I’m not good at very many things. I’m 5’ 8’’ (on a good day) so I’ve never been good at basketball. I was captain of my high-school lacrosse team…wait…the JV lacrosse team. I was pretty good during my time in politics for…damn… John McCain’s 2008 campaign. I can’t network. I hate small talk and tend to bore girls at the bar within about 35 seconds. I blame my shortcomings on the smart, tall, good-looking, athletic successful people who hogged all the talent when the” Man Upstairs” was allocating all the positive attributes. However, there is one thing I’m pretty good at: Picking losers.
That’s right, losers. Now don’t say it: “Takes one to know one.” No. What I am talking about is picking loser companies. And I don’t mean the Sears, the Best Buys and the Zyngas that everyone knows are dying a slow death. I mean the companies that everyone thinks are doing great but in reality are grossly over-priced.
So who is the latest loser? LivingSocial. With Recent slashes to their workforce and deal offerings far removed from anything social, it is evident they are going down the tubes. I would like to talk about the reasons I see for their decline.
I called this a crash-and-burn company about a year ago when they raised a round of funding that valued them at around $9 billion. I recognize that this article might be seen as Monday Morning Quarterbacking, now that their demise is evident and obvious. But I figure I can at least give my rationale for their inevitable, let’s call it “correction” about which I have been spouting off to deaf (or at least bored and annoyed) ears for the better part of this year.
I will focus on LivingSocial, but it all pretty much applies to its evil twin, GroupOn, as neither company has done anything to differentiate itself from the other—save for GroupOn going public first, lifting the veil on the overhyped and unsustainable group-deal business model.
Know Thy Customer
Here is the problem with both LivingSocial and GroupOn: They don’t know who their customer is (or at least whoever is basically lighting money on fire giving them a $9 billion valuation doesn’t know who the customer is). Because if they did, they would realize they don’t have very many of them, they are burning through them fast and the “party” is ending at 11.
So you might be saying, “What do you mean?! They have over 70 million users!” (As reported by spokesman Andrew Weinstein recently in the LA Times.)
Here’s the problem: The 70 million “users” (the people like you and me buying the coupons) are not the ones really keeping the lights on at the plush LivingSocial offices. The users are, in fact, the suppliers—or more precisely—the products themselves. LivingSocial gets paid to provide traffic to the real customers: the small businesses that run deals with it in the first place.
Though the question, “Who is our customer?” may seem a rudimentary one at best—or at worst, one asked only in classrooms filled with ideological MBA academics—I believe it is one worth exploring.
Let’s define a customer as someone with a need willing to pay to have someone meet that need and a supplier as one who provides the materials or services to satisfy that need.
To illustrate, let’s pretend we run a lemonade stand. We find ourselves on a hot day and recognize a group of people with a serious need: an ice cold, delicious beverage. There are many things that can satisfy that need: soda, water or maybe a Budweiser (‘Merica). However, what would really hit the spot is an ice-cold lemonade. Recognizing this need, we go to the local supermarket and pick up a few bottles of lemonade (we’re real lazy), pay the clerk a few dollars, set up our stand, and start raking in the bucks. So who is our customer and who is our supplier?
In this case it seems pretty clear who our customer is and who our supplier is. Our customer is the guy giving us money to satisfy his need (thirst). Our supplier is the person who makes available resources we need to satisfy that need (lemonade).
How LivingSocial Works: Burgess’ Buns
So let’s take a minute and think about how the LivingSocial business model works. I will use a gourmet burger joint, Burgess’ Buns (unfortunately for all of you ladies, it’s just a hamburger place) as an example.
Burgess’ Buns just opened and has a few customers, but what it really needs to get the word out that they have the best buns around is some feet through their doors to experience the burger-ecstasy that is Burgess’ Buns.
Burgess’ Buns has a few options here: send out mailers, get an ad in the local paper or have a guy streak across Nationals Park wearing nothing but a Burgess’ Buns t-shirt. These could all be effective, but they are also expensive and may not produce the conversion rates they need to make the marketing spend (or a night in jail donning a Burgess’ Buns t-shirt) worth the expense.
Enter LivingSocial. They will design an advertisement and send it to thousands of people in Burgess’ Buns’ area and they won’t have to pay them a dime. Sounds good, right? Sort of…The typical deal structure with LivingSocial is that your deal must be at least a 50% discount below the original price of the merchant’s offering. Then they split the revenue 50/50 with the merchant. So that means the merchant is getting a measly 25% of the original price.
