Groupon Is Broken

I have been thinking about Groupon and all the hype surrounding it over the past year, having casual conversations with friends and co-workers.  What I find amazing is that I tend to flip flop on my love/hate opinion about Groupon way too often.  So I'm going to try to create a reasonably objective analysis of what they do, sprinkle it with my own biases and arrive at something concrete. 

Great, let's check out what these guys are doing.  Easy:

• Product - deeply discounted hyper-local offers (goods & services) that "activate" when enough customers sign up, about 500-1000 customers

• Price - low, low, low - 50%+ discount on goods that seem to be in an affordable range for mass - generally under $100

• Distribution - end customer email lists, segmented by geographical location

• Promo - two targets for promotion 1) end customers and 2) local business.  The end consumer promo channels seem to be heavily skewed to Facebook ads as well as viral / word of mouth.  (I'm sure they're experimenting with everything).  Businesses are generally targeted with a combo of direct sales force with other online ads.

Business model 

Groupon will ask the local retailer to discount the product about 50% and then take 50% of the remainder in a rev-share.  In some cases, Groupon will share profits for lead gen or commissions, on the order of 20%.


Groupon

Awesome and simple, right?  Absolutely.  I'm not going to go into the obscene valuation of Groupon itself, it's clearly large.  Rightly so?  Maybe.

Let's look at the LTV (lifetime value of a Groupon customer).  Making some quick assumptions, let's say a paying customer executes on just 1 groupon offer of a 50% discounted $99 offer.  That's $50 split between retailer and Groupon, for top line of $25 for Groupon and maybe less 25% for sales commissions, so call it $20 net revenue per customer.  How many Groupon offers would one customer convert on?  Well, at such a deep discount on local things that aren't that expensive in the first place, probably a lot.  Let's call it 10 times, so LTV of $200.

Wow, holy crap, that's not too shabby, given that your costs of acquiring a user can be relatively well controlled though Facebook ad targeting and Google AdSense.  With respect to customer acquisition ROI, looks pretty solid.

So, on the surface (and a bit deeper), looks great!  Get a customer to come in to a store on a valuable loss-leading product, grab a giant share of that revenue, then try to do it over an over again.  On just one campaign, selling 500 items Groupon makes $10,000. Brilliant! 


Retailer

What about the retailer, what do they get?  Well, here's where things get a little fuzzy.  We're talking brick-and-mortar guys that are trying to bring people into the store. With respect to products, retailers are clearly selling at negative margin (unless they're super high margin products, but in this case they would probably be high-end or niche and be too expensive to qualify for the Groupon model in the first place).  So in most cases, we're talking about a retailer taking a loss on each product sold, receiving roughly 25% of the item's list price (yes, big ouch!)  Add to this - the retailer sells a LOT of this one loss-leading product, anywhere between 500-1000 items.  Quick math - on goods, let's say your gross margins are roughly 50% (being very generous), so you're talking about a $25 loss on each $99 priced item, and that's not even net of your costs yet.  On 500 sales, that's a loss of $12,500 on every Groupon campaign.  Wow, not so great for the retailer.


The score so far - Groupon just made roughly 10k on this campaign, the retailer lost about $12,500.  Why would the retailer do that?  The argument is that the person who'll come in to buy this product will "discover" the retailer for the first time and will become a long-term shopper.  Think of the Groupon campaign as similar to a loss-leading advertizing item on flyers and coupons, like half off 2L bottles of Coke.  Presumably after discovery, the customer will make enough profitable purchases from the retailer to more than make up the difference.  Really?  I mean we're talking about EACH of the people that converted on this campaign has lost the retailer some serious dough.  What percentage would you expect to come back and make a second purchase? 20%?

Are these the right customers?

And now for the kicker.  Groupon brings in extremely price-conscious customers to retailers, asks the store to take a giant loss on the campaign, with the argument that these same cheapskates (no offense, I'm one of them) will then come back and convert on regularly priced items many times over?  I'd say highly unlikely!

The only decent argument I've seen so far from retailers is for highly seasonal businesses, where certain months of the year are just so bad it's not worth keeping the place open - restaurants sometimes fall under this category in the winter months.  In this case, if you could time the Groupon offer to coincide with the down months, you may be able to squeeze a bit of value out of continuity - cover rent, keep employees on, things like that.  There's value, but it's a stretch.

Growth vs Sustainability

And now we're back at valuation.  Groupon is growing like crazy, with month-over-month revenues reportedly growing by double digits.  Valuation is somewhere in the billions (at this point it doesn't really matter how many).  Why?  Groupon has been around for 2 years and is the fastest growing company, like ... EVER.  Where's the growth coming from?  Geographic expansion, taking on more and more retailers.  Groupon has been extremely successful at converting the retailer on the first campaign, because the promise of new customers is just so great.  However, how many times have you seen Groupon convert the same retailer for the second time?  I haven't seen it once yet.  Once the geographic expansion is done (and there's still plenty of that left), Groupon's success will be directly dependent on their ability to bring SUSTAINABLE value to the retailer.  So far, I fail to see it.

Competition

Quick note on competition.  I live in Victoria, Canada - about 500,000 people and I'm being generous.  I'm now getting 3 groupon-like offers every morning, from Groupon, Couvon and ethicalDeal, specifically for Victoria.  What do you think is going to happen to Groupon's margins over time?  Hmm.

Industry or Communication Channel? 

So, my friends and collegues, where does that leave Groupon?  It's a high growth business with a very uncertain future.  Is this a new industry?  No.  Groupon is a new communication channel, that has been very effective at bringing customers into stores, albeit just once.  Like every new channel (that works), it's getting a ton of attention, much like in their time did Newspapers, Radio, Television, Flyers, Coupons, etc.  Every one of these gets saturated over time and returns decline.

