18 Comments

Summary:

Among those debating the value of Groupon as it filed for its hotly-awaited initial public offering were two startup entrepreneurs — 37signals partner David Heinemeier Hansson, who argued it is doomed to fail, and SimpleGeo founder Joe Stump, who looked on the bright side.

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Among those debating the value of Groupon as it filed for its hotly-awaited initial public offering — which could give it a market capitalization as high as $30 billion — were two startup entrepreneurs who took to Twitter on Thursday night. On the “Groupon is doomed to fail” side of the question was David Heinemeier Hansson, a partner at 37signals and creator of Ruby on Rails, and on the “give Groupon a chance” side of the debate was SimpleGeo co-founder Joe Stump. Who won? You will have to judge for yourself. Their conversation is embedded below.

Hansson started the debate by tearing apart Groupon’s financials, noting that the company had not only lost more than $500 million so far, but that its losses and spending were actually accelerating, and that it was costing the company far more than $1 to make $1 in revenue — a fundamentally unsustainable situation. After a series of tweets on that topic, Stump joined the debate by saying Groupon should get some credit for being able to generate revenues of $600 million or so every quarter, and that this would give the company some breathing room to figure out how to generate a profit.

Stump also pointed out that Amazon started by losing huge sums of money and was widely criticized for it, but the company is “now doing $9bn a quarter and [is] quite healthy.”

Hansson, however, said that it would be difficult to figure out how to make the business profitable while still trying to come up with $120 million a quarter — the amount the company is losing. And the 37signals partner also said that it wasn’t fair to remember “the one company that made it out alive” from the 90s bubble, unlike dozens of others such as Pets.com and WebVan. Stump retorted that none of these companies had the revenues or revenue growth rate that Groupon or Amazon has had.

Is growth enough? Hansson said it is not — that increasing scale “only makes the problem worse if your losses scale just as bad,” and that Groupon’s losses are actually accelerating. Stump countered that with scale comes lower costs, and that if Hanson wanted proof he should “ask Walmart’s suppliers.”

A 30-month-old company that is generating $600 million in revenue per quarter should get the benefit of the doubt at least, argued Stump — but Hansson said it was hard to give that benefit to a company losing $117 million every quarter. He added that he was concerned that the IPO was going to be “gamed like a casino and pop massively before crashing leaving the public with the bag.” He called this a “wealth transfer to a select few bandits.”

In the end, Stump said that he wasn’t planning to buy Groupon stock, but that he didn’t believe the company was necessarily destined to fail. Hansson, meanwhile, said that while failure was not guaranteed, the company should be “treated like Greek bonds” because the likelihood of failure was so high.

Excerpts from their full conversation are embedded below:

Post and thumbnail photos courtesy of Flickr user Thing Three

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  1. Amrita Mathur Thursday, June 2, 2011

    Not sure what the issue is… Groupon makes a shit load of money and they’re also losing a shit load of money because like an advertiser they either get tired or fulfilled. Either way, they are going strong and will likely diversify in the future. Andrew Mason has tons up his sleeve.

    1. Well said — thanks for the comment, Amrita :-)

  2. One topic seems missing (unless this was only a slice of the tweets)…. “competition.”
    And let’s not forget the little phrase grandpa likes to throw around, “barriers to entry.” Amazon and McCaw Cellular had them in spades (Oh grandpa, so long ago!?). Not so much for Groupon.

    Groupon is obviously comfortable that they’ve divined the right formula (through careful trial and error) so to win fast and big their strategy includes spending every penny of revenue and investment dollars on growth right now.. more employees (to sell to and qualify vendors, call center, etc), more compute power, more cities, more countries.

    This is a vastly different situation than a “Gee I just don’t know where all that money is going. I hope we’re profitable someday.” problem.

    Some of the things I’d like to know:

    Typical Vendors stays for how many deals
    Typical Vendor does how many deals per quarter
    Sales people compensated how? (1st deal only? repeat deals?)
    % of deals arranged by direct sales vs automated

    Probability customer goes away never to return after 1 expired deal, 2, 3, 4, 5+
    # of the millions of customers that are completely cold (but haven’t opted out yet)
    # days on avg between purchase of a deal and redemption of deal

    assumptions going forward regarding price pressure from competition

    Of course, they aren’t likely to publish any of that (until the road show?).

    And let’s not forget what could become known as the Groupon Gambit… filing the S-1 is actually a groupon itself!
    “Limited time. Act now. BUY US.”
    ;-)

    @DanFarfan

  3. While their financial scare me, I can accept Groupon’s argument that they are investing in future revenue. They are buying customers with their massive losses. However, that will work only if there is customer and merchant loyalty, and I don’t see how they lock them in. They have a huge expense structure in their sales force, which they use to build sales, but if a competitor is able to automate that process, they will be able to sell coupons with a much lower cut, leaving more for the merchant. Not only will that drive merchants away, but that may enable better discounts through the competition, which will also drive customers away. Neither the merchant nor the customer has any sunk cost in Groupon, so there is no reason to drop them for a better deal. This also doesn’t even take into account that retailers can offer only so many fire sale discounts without going out of business.

