Groupons Business Model

Profits-Revenues Data Analysis Using the Work Function

Summary
Groupon is a relatively new web-based company, founded in October 2008. It became a public company in November 2011. However, the company has reported a profit for only 4 out of 14 quarters for which data is available. It reported a small profit for 1Q2010. Since then, although revenues have increased steadily, the company has consistently reported a loss. Nonetheless, things have been actually improving, with the losses decreasing with increasing revenues. Groupon has finally reported a small profit again for 2Q2012. The profits and revenues data is shown to follow a simple linear law y = hx + c = h(x x0) where x is revenues and y is profits. This is a consequence of the classical breakeven analysis for the profitability of a company. Depending on the numerical values of h and c (which can be either positive or negative), we have at least three possibilities: Type I behavior (h > 0, c < 0) increasing profits and profit margins with increasing revenues, Type II (h > 0, c > 0), increasing profits but decreasing profit margins with increasing revenues, and Type III (h < 0, c > 0), decreasing profits and profit margins with increasing revenues. Early in 2009, Groupon was operating in the Type I mode. Revenues were increasing but the company reported a loss in 1Q2009 followed by profits in 2Q2009 and 3Q2009. Then profits suddenly took a plunge, although revenues continued to increase. Groupon reported a loss in 4Q2009 and then a profit in 1Q2010. This fluctuation in the profits can be explained on the basis of the fluctuations in the nonzero intercept c, or the cut-off revenue x0 = -c/h, and actually represents a fluctuation in the costs. Thus began a prolonged period of Type III behavior with losses increasing (profits decreasing) with increasing revenues. Following the IPO, Groupon has slowly made a transition back to Type I
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mode, which began in the quarter ending Dec 2011 and has now reported a profit again for 2Q2012. A brief description of this transition was provided earlier (click here). The purpose here is to discuss the significance of the nonzero intercept c, which can be shown to be exactly analogous to the work function W conceived by Einstein, in 1905, when he enunciated his famous photoelectric law, K = E W = hf W = h(f f0). The analysis of the quarterly data, using the work function model also shows that Groupon could potentially convert 80% of the revenues (in excess of cut-off value x0) into profits. The analysis of the limited amount of annual profits-revenues data (2009-2011), using these ideas, reveals that the breakeven revenue is about $5 billion, annually, based on the current cost structure. The cumulative revenues for the six month ended June 30, 2012 was $1.13 billion. Hence, it is unlikely that a profit will be reported for the full year ending Dec 31, 2012, or even in 2013.

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1. Introduction
The main purpose here is to analyze the profits and revenues data for Groupon Inc., a US-based web company which was started in October 2008. It became a public company in November 2011 with its IPO being the biggest since Googles IPO in 2004. Groupon has just filed its second quarter financial results on August 14, 2012 (for quarter ending 6/30/12) and has reported a profit of $28.39 million with revenues of $568.34 million, for a profit margin of 4.99%. Based on the available profits-revenues data, the company last reported a profit for the quarter ending March 31, 2010. The profits were $8.551 million with much smaller revenues of $20.272 million. The profit margin was a whopping 42.2%. However, as seen from Table 1, the company was not able to sustain this high rate of conversion of revenues into profits in the subsequent quarters. Although the revenues increased steadily, losses were reported, consistently, starting with 2Q10.

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Table 1: Profits and Revenues Data for Groupon

Quarter ending 31-Mar-10 30-Jun-10 30-Sep-10 31-Dec-10 31-Mar-11 30-Jun-11 30-Sep-11 31-Dec-11 31-Mar-12 30-Jun-12 Revenues, x $, millions 20.27 38.67 81.78 172.22 295.52 392.58 430.16 492.16 559.28 568.34 Profits, y $, millions 8.551 -35.929 -49.032 -313.23 -113.89 -101.24 -10.57 -64.95 -3.59 32.33 Profit margin, y/x % 42.2 Change, x Change, y Slope, h = y/x

264 5.7

110

0.418

Additional entries to this table (with slight differences) may be found in Appendix I.

The change in revenues x and profits y between March 2011 and 2012, yield the slope h = y/x = 0.418. The above figures were obtained from the companys SEC filings and differ from those reported here. Some losses/profits here are those values attributed to Groupon (in the financial statements) and those attributed to common shareholders. Data sources: http://files.shareholder.com/downloads/AMDAE2NTR/2021598481x0xS1445305-12-1731/1490281/filing.pdf and http://files.shareholder.com/downloads/AMDA-E2NTR/2021598481x0xS1490281-1215/1490281/filing.pdf and http://files.shareholder.com/downloads/AMDAE2NTR/2021598481x0xS1445305-12-922/1490281/filing.pdf

****************************************************************** A turn around, which has resulted in the first profitable quarter since March 2010, began with the quarter ending Dec 31, 2011. Losses have been decreasing since then, which is equivalent to an increase in profits. Thus, it appears that Groupon may have achieved its breakeven revenues, see Figure 1, and is now ready to report profits consistently.