Conclusion

Groupon's growth will continue as they take on new retailers in more and more places.  It'll look awesome, they'll have a giant IPO.  Unfortunately, this insane growth hides a weakness in the model - lack of sustainable value to retailers.

Building Metrics-Driven Teams

Here's a talk I did at Casual Connect in Hamburg last month on social game analytics and buiding metrics driven teams. 



Highlight of the trip - schnitzels, hands down.

iPad - not magical, but fun

Last week I had an excellent fortune to win a iPad, thanks to the good folks at VIATeC who recently launched their new website.  Also, big thank you to Russ and David for actually accepting it on my behalf and not appropriating it, since I was noticeably absent from the launch party where the iPad was drawn.

First impression of the iPad - a giant iPod Touch.  Literally.  I guess I was expecting some remnants of magic Mr. Jobs spoke of so eloquently, but sadly there was absolutely none to be found.  Once my disappointment had worn off, however, and I accepted this as just another toy, it started to grow on me slightly. 

Being an iPhone owner, avid user and frequent lover, I found the iPad interface to have zero magic - it's identical to the iPhone.  But I LOVE the big screen.  My articles are readable and fun to browse, my photos are much more vivid, the games are more palatable.   There is definitely excellent utility in having a larger screen on the same device, albeit not being able to hold it in one hand without feeling like you're about to drop it.

The biggest iPad success so far - my 20-month son can't get enough of it.  That's the magic!

4 reasons we will see 100,000+ apps on Facebook in 2010

Casual Connect Europe in Hamburg brought many leanings for me, but I think the most profound was that the Social Gaming space will explode in 2010.  Here are 4 reasons why:

1. Casual Gaming is on the express train to Social. Every Casual Gaming company at the conference is either boarding or is already on the train to social gaming, and this train in moving fast, because social gaming is eating their lunch.  These are guys from all over the world and in every game genre. Huge.

2. iPhone games will be Facebook games. There are 140,000 iPhone games on the AppStore as of this writing. There are 4 categories of product in the iStore, where the top 25 placement results in reasonable sales. The other 139,900 applications are not making any money. There will be a gold rush of iPhone guys into the space.

3. Facebook is a platform that lets you promote your product! Rather than hope to be in the top 25 on the AppStore, here’s a platform where you can take control over your application’s destiny by buying ads with Facebook.

4. Technical barrier is low.  Integrating with Facebook is no more difficult technically than building an iPhone Game or creating a Flash Casual Game. In fact, it’s probably a lot easier with the introduction of Facebook Connect.

With both the Casual and iPhone Gaming industries all starting to do social, and given the relatively short dev cycles, I expect a gold rush. At the very least, we’ll see 100,000 apps integrating social features. There really is no reason not to.

The big question is, will they know how to monetize on Facebook? Backstage can help.

5 takeaways from the Quiet Profitability Panel at Casual Connect

This week I spent some time in Germany, attending Casual Connect Europe in Hamburg, where I spoke on a panel titled Quiet Profitability about our company Backstage Games as well as moderated a discussion between these fine gentlemen:

Toby Beresgford – Founder of Nudge Social Media
Jens Begemann – Founder and CEO of wooga
Alexei Kostarev – Founder and Head of Production of I-Jet Media

I had been looking forward to this discussion for quite a long time, helping David Nixon of I-Play organize it.   Let’s just say the panel did not at all go as I had planned, but I was stoked that people found it interesting and informative.  Here are some key points that were highlights for me and I think they deserve a mention:

1.  ONE great game is better than TEN good games.  Jens Begeman, the creator of Brain Buddies on Facebook has certainly illustrated the concept of concentrating on your core product on a single platform.

2.  If it's tough to win globally, win locally.  Alexei Kostrarev has been able to dominate the social space in Russia, where I-Jet Media today owns about half of all revenues from social gaming – certainly a formidable result.   If you can’t be Zynga, be the Zynga or your local geography.

3.  Brands are coming to social networks in a big way.  Nudge Social Media connects brads with social audiences and has seen excellent growth this year.  I would expect focusing on branded experiences to be a growing niche in the social space.

4.  Quick Play Pays.  This was noted by me through our experience at Backstage.  Complex game dynamics confuse the hyper-casual social network players into indifference.  Quick reward loop has a better potential for monetization.

5.  Content moves the needle.  As the industry continues to converge on Virtual Goods as the business model, fresh content is the key lever to move the revenue needle.

Casual stroll into Social Gaming

Recently, I have had the pleasure of working with one of the top Casual Gaming companies, co-developing several exciting titles.  As many others, this company is looking at Social Gaming as a new 'fad' which may create some side revenue by driving users from Facebook and MySpace over to their own portals.  Unfortunately, this approach really misses the bull's eye of Social Gaming potential.

Social Games Revenues in 2009 exceeded $700 million and will almost double in 2010 to a staggering $1.3 billion (yes, billion with a B).  This revenue is primarily achieved though selling in-game virtual goods and, to a much smaller extent, advertising.

The big POW is that Facebook users monetize very well, but they do so within the comfort of the environment they choose and with a game they like.  Getting them to play is the hard part.  Once that's done, monetizing is relatively easy.  Whatever you do, do not take them out of their comfy sandbox by driving them to another site.  Taking a player out of the game and out of the social network to convert them to a game on your portal is a big waste.  The user, which was so close to monetizing, is now in a new environment with an altered product proposition.  You have to redo all the work of getting them comfortable, getting them to play, getting them to come back.

Leave players where they chose to play.   Find ways to monetize them right there and then.