Some critics argue that Groupon’s fast-growing business is a financial house of cards and that the company has no viable way of generating profits. Will CEO Andrew Mason be able to prove the doubters wrong, or will Groupon become the new millennium’s version of Pets.com?


Ever since Groupon turned down a $6-billion takeover offer from Google earlier this year, the markets have been eagerly awaiting an IPO filing from the group-buying sensation, one of the fastest-growing companies in recent memory. But not everyone liked what they saw when Groupon filed a prospectus for its initial public offering — which could value the startup as high as $20 billion. Some critics say the company is close to being insolvent and that its business model is a kind of elaborate Ponzi scheme, disguised by accounting tricks. One thing seems clear: The pressure is mounting for Groupon to prove that it isn’t just a late-1990s-style hype machine.

There’s no question that Groupon is growing at an incredible rate when it comes to both revenue and subscribers: In its most recent securities filing, the company said its revenue in the second quarter rose by 36 percent, to $878 million, more than twice what it generated in the same period a year earlier. Producing almost a billion dollars in revenue in a single quarter after less than five years in existence is almost unheard of. If Groupon continues to grow at that rate, it could generate revenue in 2011 of more than $5 billion. And the number of subscribers is also growing rapidly: The company now has over 115 million, or twice what it had in December of last year.

Profitability remains a question

That’s the good news. The bad news, as more than one critic has pointed out, is that Groupon’s ability to actually make any money on all of this growth remains a gigantic question. In a recent post at the Harvard Business Review site, Rob Wheeler — a fellow with Harvard’s forum for growth and innovation — said that Groupon’s business model doesn’t appear to be viable, in the sense that it may never actually make money, despite all the growth in revenue and subscribers.

If anything, the fact that Groupon is witnessing decreasing revenue per merchant and fewer Groupon purchases per subscriber in its maturing markets suggests that growth may actually decrease Groupon’s value to its customers.

The company has also received a lot of criticism for painting its business with too favorable a brush by using its own customized accounting methods. When Groupon filed its S-1 regulatory documents, critics quickly latched on to the company’s use of an unusual financial metric it called “adjusted consolidated segment operating income,” or ACSOI. This effectively allowed it to exclude subscriber-acquisition costs, including the hundreds of millions of marketing dollars that are spent to promote Groupon deals.

The impact on the company’s financial health was miraculous: Using its own benchmark, Groupon said it had operating income of $60 million for 2010 and $81 million for the first quarter of 2011. Using standard financial methods, however, the company actually had an operating loss of almost half a billion dollars in 2010 and lost a further $100 million in the first quarter of this year.

“Fairy-tale” accounting and big cash payouts

After some discussion with the Securities and Exchange Commission and a substantial amount of criticism of what some described as its “fairy-tale” accounting methods, Groupon filed an amended prospectus that played down the more favorable benchmark — which CEO Andrew Mason admitted was “unconventional” — and substituted generally agreed-upon standards. The company has also been criticized for paying out more than $800 million from a recent financing round to early investors and Groupon management when the business is still losing money at a tremendous rate.

Former Wall Street analyst Henry Blodget — who played a key role in the first tech-stock bubble in the late 1990s and now runs the site Business Insider — argues in a recent blog post that Groupon is only going public because it is close to running out of money and needs the cash. Blodget says that while the company is technically cash-flow positive, it is operating under a “working-capital deficit,” meaning its assets are insufficient to meet its obligations, which amount to $680 million and include close to $400 million that it has to pay to the merchants who signed up to offer Groupon discounts. Says Blodget:

As long as Groupon sells enough new Groupons in one quarter to pay all the bills it racked up in the prior quarter, it will not need additional cash. But if the company’s growth stumbles, or if competitive pressure leads to Groupon’s gross profit margin getting squeezed, look out.

Fans of Groupon, of which there are still a few — including David Pakman, a venture capitalist with Venrock — argue that there are other companies that have also lost money for a considerable amount of time and gone on to become business powerhouses. Facebook, for example, spent a long time growing its user base and expanding into different markets, and there was a lot of speculation that it would never make money, as there was with Amazon. Google is another famous example of a company that had many skeptics and no obvious business model, until it discovered advertising based on search keywords (an idea pioneered by Bill Gross at Overture).

But Groupon does have a business model. The question is, is it a model that takes time to prove itself, like Facebook’s, or is it a flawed model?

A lack of network effects?

So is Groupon a similar kind of business? Wheeler doesn’t think so. In his HBR post, he argues that Facebook and Amazon were able to focus on growth and then generate profits later because they benefited from network effects — in other words, early adopters helped the business grow, and the value of those services increased with more users. Although it is a “group-buying” business that relies on user numbers to trigger deals, Wheeler says that Groupon doesn’t really benefit from network effects at all, and there are growing signs that its value may actually be decreasing rather than increasing as it gains more users. He even makes a comparison to Pets.com, the poster child for dot-com bubble excess.