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40

Quarterly Profits, y [$, millions]

20 0

Profits

Losses
-20 -40 -60 -80 -100

-120
-140 0 100 200 300 400 500 600

Quarterly Revenues, x [$, millions]

Figure 1: The quarterly profits and revenues data since March 2011 indicate a general decline in the losses with increasing revenues. The only exception to the general upward trend is the data for quarter ending Sep 30, 2011. Has Groupon revenues exceeded the breakeven revenue needed for sustained profitability? See also an alternative view of this same data provided later in Figure 7.

2. Linear Profits-Revenues Law and Breakeven Analysis

As noted in the SEC filings, Groupon, Inc. is a local commerce marketplace that connects merchants to consumers by offering goods and services at a discount. Traditionally, small businesses try to reach consumers and generate sales by a number of well-tested methods: listings in the yellow pages, direct mail and newspaper ad campaigns, radio, TV and online advertisements, special in-store promotions and occasionally even using someone dancing at the street corner in a

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gorilla suit. Groupon offers a new way for local merchants to attract customers and sell their goods and services. Essentially, Groupons sells coupons online, offering say a 50% discount, to customers who will then redeem them at local stores which have entered into a contract with Groupon. The Groupon business model has also been the subject of some scathing criticism (click to see the recent article by Farhad Manjoo in Slate magazine) as being more like a loan sharking business. Groupon was started in October 2008 and has experienced a significant growth in revenues (see also the revised Table 1 in Appendix I). Also, according to its SEC filings, the number of active customers, defined as individuals who have purchased Groupons during the past twelve months, has increased from 8.9 million as of December 31, 2010 to 33.7 million as of December 31, 2011. Groupon launched its IPO and became a public company in November 2011. As noted already, the purpose here is mainly to analyze the profits-revenues data for Groupon using a new methodology which has been described in several articles available on this website (written since the Facebook IPO on May 18, 2012). A bibliography list is provided at the end of this article. Very briefly, it has not been appreciated that all companies follow a simple and universal linear law, y = hx + c, which relates revenues x and profits y. The constants h and c in this law can be deduced using the available financial data, such as that compiled in Table 1. Indeed, this linear law can be shown to be the consequence of the classical breakeven model for the profitability of a company. Consider a company making and selling N units of some product (e.g., internet coupons offering a discount, in the case of Groupon). The total cost C associated with the operation is the sum of the fixed costs a and the total variable costs bN where b is the unit variable cost. Thus C = a + bN. If p is the unit price, the total revenues generated R = pN, or equivalently, units N = p/R.

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Hence, the profits P = Revenues Costs = R C = pN a bN = (p b)N a. Eliminating N using we get, P = [(p b)/p] R a which is a linear relation between profits P and revenues R and can be rewritten as y = hx + c, where Slope h = (p b)/p = 1 (b/p) - Depends on unit variable cost b and unit price p Intercept c = - a - Depends on the fixed cost a Although deduced here by considering a single product, the linear law can be shown to hold for a number of companies, large and small. Some examples are Microsoft, Apple, Google, IBM, Southwest Airlines, Exxon Mobil. Depending on the numerical values of h and c (which can be either positive or negative), we have at least three possibilities. 1. Type I company (h > 0, c < 0): Profits and profit margins increase with increasing revenues. (The reverse is also observed, i.e., profits decreasing with decreasing revenues and is called INVERSE Type I behavior.) 2. Type II company (h > 0, c > 0): Profits increase with increasing revenues, but profit margins decrease. (Companies are usually observed to make a transition from Type I behavior to Type II behavior with increasing revenues, as seen, for example, with Microsoft). 3. Type III company (h < 0, c > 0): Both profits and profit margins decrease with increasing revenues. (Sometimes, even the opposite is observed, i.e., profit and profit margins INCREASE with DECREASING revenues). Each of the linear laws described here applies over a limited range of revenues (and profits). Transitions from one type of linear behavior to another (Type I to Type II, or Type I to Type III, or Type I to Type II to Type III) are observed and the general profits-revenues law is a smooth curve with a maximum point. We thus observe small linear segments of a more general non-linear law, which can be written as follows. Further details about the implications of this general nonlinear profits-revenues law may be found in the articles cited.

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y = mxn [e-ax /(1 + be-ax) ] + c and, dy/dx = [ (y c)/x ] [ n ax - axg(g - 1) ] where g = 1/(1 + be-ax) note g = 1 for b = 0

(1) (2) (3)

