

So what makes one young company estimated to have $2 billion in revenue worth 10 times the amount of another company estimated to have $2 billion in revenue? Well, the fact that Facebook has such as massive user base plays into it. As much money as Groupon makes, they still aren’t anywhere near having 500 million users. Then, there’s the revenue split. Though Groupon’s revenue is impressive any way you slice it, they have to split it with merchants, and likely salespeople as well. Facebook isn’t splitting ad revenue with anyone, so net profit is probably a lot higher. Still, is that worth more money than say Time Warner for example? This is the company that owns a cable company, cable networks, magazines and more, and somehow those things are worth less than a single website? Granted it’s a massively popular website which has been innovative in extending itself to other websites, but are we the only ones wondering if this is going to end in an AOL-like drop off in a few years?

For the year ahead though, we’re looking forward to how this all plays out.

Groupon for one, please.

For $6 billion, this site would be sold in a nanosecond (possibly with a kidney included), but Groupon looked the multi-billion dollar offer in the face and decided to walk away. Chicago Breaking Business {via TechCrunch} reports that two sources close to the deal have confirmed that Groupon has decided to stay independent, possibly in advance of a IPO filing, though a decision on that won’t come until 2011.

How could anyone possibly walk away from $6 billion? According to Kara Swisher at AllThingsD, the $500 million annual revenues that everyone’s been tossing around (including us) are actually closer to $2 billion. While that figure doesn’t take into consideration what Groupon pays out to merchants, most estimates have Groupon taking a 50% cut of each deal that passes through its site, which means the company could be seeing $1 billion from the deals that pass through their system. Considering this is still in a span of just 2 years, heading for an IPO might make more sense. With their own focus on acquisitions – of both smaller companies outside the US and new customers – Groupon hasn’t been resting on their first to market status to grow, and it’s obviously working out amazingly well. If they hit $3 billion in revenue next year, an IPO could easily see the company valued at much more than the $6 billion Google offered.

Only time will tell if this is the right move: when Facebook turned down a $2 billion offer from Yahoo!, many observers who’d seen Friendster’s rise and fall thought it was a risky move. Today the company is valued somewhere close to $50 billion and it looks like the right bet. As successful as they’ve been, it’s still impossible to know for sure if Facebook will continue to hold the number one social network spot that MySpace once held, and officially conceded. For Groupon, the loudest criticisms of their multi-billion dollar valuation have been over the fact that the model can be easily duplicated, and that there’s not much that would keep someone loyal to Groupon exclusively.

While they may not be the only daily deal site that customers keep up with, Groupon is quickly turning the space into a winner take most market and sometimes that’s enough to build a defensible business on. The momentum Groupon has going for them at the moment may be a challenge to sustain, but it would be an even tougher battle for competing companies to overtake them.

Meanwhile, this puts Google back to square one. Amazon recently offered competitor LivingSocial $175 million, BuyWithMe is the next largest competitor, but not in enough cities for Google to spend money on an acquisition rather than trying to build its own product and sales force. Will we see Google Deals/Goopons making their way into local listings? Google branded products have been hit (Maps, Earthview, Gmail, News) and miss (Video, Buzz, Wave, Froogle, Base) so it’s difficult to say how they’ll move forward, but we can’t see them walking away from the  daily deal model after what was on the table.

With revenue estimates between $350-500 million per year, that makes the $5 to $6 billion estimates more likely than earlier reports of $2.5 billion. For context, in April of this year, Groupon was valued at $1.35 billion during an investment round. It’s hard for most entrepreneurs to wrap their head around that many zeros, and even for Google, this would be a big buy – it’s biggest ever, in fact. Still, judging by previous purchases, it’s not an unfair price. Consider that YouTube, which Google purchased for $1.65 billion, lost money on hosting costs for many years. While video advertisements are starting to pay off, it took a while. Google’s other big acquisition was DoubleClick, the ad serving company that powers advertising for a signifcant number of ad agencies, large brand advertisers and major publishers. Combined with AdSense, it gave Google the largest online advertising trafficking company and they got that for a mere $3.1 billion. {TechCrunch}

So what makes Groupon worth so much more? For starters, the company has shown potential for bringing in as much as $11 million in one day. That happened during a national promotion with the Gap, which may not be representative of daily income on smaller local deals, but is a good indication of the potential. Estimating an average daily revenue rate of $5 million and stagnant growth, Google would earn their investment back in roughly 3 years. Considering the $130 million investment in April looks poised to give investors a pretty serious return in just over 6 months, it may not even take that long. Groupon’s growth in short periods of time is nothing short of amazing.

Second, Groupon is one of the few companies with serious traction in the online to offline small business market. It’s estimated thatsmall business represent $100 billion in revenue, but centralizing their offerings and scaling them has proved difficult for many startups. There’s Yelp, but that deal fell apart, and Google was only offering $500 million for the popular directory. Marissa Mayer, a highly visible VP at Google recently left her role heading Search for one heading Location and Local Services. Having taken video and display, Google is obviously betting on local offerings as the next advertising market to conquer.

Finally, after Groupon’s own acquisition spree of copycat sites in Europe and South America that had started finding their own audiences, it’s probably a cheaper and safer bet for Google to buy their way into the local deal market than to try going after it on their own. While Google is a behemoth, Google Video never overtook YouTube, Froogle never overtook other shopping engines and Google Base never displaced Craigslist. When it comes to verticals, Google’s products don’t have the best track record when a competitor with a solid community is the opponent.

Apparently, we’re not the only ones who noticed.

A screenshot of a wine tasting deal on Gilt City

As of a few days ago, Gilt is now offering Gilt City, a New York specific section of the popular site dedicated to deals on local experiences ranging from a 3-course meal for two at Rouge Tomate, to frozen yogurt at 16 Handles and discounts on salon services at Vartali Salon.

There are notable differences from Groupon: offers are updated weekly rather than daily, but there are multiple deals rather than a single one and merchants can offer multiple options. {TechCrunch}

Vartali Salon, for example, offered two haircut deals, a Keratin/Brazillian straightening offer, and a 3-step processs. Both of the haircut offers have sold out, as has the 3-course meal at Rouge Tomate, and orchestra seats at the musical A Little Night Music starring Catherine Zeta-Jones.

Gilt’s significant existing user-base means that unlike other Groupon competitors, they’ll be able to launch with built-in demand in enough cities to pose a solid offense. With many people questioning how long the excess merchandise will last, and what will happen when there are no longer enough true clearance items to satisfy growing demand, this seems like a good way to increase overall sales when growth in the discount designer fashion segment hits the predicted wall.

One company that seems like a natural fit for the model is Daily Candy. After their acquisition by Comcast, the newsletter that offers daily snapshots of fashion, food and fun added sample sales to compete with Gilt, but the Groupon model would certainly make even more sense for the locally-focused company. We’d be surprised if there isn’t some kind of announcement from Daily Candy before the end of this year.

In addition to the existing shopping sites, newspapers like the San Diego Union Tribune have been eyeing Groupon style business models as a way to offset declining classified advertising revenue. So in addition to Gilt and Groupon (and Daily Candy, if they move quickly), we wouldn’t be surprised if New Yorkers could soon have the option of deals from New York Magazine, the New York Times, the New York Post… There’s certainly no shortage of print publishers who are looking for ways to make more money from their online operations, and with Groupon’s revenue growing almost as quickly as the number of competing sites, their model makes an attractive target.