Groupon CEO Andrew Mason has said that the hundreds of millions of dollars being spent on marketing and expanding the user base are not a loss but an investment and that this will start to pay off once Groupon achieves a certain scale. But that is looking to some like an increasingly risky bet. Will Groupon be able to prove the doubters wrong, or will it become the new millennium’s version of Pets.com?

Post and thumbnail photos courtesy of Flickr users Groupon and Refracted Moments

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  1. Two thoughts to add — as I mentioned in my tweet, many per-IPO quiet period companies go through a bunch of negative reporting at this point since they cannot respond to many media inquiries. Amazon wen’t through a lot of this and their death was routinely predicted. But Groupon is spending lots of money on customer acquisition presumably because they think they can sell lots of things to those customers as they expand. I look at the massive local advertising market ($150B+) and see how unsatisfied that is by other online properties and believe Groupon has their sites on that as well as offering more services to local businesses. I think they will emerge as a long-term enduring internet brand.

    1. Except that they haven’t — the amended S-1 clearly shows that most people aren’t repeat buyers. (As much as they try to obfuscate it.)

      They’re just like Groupon customers at a small business. Visit once and never come back.

      1. exactly. i just posted a long-winded comment with a few more articles on this. one is really in-depth, worth a read IMHO.

      2. Groupon has two important revenue streams that going to explode in near future:

        1. Cross selling popular e-commerce products like electronic gadgets, books and so on to its current subscriber base. Essentially, becoming a competitor to Amazon. The recent success of Groupon’s deal with Expedia proves this fact. This can potentially increase the ARPU by 3-4 times.
        2. Selling lot more value added services to local merchants. For example, they may start offering loyalty program and business analytic services to merchants. So far merchants are not the paying customers directly. Once they crack this they can expect an average of 500 USD per month from each merchant.

        On the top of this, Groupon is still in its infancy in most of the 42 international markets it operates. Even if it can occupy a place in top 3 ranks in half of these markets, current revenue can easily be multiplied by 5 times.

        So, the prospects for Groupon look rock solid. Ofcourse, you need to come out of your narrow definition of Groupon as a daily deal site to understand and appreciate this

    2. respectfully, the “quiet time” issue has been addressed directly by the SEC as not applying here & is instead being coyly used to avoid questions & keep people guessing. i just posted a long-winded comment pasting over thoughts i posted i response to a techcrunch article shared on Google+. if you would like to read the whole thing, here’s the direct link: https://plus.google.com/107753428759636856492/posts/KzuCJUiDJwB not sure if you are on G+ or not yet. take care.

      1. Users buying Groupon because it is 50% off, they cannot sell electronic gadgets and books at 50% off (the Amazon price) all the times.

    3. Thanks for the comment, David — I think that is one of the big questions that remains unanswered: can they sell more to those customers as they grow, and do so profitably?

      1. As I said, that question has largely been answered in the amended S-1. The median number of Groupons purchased by someone who has purchased a Groupon is 1.

        See my in-depth analysis of the terrible numbers in Groupon’s S-1:

        Deal quality is rapidly declining as the most attractive merchants realize what a crappy deal running a Groupon is. Someone recently sent me Groupon deals for enemas in Atlanta.

    4. As very reliable private company financial data site PrivCo.com analyzes it beautifully, Groupon would have zero cash in the bank today if they didn’t delay paying their merchants 60 days for their share of groupons sold. The $225 million in cash (and falling) is solely as the result of this float. Groupon is running out of money and time and must raise financing from either a bargain basement IPO or asking their venture capital backers to cough up hundreds of millions of dollars to keep the whole enterprise afloat:

    5. As reliable private co. financial site Privco.com put it in their analysis, Groupon has negative net working capital, so its cash in the bank is purely the result of their 60 day delay in paying merchants for their share of groupons. They’re currently surviving solely on this 2 month short term loans from small merchants, without which Groupon would have no cash left.

  2. Groupon is definitely a ponzi scheme that is dangerous & damaging to small businesses who get sucked in without fully considering all ramifications. i will feel very sorry for those that do buy any stock if there is an IPO. those that do, you better sell quick, while you can make a little profit, cuz that’s gonna fade away pretty fast. i sincerely hope they don’t make IPO however, as the volume of people that could (and would) lose money on their investments would only balloon quickly!

  3. here’s my comment on this from another earlier article posted on TechCrunch: why is everyone promoting Groupon & encouraging it’s damaging, shady business model? does no one pay ANY attention to the SEC investigation of its questionable math in calculating the non-existent valuation numbers, when it’s nearly out of and/or hemmoraging money?! most of it has gone in bonuses or payments to the CEO & others, cuz apparently shady business plans are the thing to reward folks for. shame on all the leading tech/social media blogs for giving this ponzi scheme more visibility & publicity. i feel sorry for the staff working there. i’m fairly sure that IPO, if it even happens at all, will be very short-lived & blatantly hollow. at a minimum, it would be fraudulent & steal money from every single person who bought the shares. maybe it would be coming to them though? if you don’t do your research do you deserve to lose your money in a public ponzi scheme? i guess so. some links to other articles that call BS on this:



    the knewton post is a VERY in-depth break-down of the whole kit & kaboodle. does a pretty good job IMHO. i’m not the only one saying this however. Groupon itself didn’t even try to argue against this criticism.