As discussed elsewhere, equation 1 can be derived by generalizing the statistical arguments invoked by Max Planck to develop quantum physics, in December 1900. Instead of the total energy UN associated with N particles (called oscillators by Planck), we now consider the total revenues (and profits) associated with N different products each having its own triplet (a, b, p) which defines the costs and revenues. Thus, energy in physics is equivalent to money in economics (or the business and financial world). The power-exponential law, given as equation 1, thus follows if we systematically reinterpret and extend the meaning of each of the mathematical symbols in Plancks famous paper. The derivative dy/dx of this general function (the slope of the tangent to the curve) relating profits and revenues is given by equation 2 where the function g, defined in equation 3, is introduced for convenience to perform the operation of differentiation. (The rule for differentiation of a product is all that is required.) The linear law is deduced as a special case for n = 1, a = 0, and b = 0. The power law, y = mxn + c, is deduced as a special case for a = 0 and b = 0. Profits increase with increasing revenues at an accelerating rate (n > 1) or a decelerating rate (n < 1). For n = 1, we get the linear law. The power-exponential law, y = mxne-ax + c, is deduced as a special case for b = 0. The x-y graph now reveals a maximum point at x = n/a. The case of a, b 0 is the most general and again reveals a maximum point. The profits-revenues data for several real world companies can be shown to reveal such a maximum point. Some examples of companies operating past their maximum point are Ford Motor Company, General Motors (which went into bankruptcy in June 2009), Air Tran (which entered into a merger with Southwest Airlines), Southwest Airlines (even prior to Air Tran merger), Yahoo, Verizon
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Communications, and Kroger. The implications of the appearance of the maximum point and prolonged operation in Type III mode (profits decreasing with increasing revenues) have been discussed in detail and needed not be repeated here. The various transitions outlined (including Type III behavior and operation past the maximum point), very simply put, are due to increasing costs as the company grows and its revenues increase. As we will see shortly, Groupon has been operating in the Type III mode and seems to be making a transition to Type I mode. This transition also reflects the increasing costs of operation as revenues have increased.

3. Analysis of Profits-Revenues data: Breakeven revenue

Although a nonlinear trend is evident in the profits-revenues data in Figure 1, caution must be exercised in applying nonlinear models, such as the power-law model, y = mxn + c, to describe this data since extremely bullish or bearish predictions will be obtained, which are eventually proven to be inconsistent with long term observations (see, for example, the discussion of the data for Google and Facebook, click links here; see also links given in the bibliography list). True nonlinearity, such as power-law behavior, is often merely due to a transition from one linear mode to another with increasing values of x. Essentially, the slope h and the intercept c change as x increases and the system is operating along two linear segments for different ranges of x and y values. A smooth curve can be used instead of two line segments. Engels law relating income x and food expenditure y is a good example of such a power law (n < 1). Another example is the frictional drag, or aerodynamic resistance, experienced by a moving object (such as a spaceship, an aircraft, an automobile, or even an Olympic runner) as its speed (or, more strictly, its velocity v) increases. Such nonlinearity should, however, be carefully distinguished from what we see here in the financial data. The Ockhams razor principle is especially applicable in the analysis of financial data where one is often interested in the short term predictions (see Jeffreys, W. H.,
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and Berger, J. O. (1992), Ockham's Razor and Bayesian Analysis, American Scientist, 80, 64-72 Erratum, p. 116). This principle states that, of all possible models, the simplest model is the one that is to be preferred. Keep it simple, said Einstein, but not too simple. (The latter quote can also be used in a detrimental way to promote complicated theories. It is NOT a polemic against simplicity. Rather, what Einstein is emphasizing is that we understand the essence of the problem that we are dealing with.) Thus, after careful consideration, it is suggested that the nonlinearity embodied in the power-law, or the power-exponential law (equation 1) is NOT a good model to analyze financial data, where one is essentially looking at the short term projections. What we often witness in the financial world are line segments of the more general nonlinear curve represented by equation 1. What we observe is really what amounts to small fluctuations (with occasionally large fluctuations) in profits along a Type I, Type II, or Type III line, with increasing revenues. Good companies, such as Microsoft, which has certainly set the standard for excellence in the business world (at least as far as financial performance is concerned), seem to operate along a set of parallels in the profits-revenues diagram with profits and revenues jumping back and forth (fluctuating) from year to year, or quarter to quarter, between these parallels. The reader is encouraged to review, in particular, the analysis of Microsoft profits-revenues data. Kia Motor Company also reveals an exactly similar behavior, with the profits and revenues data following two parallel lines. The variation in the numerical value of the nonzero intercept c is thus the primary reason for this movement between parallels on the profits-revenues diagram. Thus, we must understand the significance of the nonzero intercept c. The breakeven model teaches us that this is related to the companys fixed costs a. The quarterly data for Groupon plotted in Figure 2 reveals significant scatter. Nonetheless, a careful study of the data shows an unmistakable confirmation of the linear law. Consider, for example, the two recent quarters ending March 2012 when Groupon reported a small loss ($3.59 million) and June 2012 where a profit ($32.33 million) was reported for the first time since March 2010. Revenues
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increased between these two quarters and one would therefore expect an increase in the profits (or reduced losses). Since Groupon seems to have been close to the breakeven revenue, a profit was indeed reported for June 2012. The breakeven revenue represents the minimum revenue x = x0 = - c/h which must be exceeded to report a profit. This can be deduced from the linear law, y = hx + c = h(x x0). The constant h and c can be fixed by considering any two (x, y) pairs in the data set. The equation of the straight line joining the March 2011 and March 2012 data points is y = 0.418x 237.47 = 0.418(x 567.9). This is a Type I equation with slope h = 0.418 > 0 and intercept c = - 237.47 < 0. Thus, based on its current operations, we estimate the cut-off revenue x0 = $567.9 million. Groupon is therefore expected to report a profit is revenues exceed this minimum value.
300

