Analyzing Groupon’s Customer Base: Can Repeat Purchasers Compensate for Customer Attrition?

Groupon’s long term viability is dependant on being able to reduce marketing expense while keeping on selling to the acquired subscriber base.

So the big question is: Will the subscriber base keep on purchasing?  

In Q3 the number of groupons purchased was almost the same as in the previous quarter (a mere 1.5% growth). The number of cumulative customers increased by 28%. And interestingly enough repeat purchase has grown by 33%.

What does this indicate?

1. Lost customers: Since there are many new customers even though the number of groupons has not grown much, this indicates that there is a section of previous customers who did not purchase in Q3. This might be because of deal fatigue or the novelty wearing off. Or it might be that the deal mix did not suit them.

2. New Repeat Buyers: There is a smaller section of customers who have become repeat buyers in Q3. They bought once (either in Q3 or previously) and came back for more. This is precisely the sort of customer base that will help Groupon attain profitability in the longer term without requiring marketing.

3. Continuous repeat buyers: There is no data on the number of customers who were repeat customers in previous quarters and continued to buy. This again is a crucial segment to drive future profitability. If this number is large enough it makes a huge difference to Groupon’s economics.

4. New Customers: There is a section of Q3 customers who had previously not purchased anything. Now these customers could come from older subscribers who never purchased anything previously, or from the latest subscribers acquired in Q3. If the deal mix did not change a whole lot in Q3, it is reasonable to guess that a lot of new customers might have come from the latest Q3 subscribers, because if the older subscribers were not interested in previous quarters’ deals, why would they suddenly get interested now? The good thing is that a healthy number of new subscribers are converting to customers. But the question is whether these customers will continue to purchase in the longer term without being marketed to – this is what will contribute to Groupon’s profitability.

The same trends are visible in Groupon’s older markets of Chicago and Boston. The number of groupons sold has actually decreased in those markets, At the same time there is a segment of new customers. This indicates that a segment of older customers has stopped purchasing. This is of concern because for the Groupon model to be viable in the future, Groupon will have to cut marketing expense which drives new customer acquisition. At that stage profitability would be dependant on continuous purchase by older subscribers and customers.

Takeaway: There is growth in repeat purchases in Q3, but there is also a loss in the customer base. The signals are therefore mixed and the S-1 doe not provide enough data with which to determine whether revenue from repeat purchasers can overcome customer attrition.

Is Groupon’s Daily Deals Business Model Viable?

Groupon’s innovative daily deals model has evoked extreme responses. Either it is regarded as the model that will unlock the potential of local businesses online, or else it has been reviled as a ponzi scheme.

Here is an attempt to take a more measured view of Groupon’s business model based on their SEC filings.

1. Groupon’s daily deals business model involves both a high Marketing expense and a high SG&A expense. This is a big barrier to profitability. Marketing expense was 55% of revenue and SG&A was 51% of revenue in the first 9 months of 2011.

Revenue numbers are lower than the Cost Structure (SG&A, Cost of Sales, Marketing cost)

2. Q3 was a comparatively low growth quarter. Major metrics such as revenues, gross billings, featured merchants and # of groupons showed lower growth rates. However given the very high growth rates in previous quarters, Q3 had to grow on a higher base.

Note that these are growth rates and not actual values. All the metrics grew in Q3, but at lower rates than before.

3. SG&A expense is a necessity for the daily deals business. Self serve has been the holy grail of the local space but a having a salesforce is important in order to locate and negotiate quality deals with the right level of discounting. Groupon mentions in its filing that it tries not to repeat merchants, and this adds to the sales cost. In Q3, Groupon has done larger deals which probably reduces the SG&A per deal, still, this expense is unlikely to reduce greatly. Additionally, Technology expense, which has not been very high (only 4% of Groupon’s employees are in technology) will have to increase in the future, because Groupon has to invest in targeting and other technology to support both subscribers and sales teams/ merchants.

4. Marketing expense has significant correlation to growth. In Q3 2011, marketing expenses were reduced to 181 M from 432 M in previous quarters (Q1+Q2 combined), presumably to get closer to break-even ahead of the IPO. Revenue growth slowed from 33% in Q2 2011 to 10% for Q3 2011. That is still a decent growth rate but a lot of growth was also driven by International segment where marketing expense was higher than in the US.

5. Groupon’s 2011 operating loss is 3% for the more ‘mature’ North America segment, compared to 22.5% for the fast growing International segment.

Takeaways:

• Post IPO, in the immediate future, I would expect Groupon to see high growth rates, as they once again turn up marketing expense and expand internationally. This will impact profitability.
• In the longer term, Groupon’s daily deals business has the potential to be profitable but with moderate to low growth. This makes for a decent but not terribly sexy business model.