*contains graphic material

The Guardian has today run an interview with Andrew Mason, founder of Groupon. It’s a fascinating slice of tech bubble myth-making. The basic message is this: the Groupon idea is basically a magical loophole in the laws of business; businesses are falling over themselves to get involved (well, if they read this horseshit, they would be); Groupon is printing money guys! Get on board! I quote:

A pizzeria, in a quiet period, could offer 60% off – but only if a sufficient number of customers bought the deal in advance, thus eliminating all risk for the restaurant

That does not “eliminate risk” for the business at all – in fact quite the opposite! It sets a floor for a minimum level of risk that might eventuate if, say 3,000 walk into a small bakery and demand a loss-making offer.

Its revenue for 2010 exceeded $700m

Gross revenue. And only by Groupon’s absurd accounting model is their gross revenue $760m. Groupon accounts gross revenue as all money spent at the partner business redeeming the coupon, including that business’ 50% cut.

It was around the same time that Mason’s allergy to making money seems to have vanished overnight. Which was fortunate, in hindsight, because recently he has been making quite a bit of it.

Most people would regard ‘making money’ as profit. Groupon has not ever made a profit.

Remember how after the global financial crisis we all said the media was partly to blame by not looking hard enough at absurd claims about asset classes? i.e. ‘house prices will never go down!’. Well, that.

A while ago I wrote about group buying, saying this:

The key metric I want to see is repeat business from small businesses, because if they don’t have that, sooner or later they’ll stop making real money.

If they’re continually churning customers at a high rate then customer acquisition costs will grow and grow and be a permanent, significant cost in their business, eating into profitability and probably closing their doors eventually. This is being masked while the company continues to spread into new markets, but sooner or later they will need to rely on organic growth. But how high is the churn rate? Here’s a frightening post from Dylan Collins about the beauty salon market in the UK/Ireland:

Groupon’s churn rate could be as high as 90%.
Out of all our salons who have run a Groupon deal, only about 10% are either planning to (or have already) run a second campaign. However, this 10% actually needs to be qualified as an increasing number of smaller salons now survive solely on Groupon deals. This phenomenon happens when a salon runs a very successful Groupon deal but spends so much time servicing it that they lose all their original clients. They then have no choice but to go back to the well and run another Groupon deal just to ensure their survival. These salons are then caught in a deal-loop where they can’t escape Groupon!

So the customer churn rate could be 90%. That’s extraordinary, explosive stuff, and confirms my most bearish instincts. If churn is similarly high across other categories then marketing costs will be a tremendous burden on the business, and as new competitors emerge, will make it nigh on impossible to turn a profit.

But the disgraceful thing is the company’s founders are pretending this isn’t an issue. By using an accounting concept called ‘adjusted consolidated segment operating income’, they strip out their online marketing budget from the bottom line as they argue their marketing costs aren’t indicative of future expenditure. That is pure fantasy. I quote from the FT’s John Gapper, who absolutely nails Groupon:

The problem is that it is having to pump a growing amount into sales and marketing to maintain its expansion. Its sales, administration and marketing expenses rose to $387m from $11m in the same period, turning it from a profitable business to a massive lossmaker (it has a cumulative deficit of $522m).

Groupon has attempted to comfort investors with its own measure of profitability known as “adjusted consolidated segment operating income” or “adjusted CSOI”, which ignores acquisition and online marketing – much of the expense of achieving all this growth. But that is transparently nonsensical. Without the marketing to find new prospects, it would grind to a halt.

This leaves potential IPO investors with a conundrum. As Conor Sen, a private investor, phrased it on the Minyanville investment website: “How do you value a business that could do $3bn in revenue this year but might not be able to keep the lights on in 12 months?”

With great caution, if the behaviour of its founders is anything to go by. Mr Lefkofsky this week appeared to breach the SEC-enforced “quiet period” for IPOs by insisting to Bloomberg that Groupon would be “wildly profitable”. Barron’s reported that Mr Lefkofsky told employees of another of his businesses in 2001 to be “wildly positive in our forecasts” before it went bankrupt.