Quarterly Profits, y [$, millions]

200 100 0 0 -100 -200 -300 -400 200

Type I line y = 0.42x 237.5 = 0.42 (x 568)

400

600

800

1000

1200

Quarterly Revenues, x [$, millions]

Figure 2: Quarterly profits-revenues data for Groupon Inc., confirming the linear law and the classical breakeven model for profitability of a company.

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The revenues for the quarter ending June 30, 2012 were $568.34 million confirming both the linear law and the breakeven model. The profits for 2Q2012 were actually higher than predicted by the Type I equation. This can be interpreted as a slight fluctuation in the value of the nonzero intercept c from the value deduced using just two data points. Notice also the general upward linear trend in the data if we overlook the outliers, close to the origin (small revenues and profits/losses) and the (x, y) pair for Dec 2010. Indeed, the following equations can be deduced if we consider the four data points, at smaller revenues, that lie just above and below the Type I line indicated in Figure 2. y = 0.36x 244.3 = 0.36(x 670.4) June 2011 and Dec 2011 y = 0.31x 144.1 = 0.31(x 464.2) Sep 2011 and June 2012 Best-fit line, y = 0.47x 259 = 0.47(x - 549) with r2 = 0.714 The slopes h = 0.36 and 0.31 deduced here roughly equal suggesting a movement along parallels. The slope h = 0.42 deduced earlier for the March 2011 and March 2012 is also roughly comparable with an average slope of 0.364 for these three sets of (x, y) pairs. Furthermore, a linear regression analysis (excluding the outliers, standard practice in any such statistical analysis) yields the best-fit equation with a higher slope h = 0.47, with a very high positive regression coefficient r2 = 0.71. (Recall that r2 = + 1.00 for a PERFECT positive correlation and when all points lie on a perfect straight line.) The best-fit line has a higher slope because it must pass through the point (xm, ym) = (456.34, -43.65). These are the mean values of x and y for the six data points mentioned above. The best-fit line pivots to a higher slope about this mean point to minimize the sum of the squares of the deviations (y yb). Here yb is the predicted value for profits on the best-fit line. The mathematical formula for the slope h in the linear regression analysis is derived by minimizing the sum (y yb)2. The alternative viewpoint is that of finding an operating line such as the line joining the March 2011 and March 2012 data and examining the data carefully for movement along a set of parallels with varying values of the nonzero intercept c.

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Quarterly Profits, y [$, millions]

200 100

0
-100 -200 -300 -400 0 100 200 300 400 500 600 700 800

Best-fit, Type I, line y = 0.47x 259 = 0.47 (x 549)

Quarterly Revenues, x [$, millions]

Figure 3: The profits-revenues data for Groupon, for the most recent quarter, can be explained by invoking a simple linear law, y = hx + c. The constants h and c were determined using classical linear regression analysis. Using the analogy energy in physics = money in economics, the nonzero intercept c is seen to be exactly analogous to the work function W in Einsteins photoelectric law K = E W = hf W = h(f f0). The outliers here thus represent fluctuations in the work function, or the costs associated with converting revenues into profits.

4. The nonzero intercept c and the work function W

Groupon is an interesting company for two reasons. First, it is an infant company with only three full years of operation. Second, unlike Microsoft, which reported its first ever quarterly loss in 26 years, for 4Q2012 (for the full fiscal year Microsoft did report a profit), Groupon has been reporting quarterly losses rather regularly since its inception in October 2008.

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The quarterly data for 2009 has been included in the revised Table 1 which may be found in Appendix I. Prior to the quarter ending June 30, 2012, Groupon has reported a profit for three other quarters. Let us consider the evolution of revenues and profits in 2009. Groupon reported a loss in 1Q2009. In 2Q2009, revenues increased and Groupon reported a profit. The profit margin y/x was rather small, only 0.6% (see revised Table 1). Notice that x = $3.049 million and y = $0.33 million yielding a positive slope h = y/x = 0.108. In the following quarter, 3Q2009, revenues increased again (x = $6.697 million) and Groupon reported a profit once again (y = $0.829 million). The slope h = y/x = 0.124. The profit margin y/x, however, increased dramatically to 8.5%. If we consider the overall change between 1Q2009 and 3Q2009, x = $9.746 million and y = $1.159 million and the slope h = 0.119. In fact, the three slopes are seen to be roughly equal to each other. On a x-y graph, see Figure 4, the three data points can be seen to lie on or very close to the straight line, with the equation y = 0.12x 0.34 = 0.12 (x 2.85). This equation is deduced by considering the two extreme points and is a Type I line (h > 0, c < 0). This means there is a cut-off revenue x0 = $2.85 million, above which profits will appear. This is the situation for 2Q2009. Profits and revenues continued to increase along the same Type I line through 3Q2009. Also, it is now easy to see why the profit margin y/x increased from 1Q2009 to 3Q2009. The linear law means the ratio y/x = 0.12 (0.34/x) will increase as x increases along the Type I line. A straight line can always be drawn between any two points in (x, y) space. Here, however, we find three points lining up nicely on a straight line. The fact that the 3Q2009 data lies close to the extension of the line joining the 1Q2009 and 2Q2009 is indeed remarkable. (Alternatively, 2Q2009 data point lies close to the line joining 1Q2009 and 3Q2009, which permits the slope h to be fixed by considering a larger range of x and y values.) Also, why do the three data points fall on a nice straight line instead of being scattered? Why is it a Type I line, rather than a Type II or Type III line?

