Innovators, Imitators and Idiots

Innovators, Imitators and Idiots

How Groupon and 491 Daily Deal clones destroy capital on email marketing

I originally posted this on on Business Insider here: http://read.bi/nbtI3L 

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. Last Wednesday the SEC rightly criticized Groupon for removing this marketing expense from their profit equation. Accounting should be the least of their concerns. According to data in the company’s S1, Groupon is now earning a negative return on their $800M marketing budget.

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 in 2011, a 152% from the price paid during the same period last year. 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 (CSOI), 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 percent, 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 percent unsubscribe each day.

Plug these numbers into a Google Spreadsheetand you get a lifetime value of $4.86 for Q1 ’11, a 64 percent decline from Q2 ‘09. Insiders refer to declining lifetime values as the ‘tragedy of the commons’: the value of an inbox decreases each time a subscribers adds a competing service. Groupon’s most active consumers now get five to 10 daily emails from competitors.

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 percent return on every dollar they spend on email marketing.

Why would the company continue to make an ROI negative investment? Groupon has dozens of strategy and marketing executives who almost certainly run a version of this analysis. I think 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 monetize consumers and merchants – notably deal personalization 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.