So if a meal at Burgess’ Buns is priced at $10, they are required to offer a deal for the meal for at most $5. Of that LivingSocial will take half, leaving Burgess’ Buns with…carry the one…$2.50. That is not a lot of revenue. Even if it does cover the cost of the hamburger, buns and condiments, it surely won’t cover the other expenses, such as the cooks, clerks and wear-and-tear on the equipment that still needs to be paid for to fulfill the orders.
Now I’m not saying that LivingSocial doesn’t add value or is ripping off business owners. The losses sustained by Burgess’ Buns can (and should) be considered a cost of advertising, the same as putting an ad in the paper, except that Burgess’ Buns doesn’t pay a dime unless people are buying the deal.
Who is the customer and who is the supplier?
Let’s go back to our lemonade stand. The customer was the guy with the need (thirst) who gave us money in exchange for a product (lemonade). The supplier was the guy who gave us a product (lemonade) in exchange for something he wanted (money). The grocery store doesn’t care if someone uses their product to sell to people on the street or a party that evening. They have a fixed amount of lemonade for a given price.
What LivingSocial delivers is foot traffic. It has successfully identified the need of small businesses to generate people actually entering a store. That is what LivingSocial can do that Google or facebook cannot with all of its banner ads. LivingSocial can deliver people’s most precious resource: time. It does so by tapping into a market of thousands of individuals who are willing to exchange their product (time) in exchange for something they value (instead of money, it’s 50-75% off a delicious burger).
Just as the store clerk doesn’t care who buys his lemonade (as long as the price is right), so too are LivingSocial subscribers, indiscriminant of with what business they will spend their time (as long as the deal is right). Granted, LivingSocial subscribers are spending money but, assuming the steep discounts are discounted from the true market price, the real challenge is not to convince someone to purchase a delicious hamburger for 75% off, but rather making them aware of it in the first place.
Think about it…If I had a giant email list of people to whom I was offering 50-75% off deals, I could provide buyers all day. The real challenge would be to convince businesses to pay me in the form of cheap deals plus half the revenue from those deals in return for foot traffic.
Don’t believe me? Test it. Right now, Google the name of your home town, plus the words “group deal”. First, notice how many companies pop up. Then notice the types of companies. I bet you a massage for 50% off retail value that (1) there are a ton of companies with group deal offers and (2) they are mostly offered by organizations, such as local newspapers, that have an organically large exposure to people.
So we have established that, just as the grocery store clerk and his bottles of lemonade aren’t going anywhere so long as people are paying for their product, so too will people be willing to offer their time and money so long as there are great deals to be had.
But if LivingSocial is providing value to its small-business customers then why are they facing such dire straits and an inevitable correction to their valuation? I see three problems:
- A bad product
- A self-titled paradox
- A lack of real customers
Problem One: A bad product
The first problem is the nature of the customers that are attracted to coupons. If you were running Burgess’ Buns, what sort of customer would you want? The guy who sees an ad for your delicious burger, recognizes its full, decadent value and happily gives you money in exchange for that medium-rare slice of heaven you call a hamburger? Or do you want the guy who trolls group deal sites in search of the cheapest burger he can get his indiscriminant, barbarous, three-dollar-loving hands on? The point is that every business has an ideal customer whom the business must relentlessly target, and that ideal customer will find you if you are good at what you do without demanding a 50% cut in the price.
Best Buy learned this lesson a few years ago when it rolled out a large coupon campaign. If getting customers in the door was their metric for success then they were wildly successful. But their goal was not to get customers in the door or raise awareness that Best Buy existed—people already knew that. What Best Buy needed was profit—or achieving a return on the investment they made through the discounts they offered their customers with coupons.
What they found was that a lot of customers were coming through the door and buying up big screen TVs at a steep discount but those customers were not coming back to buy that new laptop for the regular price.
If LivingSocial cannot provide subscribers that will continue to patronize the businesses after the deal, never realizing the customer value needed to justify businesses running deals, they will continue to find themselves as they do now…with no customers.