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This has to do with the organizational structure of the company being studied. This structure dictates how costs increase with increasing revenues. The simple breakeven model teaches us that profits will appear only if revenues exceed a minimum amount, the fixed cost a. As revenues increase further, not all of the revenues will be converted into profits because of the variable cost. Only a portion (pN bN) will appear as profits. The rate of conversion of revenues into profits is given by the slope h = 1 (b/p). The lower the unit variable cost b the higher the slope h. Also, the higher the unit price p, the higher the slope h.
1.20

Quarterly Profits, y [$, millions]

1.00 0.80 0.60 0.40 0.20 0.00 0

Type I, line y = 0.12x 0.34 = 0.12 (x 2.85) y/x = 0.12 (0.34/x)

10

12

14

16

-0.20 -0.40
-0.60

Quarterly Revenues, x [$, millions]

Figure 4a: The profits-revenues graph for the period 1Q2009 to 3Q2009. Revenues increased with each succeeding quarter and profits also increased. The three points are seen to lie on a nearly perfect straight line. It is this subtle interaction of costs and revenues, in other words, the organizational structure, or the business model of the company, which dictates whether the three (or more) data points that we have just considered fall on a Type I line or a Type II line, or even a Type III line.
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As we from the profits-revenues data, Groupon was not able sustain this profit generation rate beyond 3Q2009. For 4Q2009, Groupon reported a loss, which implies a sudden jump in the costs, i.e., a change in the nonzero intercept c. The (x, y) pair for 4Q2009l, see Figure 4b, falls well below the Type I line. With increase in revenues (to $16.920 million), an extrapolation along the Type I line would have yielded a profit of $1.673 million, i.e., the projected Costs = Revenues Profits = $15.247 million. Instead, Groupon reported a loss of $1.903 million, i.e., Costs = $18.823 million. The difference in the projected profits and the actual loss 1.673 (-1.903) = 3.576 is exactly equal to the difference in the costs (18.823) 15.247 = 3.576. The higher costs meant a loss instead of profits.
1.0

Quarterly Profits, y [$, millions]

0.5 0.0 0 -0.5 -1.0 -1.5 2 4 6 8 10 12 14 16 18 20

4Q2009
-2.0 -2.5

Quarterly Revenues, x [$, millions]

Figure 4b: The 4Q2009 data falls off the Type I straight line followed by the data for the period 1Q2009 to 3Q2009. This can be explained by a sudden jump from one value of the nonzero intercept c to another, i.e., a change in the fixed cost.