[Groupon founder and CEO Andrew] Mason is inviting investors to come with him on a wild and unpredictable ride filled with, as he puts it, “moments of brilliance and other moments of sheer stupidity”. The founders have already shown their brilliance by extracting half a billion dollars from an unprofitable start-up with an unproven business model. That’s not funny.

Tim Dunlop, excellent blogger at B-sides, has written in The Drum about News Ltd’s paywall plans, and focused on The Australian and it’s partisanship. I quote

The Australian is ground zero for hardline, anti-Labor, so-called “campaigning” journalism, a position that has solidified since federal Labor came to power in 2007. This editorial disposition has made them a laughing stock amongst at least half the market for serious journalism that Simons is suggesting they are going to need to make the paywall pay.  

In other words, The Australian’s overt partisanship – which has seen them not only turn Newspoll into a tool for generating anti-Labor stories but has also led them to offer possibly the worst coverage of climate change of any broadsheet in the Western world — has alienated a sizeable percentage of their potential audience.

If you are talking about a strategy for maximising the number people who will cough up – in perpetuity, week after week – money for your product, then The Australian’s partisanship is a losing strategy.  In a market as small as Australia, trying to build a viable subscription base when you have spent a decade holding at least half your potential audience in utter contempt is going to be a tough ask.

I disagree with these conclusions. Don’t get me wrong – The Australian is a paper with many limitations. It is absurdly touchy and self-obsessed, it allows the personal vendettas and/or ignorance of senior staff to affect their content, and it publishes any old poorly-researched rubbish as it long as it represents the corporate line.

But these are criticisms of execution, not of strategy. As is widely acknowledged, straight reportage is becoming commodified. If news is a commodity, then the only hope for successful paid-for online content needs to exploit the commercial potential of added value – opinion, commentary, editorial. Having a clearly-defined editorial ‘brand’ will be crucial.

In these challenging times, the most successful ‘traditional’ media organisation of the past decade has been Fox News. They’ve also been the most overtly partisan. In the UK’s newspaper market, the papers best positioned for the future are those with the most clearly delineated editorial stances – The Daily Telegraph (upmarket Tory), Daily Mail (mid-market older Tory), Guardian (young and middle-aged upmarket progressive). The papers that are struggling are those like the Daily Mirror and Independent with positioning that’s harder to locate (The Independent is ‘independent’).

News Ltd’s Oz is right to try and capture the Liberal voting, older, affluent demographic – Managing Directors and Senior Partners, self-funded retirees, well-off small businessmen. Contrary to Tim Dunlop’s views, there are plenty of these people in Australia, and they have a tremendous value to advertisers, and large disposable income. But News Ltd just hasn’t targeted these people consistently. In my view, a lot of content the Oz chooses to major on is actually of little relevance to these people’s lives (~20 articles on Larissa Behrendt’s tweet? #Twitdef? Tim Flannery? ABC bias? Please), but I do think they hit the mark elsewhere – the mining tax being a great example, for better or worse (alright worse).  They just need to do this more regularly, and hone their ‘news sense’. (Sometimes I almost suspect their content is driven by asking “what will annoy Twitter the most?”)

And yes, they should continue to ignore young, progressive tweeters, like me, who are well-served by Fairfax, the ABC and Crikey. And when the Oz goes behind a paywall, we’ll find it a lot easier to ignore the Oz. Everyone’s a winner!

A few months ago I jotted down my thoughts on group-buying. I was pretty sceptical and bearish on the whole category and said “the key metric I want to see is repeat business from small businesses, because if they don’t have that, sooner or later they’ll stop making real money.” My essential view was that Groupon was probably going to have tremendous customer churn. They would need to constantly manage that through continuous marketing to keep the pipeline of customers coming thick and fast.

So it was with interest that I read the following about Groupon’s upcoming IPO:

Groupon is shedding some light on its financials for the first time. But one question leaps out: What is the new metric the social-buying company calls “adjusted CSOI”?