    Amazon, which is the only successful company that Groupon can be compared to, isn’t really a valid comparison, as they were investing in software and infrastructure that would lower their costs. This is a big difference than using money to (temporarily) buy customers. The technology and distribution centers enabled Amazon to provide incredible customer satisfaction, which has resulted in loyalty that Groupon cannot expect.

    So I’m in favor of another over-priced IPO. It’s hard to find no-brainer puts these days.

  4. So look, I’ve been of the opinion for years that people in the valley who pooh pooh the first or second to market and explain that this or that is a flash in the pan are generally kidding themselves. Usually, the people that invent a market win that market, especially when they are well capitalized and execute well.

    That said, there are real things that ought to give people real pause in the Groupon filing. A couple that stand out:

    1) The fact that they want you to pay attention to an entirely fake, 1999 era metric that looks a lot like “EBITDAM”, i.e. our cash flow but don’t count our marketing spam.

    2) That marketing spend is generating tons of registered users, but only 20% of Groupon’s registered users bought anything last quarter.

    3) There are no end-user switching costs and lots of Groupon customers already receive other deals e-mails and would probably welcome those of Google, et al.

    Let’s just agree that the Groupon growth story is breathtaking. Let’s also agree that it’s worrisome that U.S. growth is a lot less breathtaking and that cutthroat competition here is having an effect. Let’s further agree that diversification into Groupon Now, travel, etc. is going to put up really big top-line numbers for quarters to come.

    That said, when a company that’s scaled top line so quickly is profitless, likely to remain profitless for at least a couple of quarters, is facing increasing competition, is asking us to ignore its gigantic marketing spend, is not demonstrating that the marketing spend is buying any particularly valuable customers… well, this is not an IPO for the ages. It’s an IPO that leaves a lot of people scratching their heads and asking how much this company is really worth right now.

  5. Thomas Cornelius Friday, June 3, 2011

    Look back and you will find that Jason Fried, one of the founders at 37 Signals was elected as a board member of Groupon in October 2009, but then had to step down in 2/2011.

    David may have some insight that is interesting in how the business is run from conversations with Jason??!!!

    1. Interesting! Didn’t know Jason was elected and then stepped down. Perhaps Mathew Ingram can interview him and get the scoop ;)

      1. Jason posted a comment on Hacker News about his involvement with Groupon: http://news.ycombinator.com/item?id=2617160

  6. “Stump countered that with scale comes lower costs, and that if Hanson wanted proof he should ‘ask Walmart’s suppliers.'”

    I don’t see Groupon gaining many savings with size; it’s not as if they are producing a physical product like Walmart’s suppliers, which does decrease in cost with scale. Scale won’t make sales people, engineers, writers, and online advertising any cheaper. Is there something I’m missing?

    1. Yes, Charles, you’re missing the kool-aid. Drink up.

  7. Brian Krassenstein Friday, June 3, 2011

    A $30 Billion Valuation is too much here, and if it IPOs at that, people are overpaying IMO. They have already stated that there is signs of fatigue in the early markets, a sign that things could slow down in the current markets. Sure there is a ton of growth potential, but with growth will come even higher costs. Until they diversify a bit into other areas there is no way I’d buy them at a $30 million market cap.

  8. Hey, the Groupon guys are smart: They know they can’t drive their value much further, so they have to get the $$ while the getting is good. Are they smart enough to use the $$ well?

  9. Groupon’s mistake is that they’ve priced themselves out of becoming a viable takeover target. Consider the service they offer: Amazon, Google, or Apple could make the same service with near-zero risk and destroy Groupon and LivingSocial.

    Groupon should’ve aimed lower and offered themselves to one of these companies.

  10. Groupon is pure crap, as are the rest of them. The losses are a bad sign, first of all, as is the flight to Wall Street. I’ll tell you what will happen here. The banks will make out like bandits, the price will rise higher than you would believe, and then half of that value will disappear, chomped up by the executives of Groupon and the underwriters. The little people who jump in on the first day will get royally screwed. Haven’t we seen this stupid movie before? If it’s such a great business, try running it for a profit. Heck, until the oil embargo of the ’70s, Green Stamps made a ton of money in the ’50s and ’60s. My mother had cartons of them, and she was always finding crap to buy in their cheesy catalog. You want to turn the Internet into a cheesy rip-off? Go right ahead. None of my money will be in it.

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