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Groupon Might Be Fine, If Only Its Customers Weren't Burning Out

The game of public badminton over Groupon's real financial state has actually managed to get even hotter. My BNET colleague Jim Edwards calls the company's business model a Ponzi scheme. The Atlantic asks if the company is running out of cash.

CEO Andrew Mason tried unsuccessfully to dismiss the talk with a memo that got "leaked" to the press. And Groupon does have some people not employed by the company who think it can work. But all the talk sent me back to Groupon's most recent S-1 version, where I found something new. The company's own figures suggest that its paying customers lose interest over the long run, which blows to hell the concept that Groupon can make money by eventually eliminating its massive spending on customer acquisition.

Groupon does have a chance
Henry Blodget at Business Insider recently argued that Groupon does have a chance at success if it can avoid running out of cash. The main reason is that sales to existing customers are the majority of the company's revenue.

It's a good point. Under that view, reducing customer acquisitions -- really building an email marketing database -- wouldn't kill things because Groupon would drop its massive acquisition spending and still keep most of its revenue.

But that makes one major assumption. To make this work, Groupon's existing customers have to keep spending. Unfortunately, the opposite seems to be happening.

Sales per customer per quarter fall
You don't see this clearly in the way Groupon reports its numbers because it aggregates some important numbers: cumulative paying customers and cumulative deals purchased per customer.

But that's misleading, because the huge growth in both subscribers and customers can create impressions that aren't really there. If you dig back to page 57 in the S-1, there's a table of results by quarter. Start looking at what happens in each quarter by average paying customers and the results are interesting.

Here is the number of deals per paying customer by quarter:

Here is the gross revenue per paying customer by quarter:

And here's the net revenue (what Groupon calls gross profit, but what is really gross revenue minus cost of revenue) per paying customer by quarter:

People spending less and less
All three are trending down. That doesn't by itself mean that Groupon can't eventually become profitable. But it gets much harder. Blodget's estimate depended on the customers upholding revenue. When the number of paying customers gets static, though, and revenue per customer drops, overall revenue drops.

Depending on how the trends continue, there's a significant chance that Groupon's sales will shrink over time. And given that overhead spending has been even higher than marketing, that could mean a corporate implosion.

What's interesting to look at is the average cumulative deals per customer that Groupon likes to report. It was 3.3 in 2009 and 3.5 in 2010. In the first six months of 2011, it's been 4.

Stagnant customer base
Combined with the number of sales and amount of purchasing per average customer, it looks as though each new wave of customers starts with a lot of enthusiasm and buying deals, but then chills over time. Not that even a few purchases a year is necessarily bad.

With each customer presumably seeing 365 deals a year, that's a response rate greater than 1 percent, and that can be decent for direct response. But these are the core customers, and if they react less favorably over time, it's a bad trend.

Groupon may have a short customer life span, which means it has to keep acquiring customers. But it admits there's a limit -- there always is. Although the company has a chance, I think it's a lot slimmer than Blodget is estimating.


Image: morgueFile user jusben, site standard license.
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