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A sudden change in the nonzero intercept c, or the costs, between 3Q2009 and 4Q2009 thus provides an explanation for the sudden plunge in the profits. Indeed, as also discussed in earlier articles, the nonzero intercept c in the linear law y = hx + c = h(x x0) is exactly analogous to the work function W introduced into physics by Einstein, in 1905. Einstein uses Plancks radiation law (the nonlinear law generalized as equation 1 above) to arrive at the simple linear law K = E W = hf W = h(f f0). As discussed briefly in what follows here, this analogy is indeed compelling and cannot be overlooked. In Einsteins law, E = hf is the energy of a photon and K is the maximum (kinetic) energy of the electron, h is the Planck constant and f is the frequency (of the light wave). When light (which can be thought of as being a stream of photons each having the energy E = hf) shines on the surface of a metal, it ejects electrons from within the surface of the metal to produce a photocurrent. However, some of the energy E must be given up to produce the electron. Einstein called the energy that must be given up as W, the work function of the metal. This must be determined experimentally. Thus, K < E. Also, the nonzero work function W means that electrons will be produced only if the frequency f > f0 = W/h, the cut-off frequency. Furthermore, the K-f graph will be a series of parallel, if we perform experiments with different metals, having different work functions W. We see an exactly similar behavior in the profits-revenues data for various companies. Energy in physics is just like money in economics. Profits and revenues are exactly analogous to the energy of the electron K and the energy of the photon E = hf. Just as some energy W must be given up to produce the electron, some of the revenues must be given up to produce the profits. The difference is known as the costs. And, just as the frequency f must exceed the minimum value f0 = W/h before electrons appear (in the external circuit), the revenues must also exceed a minimum value x0 = -c/h before profits appear. Also, just as the K-f graph is a series of parallels, we see clear evidence for a movement along parallels on the profits-revenue diagram. Although, Microsoft and Kia provide the best example of such a movement along parallels, the data for Groupon reveals a similar pattern. Of course, it would seem
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that we have ignored the outliers. We have not. The outliers simply represent extreme fluctuations from the general behavior that has been postulated here (much larger variations in the fixed costs, embodied in the constant c). Notice also that the data for March 2010 (y = 8.551) and Sep 2011 (y = -10.59) and March 2012 (y = -3.59) all represent points where Groupon was very close to its breakeven revenue. However, as the company has grown and its revenues have increased, both the fixed cost (the parameter a in the breakeven model) and the variable cost (parameter b in the breakeven model) obviously changed as revenues increased. Thus, Groupon was unable to report a profit. It appears that a stable operational mode is now established. Perhaps, new insights can be gained, as noted also in earlier articles, with a wider appreciation of the significance of the linear law being discussed here and also the work function (nonzero intercept c) well beyond physics. Both nascent companies like Groupon, and mature companies like Microsoft and IBM can be analyzed using this model and the idea of a work function. The nonzero intercept c also means that the profit margin y/x = m = h + (c/x) is not a constant and will keep on increasing or decreasing as revenues x increase. The maximum profit margin y/x = m = h the slope of the profits-revenues graph.

5. The Line of Excellence

Finally, let us re-examine the quarterly profits-revenues data to determine the maximum profit potential for Groupon. This is exactly similar to finding the maximum kinetic energy of the electron in the photoelectricity experiments. (An accurate value of the fundamental Planck constant h can only be obtained if we determine the maximum value of K as a function of the frequency f.) The quarterly data for 2009, along with the data reported in the registration statement filed with the United States Securities Exchange Commission has been complied in the revised Table 1 in Appendix I. The data is plotted in Figure 5. The following the Type I equation, y = 0.798x 450.6 = 0.798 (x 564.89), envelopes all of the data in that all the points lie above and to the left of this line.
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It also has the highest conceivable slope h = 0.798. This line may therefore be thought of as the Line of Excellence (click here) the significance of which also been discussed earlier (see Ref. [13] in bibliography) within the context of Googles profits-revenues data.
400 300 200 100 0 -100 -200 -300 -400 -500

Quarterly Profits, y [$, millions]

Mar 12

Dec 11

Dec 10
0 100 200 300 400 500 600 700 800 900 1000

Quarterly Revenues, x [$, millions]

Figure 5: The highest profit potential for Groupon is revealed here by considering all of the available quarterly data going back to 2009. The Type I line joining the (x, y) pairs for Dec 2010 and Mar 2012 data, with the equation y = 0.798x 450.6 = 0.798 (x 564.9) has the highest slope and envelopes the data. It also passes close to the Dec 2011 data point. The two points that fall below and to the right of the line were excluded since they represent the data with the restated revenues (with no change in the profits) between the S-1 registration statement (filed prior to the IPO) and the first 10-K filing for the full year 2011, following the IPO.

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The graphical representation of the profits-revenues data here suggests that Groupon could potentially convert nearly 80% of its revenues, in excess of the breakeven or cut-off value x0, into profits. Indeed, the short line segment joining Dec 2011 and March 2012 data points can be shown to have a slope h = 0.901. This means that Groupon was able to convert 90% of the additional revenues ($67.12 million) generated between the quarters ending Dec 31, 2011 and March 31, 2012, into profits (y = $60.5 million). Furthermore, Groupon seems to be poised to make the transition from a sustained period of Type III (h < 0, c > 0, negative slope and positive intercept, increasing revenues and decreasing profits, or equivalently, increasing losses with increasing revenues, Figure 6) behavior to the more desirable Type I behavior which was SEEN EARLIER from 1Q2009 to 3Q2009. A higher slope is conceivable if we join the June 2011 and Sep 2011 data points. However, in this case x = 37.58 and y = 90.67 and h = y/x = 2.41 > 1. Profits would have to increase at a very high rate, increase more than revenues do, for the system to operate along this line. This is clearly not a sustainable proposition and must be rejected. Likewise, other potential paths, with slope h > 1, must also be rejected. For example, the line segment joining the two recent quarters Mar 2012 and June 2012, has a slope h = 4.1 >> 1. The revenues increased slightly by x = $9.052 million (from $559.283 million to $568.335 million) but the profits increased by an astonishing y = $36.8 million, which is clearly unsustainable. Hence, we conclude that the highest rate of conversion of revenues into profits is about 80% for Groupon. This profit potential could be achieved if efforts are directed to understanding all of the factors in the Groupon business model that influence the fundamental (a, b, p) triplet which determines costs and revenues, and hence also the slope h and the cut-off revenues x0.

