Groupon Revenues Up, But Even Growth Disappoints the Market

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groupon_pic1Groupon reported stronger-than-expected earnings from the holiday quarter, but shares of the daily deal giant tanked in after hours trading due in part to poor first quarter guidance and concerns over declining margins. The company grew revenue by 20% from a year earlier, but it also saw a decline in margins  as its less profitable ecommerce business continued to account for a larger portion of the wider revenue mix.

The poor guidance was due in part to costs related to the integration of Korean deal site TMON, which the company acquired from LivingSocial in January. The company also said it planned to spend $25 million in marketing in an attempt to improve consumer awareness around its new searchable deal bank, the cornerstone of a strategic shift away from daily deals to a more evergreen “pull” marketplace.

The move to “pull” is part of an attempt to deal with the increasing importance of mobile for the company, which it said accounted for nearly half of all transactions during the fourth quarter. During an earnings call Wednesday, Eric Lefkofsky, chief executive at Groupon, reaffirmed the the company’s commitment to local, saying that it would play a critical in helping the firm profit from the shift to mobile.

“In order to win in mobile you have to win in local, and everything we do is with local in mind,” Lefkosfky told investors. “We have yet to truly deliver an experience that our customers cannot live without.”

A critical part of building that experience is sourcing enough deals in target areas to make the local “pull” (e.g. search) experience valuable to the consumer. In addition to putting more emphasis on sourcing recurring deals (as opposed to the one-off “daily deal”), the company also rolled out self-service tools aimed at bringing on the segment of very small business, which account for a large portion of the local market.

In North America, the company’s local commerce business remained relatively flat, with revenues growing by 10% from a year earlier but declined slightly quarter over quarter. Lefkofsky attributed the muted growth in part to a decision by leadership to increase the take rate — the company’s cut of each transaction — after it made substantial reductions during the end of 2012 and beginning of 2013.

Overall, the company’s core local business continues to show solid operating leverage. Margins continue to increase as the cost of revenue as a portion of revenue continues to decline. The problem, as we’ve reported before, is that the ecommerce business, which the company opened in the fall of 2012, continues to show very little synergy with the local play.

In the fourth quarter, the goods business accounted for around 60% of the company’s North American revenue but only 12% of its profits. The company’s CFO Jason Child attributed the poor margins, which continued to fall in the fourth quarter, to distribution inefficiencies related to challenges in building out a national fulfillment network. The company, which opened its first fulfillment center last November, has to pay substantially more for shipping and freight costs to move goods than more mature ecommerce firms like Amazon, which already has over 50 centers across the globe.

During the call Lefkofsky painted the two businesses as complimentary, saying that the company “does not view goods as being distinct from the local commerce strategy — rather an extension of it.” He argued that in mobile commerce, the customer will not differentiate between the means of fulfillment — whether they pick it up in store or have it delivered the next day.

That might be true in a decade, but today, the dynamics of a local commerce business are wholly different from those of a remote (ecommerce) play. Local, for one, is a network play, in which the vendor (Groupon) is simply connecting the dots between existing supply and existing demand. It’s an information problem solvable without deep investments in infrastructure. The supply chain already exists, which is not the case with ecommerce.

However, the local technology market is transforming at a blistering pace, and with its resources split, Groupon will struggle to keep up. The company’s decision to build its own point-of-sale and payments network, for instance, underscores the challenge. In order to connect supply and demand more efficiently, the company needs to access the core systems of merchants. However, instead of partnering with a number of growing back-office software providers as Yelp chose to do, the company decided to build its own systems, and compete directly in an intensely competitive and fragmented market.

Steven Jacobs is Street Fight’s deputy editor.