    the end of the beta news article is very telling. “Private investor Conor Sen alleges that Groupon is ‘operating like a Ponzi scheme that needs constant infusions of cash to stay afloat as it’s hemorrhaging money’.”

    how can a business model that forces little businesses into an almost-addiction to Groupon, in order to survive, be any good at all for our economy. once a business has used it, it almost has to keep using it in order to get a minimum of folks in the door. and even then it’s slashing it’s own wrists to even stay afloat! if a company wants to help small, struggling businesses, partner up with Square & start setting them up with those devices. $500 for an iPad & a Square device will help them much more in the long run than a scheme like Groupon’s ANY DAY!

    i think them hiding behind a supposed “quiet time” before the IPO is complete BS. i don’t think there is an answer. but i will tell you this. if the IPO doesn’t happen, Groupon is history. plain & simple. again, just MHO.

    by the way, my last URL post addresses the “quiet time” argument directly & disproves it, as far as being applicable to this situation anyway.

    a bit of background on how it works from a fellow commenter on Google+: Groupon works on a what is reffered to as a ‘breakage model’. I have dealt with similar companies and . Allow me to explain.

    A breakage model makes profit by people not claiming their gifts. So out of all the people who purchase the Groupon deal only a certain % of them will claim their gifts. If you buy a night out or a beauty treatment and then go to claim it and can’t do so then you have to wait to try again. Most people will either forget about it or just end up not using it at all, you would be shocked at the amount of people who don’t end up getting anything, and in these cases Groupon keeps the money. A merchant only gets paid when the product is redeemed and even then the merchant only gets a small amount of money due to the massively reduced margins which Groupon also take a cut from.

    (sorry for the long post. i really think people need to be educated about Groupon. not just have opinions from folks like me, but do the research & read the input from those in the industry that have their fingers on the pulse of this kind of thing & can give informative feedback!
    The vast majority of IPO’s are scams anyway and the failure rate is very high, so actually it’s a pretty typical IPO.

    1. The breakage model doesn’t apply to Groupon in the U.S. and Canada — the merchant gets to keep the money.

      In ROW, Groupon keeps the money. (Generally, though there are exceptions.)

  4. and what does this say about Google wanting to buy them for $6B?

  5. ” Selling lot more value added services to local merchants. For example, they may start offering loyalty program and business analytic services to merchants. So far merchants are not the paying customers directly. Once they crack this they can expect an average of 500 USD per month from each merchant.”

    — Good luck selling $500 month worth of software services to cash strapped merchants that are largely (at least 50%) dissatisfied with their prior experience on Groupon.

  6. I reckon that conversions for daily deals purchased will increase once they have more info on their users; ie their stated interests, likes, past deals acted on, etc. At this point it seems that they kind of spray and pray with the daily deals they offer. Case in point, the other day I received a “50% off pole dancing lessons” offer. Um, like I’m a 38 year old male who can barely touch his toes – hello?! Am I really going to be interested in pole dancing? Not (hmm, but then again, maybe this is a genius deal as it may help me with my flexibility).

    Anyway, the innovation cycle & industry as a whole is still in its infancy. It’s strictly land grab time these days and understandably so w/ the gold rush attracting such a deluge of both big and small players. Over time I imagine that % splits will be more favorable for merchants and relevancy/quality of deals sent to members will go up as the interest graph matures and is harnessed – I’ll also venture out and say that daily deal companies will find a compelling way to become destination hubs and in the process, create new revenue streams. Time will tell…

  7. It doesn’t help that they have loopholes. Users register multiple accounts to earn $10 commission!
    http://blog.just2us.com/2011/07/how-to-a lways-earn-10-for-each-groupon-deal/

  8. Groupon reminds me of that Josh Hartnett movie : August.

    Sooner of later Andrew Mason is going to find himself alone in a room with David Bowie. And David Bowie is going to say to him – “I don’t like you.”

  9. “… subscriber-acquisition costs, including the hundreds of millions of marketing dollars that are spent to promote Groupon deals.”

    I find it ironic that Groupon has been held out as a darling of the future of marketing by some industry pundits, and as further proof that traditional advertising is dead/has no future. Yet, the very thing that threatens Groupons sustainability is the high cost of buying ads in established media outlets.

  10. “Selling lot more value added services to local merchants. For example, they may start offering loyalty program and business analytic services to merchants. So far merchants are not the paying customers directly. Once they crack this they can expect an average of 500 USD per month from each merchant.”

    I do not see them being successful with this. You can hire a small business expert who will devise a superior loyalty and marketing plan. Groupon can be good for a small business but it takes planning and proper execution. Running a promotion without trying to get contact info is foolish, but it is commonplace in a Groupon marketing campaign.

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