Short for “adjusted consolidated segment operating income,” Groupon discloses in the filing that the measurement reports the company’s operating income excluding several major expenses, including marketing and acquisition-related costs.

Going by the nonstandard metric, Groupon pulled in nearly $60.6 million last year, much higher than the $3.5 million it reported in 2009.

[...]

But those are very real costs, notably its huge marketing budget. The company spent $263.2 million in marketing last year, an astronomical leap over the $4.5 million it reported for 2009.

The filing also discloses that the company spent $203.2 million in acquisitions last year, having struck 13 takeovers since May of last year.

Taking those and other charges into account, Groupon reported a $456.3 million loss for last year on a basis of generally accepted accounting principles. That’s a significant widening from the $6.9 million it lost in 2009.

In essence, Groupon has invented a new accounting term called adjusted CSOI which strips out their marketing and acquisition costs, on the basis that these are not indicative of their future expenditure. In other words, they don’t feel they will need to do ongoing marketing to manage customer churn. They also don’t feel they will need to acquire competitors in order to maintain share, despite the very low barriers to entry in the category. I think that’s optimistic on both counts. I quote Nils Pratley in the Guardian:

How can a 30-month old company claim to be able to read the future perfectly? Groupon cannot know the rate at which its current collection of users will become bored or disloyal. As with the online poker companies, “customer acquisition costs” could become a permanent overhead.

Would-be investors should keep their eyes fixed on the $117m loss and ignore the fancy footwork. Even $2bn for a young, loss-making company with heavyweight competitors would be a lot – $20bn would be ridiculous.

[Disclosure: I work for Warner Bros Australia, who are obviously heavily involved in anti-piracy initiatives, and from time to time I have been personally involved in a limited way in these, including with AFACT. This post reflects only my personal views, and does not reflect in any way the views of my employer].

The recent AFACT vs iiNet piracy case (read about it here) demonstrates one thing: the interests of the ISPs and the interests of content distributors, in limiting piracy, are directly opposed. I am not suggesting that the ISPs would ever directly encourage illegal downloading, but it is at least obvious that it’s not in their interests to go out of their way to discourage it:

1. Heavy movie or music downloaders (whether legitimate or not) consume a lot of data. That means they’ll need bigger download plans, which means higher Average-Revenue-Per-User for ISPs.

2. Taking steps to discourage illegitimate downloading would hand an ISPs competitors a huge competitive advantage.

However, two things in the near future will completely change this:

1. The ubiquity of Unlimited broadband plans. While these plans are still relatively scarce in Australia, we are steadily progressing to a point Unlimited download plans are the norm. When this happens, ISPs will no longer be able to upsell their biggest downloading customers to bigger plans and grow their topline revenue. Instead, they will need to focus on maintaining profit margins. Suddenly, the biggest downloaders become among their worst rather than best customers – they make more profit on someone who pays $50pm for an Unlimited plan and downloads 50GB, than someone who pays $50pm and downloads 200GB, due to the costs associated with delivering that data. Suddenly, it’s in the interests of all ISPs to discourage their most active users, and illegitimate downloaders are the obvious choice.

2. Content is getting more important for ISPs, especially Telstra. Telstra has launched the T-Box device, allowing customers to download paid-for on-demand video content. Both iiNet and Optus are offering FetchTV to do the same. The relationships between content distributors and ISPs are getting closer and closer. Telstra in particular sees its future as a content company – hence its purchase of digital broadcast and mobile rights to AFL for $155m. eventually, content revenue will become as important as broadband utility revenue, and then ISPs will share the interests of their major trading partners – the content distributors – in promoting paid-for content.

When both of these things happen – as I think they will, and in the near future – I think you’ll see a substantially different attitude from the ISPs. And as this is the main thing preventing serious and effective action against illegitimate downloaders (see the iiNet article linked to above) – could it be the end of large-scale piracy?