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100

Quarterly Profits, y [$, millions]

50 0 0 -50 -100 -150 -200 -250 -300 -350 100 200 300 400 500 600 700 800

Type I line y = 0.372x 212.7 Mar 11 to Mar 12

Type III trend line y = - 0.258x Joins June 11 to origin

Quarterly Revenues, x [$, millions]

Figure 6: Groupon went through a transition from the highly desirable Type I behavior (increasing profits and profit margins with increasing revenues, seen between 1Q2009 to 3Q2009, seen in Figure 4) to a prolonged period Type III behavior, shown here using an expanded scale (for negative profits) compared to that used in Figure 5. The Type III line, with the equation y = - 0.258x, joins the origin (0, 0) to the June 2011 data point. This is added here only to reveal the general Type III trend of increasing losses (mathematically equivalent to reduced profits) with increasing revenues. The Type III lines also passes through the Sep 2010 data point. (Slope h = -0.251 for Sep 10 and June 11.) A linear regression equation could be deduced but this is not deemed necessary at this stage. A more viable and sustainable alternative is presented in Figure 7 where we reconsider the data for the most recent quarters. A Type I line with a slope h = 0.372 joins the data for March 2011 and March 2012. This is essentially an alternative view of exactly the same data presented earlier in Figure 1. Instead of a nonlinear or seemingly erratic variation, we now envision a movement in the profits-revenues space along roughly parallel lines. The June 2011 and Dec 2011
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data can be seen to fall on a roughly parallel line with a slope h = 0.364. The Sep 2011 and June 2012 data fall on another roughly parallel line with a somewhat smaller slope h = 0.31. This viewpoint here is also consistent with the discussion of the data presented earlier using the representations in Figures 2 and 3.
100

Quarterly Profits, y [$, millions]

50

0
-50

100

200

300

400

500

600

700

800

-100

Type I line y = 0.372x 212.7 = 0.372 (x 571) Quarterly Revenues, x [$, millions]

-150

-200

Figure 7: An alternative viewpoint of the profits-revenues data presented earlier in Figure 1. The same six quarters, starting with March 2011 are considered here. The data for the six quarters can be seen to represent a movement along roughly parallel lines with a slope h = 0.372. The fluctuations in the quarterly profits are thus entirely due to the changes in the work function, represented by the nonzero intercept c. If the profits-revenue trend here is sustained, overall, Groupon may be considered to have made a transition from the Type I line in Figure 4 with a slope h = 0.12 to another Type I line, with a slope h = 0.37, with an intervening adjustment period with the Type III behavior (Figure 6). In summary, Groupon may have achieved its breakeven revenue level in the quarter ended June 30, 2012 and so seems to be poised to report profits on a more consistent basis. However, efforts must be made to control both the fixed costs and
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the variable costs which (as shown here) have increased since March 2010. The application of the generalized Planck power-exponential law (equation 1 here) and the extension of the idea of a work function to many problems outside physics have also been discussed in several articles cited in the bibliography. ******************************************************************

Appendix I: Annual Profits-Revenues Data

The annualized profits and revenues data for the three full years of operation is given in Table 2 and was again obtained from the SEC filings. This data is plotted in Figure 8. Although quarterly profits have been reported on four occasions (quarters ending June 2009, Sep 2009, Mar 2010 and the quarter ending June 30, 2012), Groupon has still not reported a profit on an annual basis. The loss reported in 2009 was quite small and it appeared that the company was close to its breakeven point. Since Profits = Revenues Costs = P = R C, for 2009 the costs C = 15.881 and Revenues R = 14.540. In 2010 and 2011, when revenues increased, costs also seem to have increased and the company did not report a profit, see Table 2. However, the reported losses decreased (which is mathematically equivalent to increasing profits) between 2010 and 2011, as the revenues increased. The equation of the line joining the (x, y) pairs for 2010 and 2011 can be shown to be y = 0.089x - 441.273 = 0.089 (x x0) = 0.089 (x 4952). This implies that the breakeven or cut-off revenue x0 = $4952 million which is significantly greater than the $1610 million reported for the year ending Dec 31, 2011. Hence, although a small profit was reported for the quarter ending June 30, 2012, it appears highly unlikely that a profit will be reported for the year ending 2012, or even in 2013.

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200

Annualized Profits, y [$, millions]

2009
100 0 -100 -200

x0

2011
-300 -400

2010
-500 0 1000 2000

Type I line y = 0.089x 441 = 0.089 (x 4952)

3000 4000 5000 6000 7000 8000

Annualized Revenues, x [$, millions]

Figure 8: Annualized profits-revenues data for Groupon reveals a Type I behavior with the equation y = 0.089x 441 = 0.089 (x x0) = 0.089 (x 4952). This implies a breakeven or cut-off revenue (akin to the cut-off frequency in Einsteins law) of x0 = $4952 million or about $5 billion in annual revenues given the current cost structure of Groupon. For the six months ending June 30, 2012, the cumulative revenues were only $1,127.62 million. Hence, it appears unlikely that a profit will be reported for the year ending Dec 31, 2012.

