takingpitches

My second in-depth installment looking at Groupon’s cost structure, following up on my post about the marketing line,  explores Groupon’s SG&A costs.

SG&A represented 84% of gross profit in 2010 and 66% of gross profit in 1Q 2011.  Much of this is compensation of sales people, according to the S1, although there are other things in here as well, such as payment to writers and customer service people and credit card processing costs, just to name a few.  But a primary driver seems to be sales people, although there are some questions I raise about this statement below.

Therefore, SG&A, assuming Groupon does not change its business model to rely less on sales people, represents an ongoing cost.   Unlike marketing, although Groupon says that it expects SG&A to become less as a percentage going forward (perhaps sales people can become more efficient?), there is no argument that sales compensation is an upfront cost that subsides dramatically after a certain point. This is common sense: salespeople have to refresh, on a daily basis, the deals offered to Groupon subscribers.  This is the essence of a daily deals business.

One observation is that SG&A costs are substantial.  66%-84% of gross profit, given the other substantial costs in the business like marketing, is significant.  An important question is what the level of SG&A is on an ongoing basis.

Another observation is that the performance per sales person is high.   Assuming a 40% gross profit rate (recall gross profit as used in Groupon terminology is merchant commission) as a % of revenues (to cut the difference between 2010 and 1Q 2011),  each salesperson, based on 1Q 2011 performance (each bringing in $172000 revenue a month), has been bringing in $68,800 in gross profit a month, or $825,600 a year.  I have no idea what all-in-costs for a salesperson are, but if it’s $100,000 or 12% of gross profit, this leaves a healthy margin.  (It also raises the question, given that SG&A costs are so much higher (i.e. between 66-84%), whether salesperson compensation is really the driver of the high SG&A costs.)

Groupon has to hire a substantial number of sales people as they scale (and the world economy says thank you, Groupon).  Based on the numbers provided, Groupon needs 500 sales people per $1 billion in revenue.  I have some questions about those numbers, since Groupon is at 3,556 sales people, even though they are at a run rate of approximately $3 billion in revenues for 2011 ( which would suggest 1500 sales people, or less than half of what the size of the sales force actually is).  Perhaps, Groupon is getting way ahead of itself in hiring, or the revenues/gross profit per sales person numbers in its S-1 are wrong.  Either way, we should know, as the actual revenue per sales people number is important, in terms of evaluating the long-term profitability of the Groupon business model.  (Incidentally, Groupon hired approximately 2500 sales people in 2010, and another 1000 in 1Q 2011.)

Excerpts below from S1 related to SG&A:

Selling, general and administrative expense primarily consists of wages and benefits (including stock-based compensation), credit card processing fees, consulting and professional fees, depreciation and amortization and technology-related costs. Approximately 50% of our employees were part of our salesforce as of March 31, 2011, and their compensation represented a significant portion of our selling, general and administrative expenses. Our salesforce is critical to growing and maintaining our merchant base and is the main source for driving new Groupon offers. We expect that our salesforce headcount will continue to grow over time as we continue to expand our business into new markets, but that our sales and marketing expense will decrease as a percentage of revenue.

….

Selling, general and administrative expense as a percentage of revenue was 24.5% and 32.8% for the years ended December 31, 2009 and 2010, respectively. The increases in selling, general and administrative expense as a percentage of revenue were principally related to the build out of our salesforce and investments in our corporate infrastructure necessary to support our current and anticipated growth. Over time, as our operations mature in a greater percentage of our markets, we expect that our selling, general and administrative expense will decrease as a percentage of revenue.         

2010 compared to 2009.

In 2010, our selling, general and administrative expense increased by $226.5 million to $233.9 million, an increase of 3,036%. As described below, the increase in selling, general and administrative expense for the year ended December 31, 2010 compared to the year ended December 31, 2009 was due to increases in wages and benefits, credit card processing fees, consulting and professional fees and depreciation and amortization expenses.

Wages and benefits (excluding stock-based compensation) increased by $87.6 million to $91.3 million in the year ended December 31, 2010 as we continued to add sales and administrative staff to support our business. Stock-based compensation costs also increased to $36.2 million for the year ended December 31, 2010 from $0.1 million for the year ended December 31, 2009 due to awards issued to retain key employees and awards issued in connection with our acquisitions. Credit card processing fees have also increased consistent with revenue, as this cost is generally variable based on the dollar volume of transactions that are processed. Our consulting and professional fees increased as a percentage of revenue in 2010 primarily related to higher legal and technology-related costs. Depreciation and amortization expense increased as a percentage of revenue in 2010 primarily because we recorded $47.3 million of intangible assets in connection with our acquisitions, resulting in $11.0 million of amortization expense.

2009 compared to 2008.

In 2009, our selling, general and administrative expense increased by $6.0 million to $7.5 million, an increase of 406%. Selling, general and administrative expense as a percentage of revenue for the year ended December 31, 2008 is not indicative of normal operating levels due to the small number of transactions processed in 2008 as we started selling Groupons in November 2008. Our salesforce includes over 3,500 inside and outside merchant sales representatives who build merchant relationships and provide local expertise. Our North American merchant sales representatives are based in our offices in Chicago and our international merchant sales representatives work from our 74 international offices. As the size of our salesforce has grown, the productivity of our sales representatives has increased. In the first quarter of 2009, when we first began investing in the development of our salesforce, the average number of merchants featured per sales representative per month was six and the average revenue per sales representative per month was $87,000. In the first quarter of 2011, the average number of merchants featured per sales representative per month was 17 and the average revenue per sales representative per month was $172,000. The following table lists the number of sales representatives in our North American and International segments as of the end of each quarter beginning with the first quarter of 2009:

The number of sales representatives is higher as a percentage of revenue in our International segment due to the need to have separate sales organizations for most of the different countries in which we operate. Due to local economic conditions, however, the average cost of each sales representative is lower in most countries in our International segment as compared to the costs in our North American segment.