“Alright, you caught us. We’re actually not making any money. In fact, we are really losing a lot of money.”
This is the essence of Groupon’s declaration last week that it will remove the controversial accounting metric called Adjusted Consolidated Segment Operating Income (ACSOI) from its financial statements. ACSOI essentially measures Groupon’s profits before subtracting its subscriber-acquisition costs and stock option-based compensation. The metric was an attempt to put a thin veneer of respectability on what are extremely disconcerting profitability numbers for the company. In the first quarter of 2011, Groupon posted a net loss of $113.9 million. Yet, the company reported ASCOI of positive $80.1 million. In most recent quarter, Groupon’s losses continued to mount as it begrudgingly abandoned the ACSOI metric amidst criticism and incredulity from the SEC.
But what is most interesting about its emphasis on the ACSOI metric is that,
deep down, Groupon knows what we all know: good investments are profitable investments. It was simply not enough for the firm to report earnings and explain that it was investing for growth. Rather, Groupon felt the need to include a metric of profitability, no matter how contrived, that was actually positive.
Clayton Christensen would agree with the intuition that Groupon displays but ignores: businesses should become profitable before they become big. The best way to manage a fledgling business is for managers to be impatient for profit but patient for growth. Such a strategy limits an early venture’s funding in order to force the business to develop a profitable business model and then invests heavily in growth once such a model is identified – Christensen terms such investments “good money” for incubating growth businesses and extols the strategy for three reasons.
First, when a business is impatient for profit, managers are forced to validate their assumptions and demonstrate that customers are fundamentally willing to pay an acceptable price for the company’s offering.
Secondly, expecting a business to be profitable quickly forces it to keep its fixed costs low. Because a business’s cost structure determines which customers it finds profitable, keeping these fixed costs low preserves strategic options for the company when it is choosing which customers to target.
Finally, reaching profitability quickly ensures that when outside financing dries up, the venture can succeed on its own.
Groupon’s fundamental problem is that it has not yet discovered a viable business model. The company asserts that it will be profitable once it reaches scale but there is little reason to believe this. The financial results of Groupon’s traditional business continue to deteriorate, especially in mature markets, and new ventures such as Groupon Now also have failed to drive profits. And unlike the very few successful companies that scaled before they were profitable (think Facebook or Amazon), Groupon’s business model does not benefit from significant network effects. The company’s product is not more valuable to users as more people adopt the platform. 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. Yet, Groupon maintains a blind faith that growth will be its salvation. As Pets. com learned in the last bubble, such a strategy works just fine until you run out of other people’s money to spend on growth.