Problem Two: The LivingSocial Paradox
One way LivingSocial can fix its problem is make their deals work for their customers. But they have to face their second problem: what I call the LivingSocial Paradox™ (don’t look it up, I just made that up tonight…actually go ahead and look up paradox.) Here is some background:
When Burgess’ Buns runs a deal, they collect the entire portion of their cut of the revenue, whether the coupon is cashed in or not. So for example, they sell 100 coupons for $5 they get $250. Let’s also assume that a Burgess’ Buns burger costs $2.50 each and let’s ignore the overhead expenses. So if 100% of the coupons are cashed in, they just break even. But if only 50% are cashed in then they make $125…$250 revenue – $125 costs = $125 profit…not bad. Unfortunately the actual percent of coupons that are typically redeemed is about 80%.
So the LivingSocial Paradox™ is that on repeat deals, it is in Burgess’ Buns’ interest to maximize the number of coupons it sells but minimize the number of coupons cashed in; but for LivingSocial to be able to continue to “supply” it’s real customers (the business owners) with people purchasing their deals, they have to keep their 70 million users happy. Their users won’t be happy if they keep buying coupons they never use and will soon stop buying. However, if LivingSocial’s users happily cash in most of their coupons, the business owners lose their buns (sorry, had to do it) on every deal and will likely not run additional, unprofitable deals.
Problem Three: They are out of customers
So I lied, the LivingSocial Paradox™ is not really a paradox because there is a way to keep both the business owners and the users happy: don’t make every deal unprofitable for the business owner. Sure, that means less margin for LivingSocial, but at least it is a model that is sustainable for all parties involved.
Oops, I forgot about one party…the investors.
A poorly structured group-deal company is not quite a paradox. But, a poorly structure group-deal company with a valuation of $9 billion, investors expecting to make a return on their investment and a dwindling customer base is a paradox, which ties together all the problems with a company like LivingSocial.
Here are some numbers. According to an employee 30% of all LivingSocial’s customers run one deal and never run another again, which makes sense. Why continue to sell your product for half the price and take home only a quarter of the revenue but carry the full cost?
Given the types of businesses LivingSocial deals with, there are about 2 million businesses in the US that would be reasonable users of group-deals—not 70 million. So if they lose 1 out of every 3 customers every round of deals; assuming businesses are not going to repeatedly spend 75% of every dollar on marketing (group deals); and GroupOn competing on pace with serving over 70,000 vendors a quarter, the group-deal market will be bone dry in 5 to 10 years.
I began by saying that they don’t know that their real customer is the business owner, not the coupon buyer or user (who is essentially getting paid to use the coupons) and don’t—or at least didn’t—realize how few of them are out there. LivingSocial is not publicly traded—they missed that bus in the wake of the poor GroupOn performance, hoping to wait it out and get a better valuation later—so you cannot verify their performance. So let’s look at what we can verify to see if we can put a final nail in the $9 billion coffin. Here are a couple of revealing indications of a shrinking market, demonstrated by LivingSocial:
- Cutting 9% of your employees…all from sales and customer service. LivingSocial claims efficiency. The purpose of sales and customer service people is to acquire new customers and service existing customers. If LivingSocial doesn’t see a need for these people I can only assume there are fewer potential customers to acquire and fewer existing customers to service. Not exactly a $9 billion growth story.
- Laser toe nail fungus treatment deals…not exactly “social living”. I don’t remember the last time I got the guys together for an afternoon of beer, football and the scent of scorched toe cheese. I can only infer from the rapid decline in quality deals reflecting the LivingSocial brand that they are just about out of customers. When we see the first dog doo removal deal, I’d say we can put a fork in it.
Unfortunately for them, and their employees, many of whom I’m sure had stock options, they did not recognize the rapidly eroding customer market and failed to adjust. Fortunately for the idiot at the bar telling me about the “hot LivingSocial IPO” he probably didn’t lose his shirt on that IPO.
To be clear, I am not saying that group deal companies like LivingSocial and GroupOn will go out of business or that they do not provide any value (not like the zero-revenue, black holes of the dot com bubble). They—or someone—will continue to get people through the doors of startup companies or highly seasonally cyclical businesses with excess inventory or beds to fill. LivingSocial provides value, just not $9 billion worth.
I will close with a story. I used to work in a boat yard doing yacht restorations. Our competitor next door was known to operate his business with this little gem you would expect from titan of business he was: “F@!k ‘em once, and if they come back, F#@k ‘em again.” He went bankrupt three times.
Whenever you are looking at whether or not a company will be successful, look no further than the players in the deal. If every single person involved in a deal is not better off after the deal, you better not count on that person returning to the table for long.