Table 2: Annual Profits and Revenues Data for Groupon

Year ending 31-Dec-11 31-Dec-10 31-Dec-09 31-Dec-08 Revenues, x Profits, y Change, $, millions $, millions x 1,610.430 -297.762 1,297.5 312.941 -413.386 14.540 -1.341 0.005 -1.542 Change, y 115.6 Slope, h = y/x 0.089

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Annualized Revenues, x [$, millions]

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 0 12 24 36 48 60

x = 1,297.5

t = 1 year

Time, t [months since Dec 2008]

Figure 9: Revenues growth, as a function of time, for Groupon since December 2008 (taken to be month zero). The highest rate of increase of revenues is $1,297.5 million per year. This rate is used to predict future revenues for 2012 and 2013. (The problem is exactly similar to predicting the future position of a moving vehicle based on its current speed, i.e., the measurements of position x and time t.) From Table 2, the largest increase in the revenues was $1,297.5 million between Dec 2010 and Dec 2011. Hence, the highest rate of increase of revenue, x/t = $1,297.5 per year. If this rate of revenues growth can be sustained, the predicted revenues are: for Dec 2012, $2908 million and for Dec 2013, $4205 million. The projected revenues are therefore less than the cut-off revenue x0 = $4952 million needed to report a profit, based on the current cost structure. A significant acceleration in the revenues growth is required to turn a profit for the year ending 2012 or 2013, see also Figure 9. Alternatively, since the rate of conversion of revenues (in excess of the breakeven or cut-off value x0) into profits, is given by the slope h of the profits-revenues
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graph, the higher the slope h, the higher will be the profits y. Hence, it is important to understand the factors that control the two parameters b and p that enter into the equation for the slope h = 1 (b/p), the unit variable cost b and the unit price p. Additionally, reducing the cut-off revenue x0, i.e., the fixed cost a would also enhance the profits for a fixed value of h.

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Table 1 (Revised): Profits and Revenues Data for Groupon

Quarter ending 31-Mar-09 30-Jun-09 30-Sep-09 31-Dec-09 31-Mar-10 31-Mar-10 30-Jun-10 30-Jun-10 30-Sep-10 30-Sep-10 31-Dec-10 31-Dec-10 31-Mar-11 31-Mar-11 30-Jun-11 30-Sep-11 31-Dec-11 31-Mar-12 30-Jun-12 Revenues, x $, millions 0.252 3.301 9.998 16.920 44.24 20.27 87.3 38.67 185.23 81.78 396.60 172.22 644.73 292.52 392.58 430.16 492.16 559.28 568.34 Profits, y $, millions -0.309 0.021 0.850 -1.903 8.028 8.551 -35.929 -35.929 -49.032 -49.032 -313.23 -313.23 -146.48 -146.48 -101.24 -10.57 -64.95 -11.695 28.39 Profit margin, y/x % 0.6 8.5 39.6 42.2 Higher revenues in S-1 filings restated in the subsequent 10-K S-1 filing was for the IPO launch in November 2011 Change, x Change, y Slope, h = y/x

As given in the S-1 filing June 2, 2011 Revenues were restated in 10-Q filings

264 4.99

135

0.511

Notice the slight discrepancy in the March 2011 and 2012 revenues and profits, which were used to calculate the Type I equation in Figures 2 and 3. The change in revenues x and profits y between March 2011 and 2012, yield the slope h = y/x = 135/264 = 0.511. The discrepancy is due to the restated values in 10-K (post IPO)and the figures in the S-1 filing in June 2011 (prior to IPO) and also the three line items called net loss, net loss attributed to common shareholders and net loss to Groupon. In some cases only net loss to Groupon figures are available. Data sources: http://www.sec.gov/Archives/edgar/data/1490281/000104746911005613/a2203913zs -1.htm#do79801_management_s_discussion_and_an__man03466 SEC Registration statement S-1 filed on June 2, 2011. (The March 2011 and March 2010 values are different.) http://files.shareholder.com/downloads/AMDA-E2NTR/2021598481x0xS1445305-121731/1490281/filing.pdf and http://files.shareholder.com/downloads/AMDAE2NTR/2021598481x0xS1490281-12-15/1490281/filing.pdf and http://files.shareholder.com/downloads/AMDA-E2NTR/2021598481x0xS1445305-12922/1490281/filing.pdf
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Table 2 (Revised): Annual Profits and Revenues Data for Groupon in the S-1 Filing of June 2, 2011
Year ending 31-Dec-10 31-Dec-09 31-Dec-08 Revenues, x Profits, y Change, $, millions $, millions x 713.365 -456.32 713.271 30.471 -6.916 0.094 -2.158 Change, y -454.162 Slope, h = y/x -0.637

Prior to the IPO, the registration statement with the United States Securities and Exchange Commission (SEC) contained above information. Figures were restated later in the 10-K filing for 2011. Although revenues increased between 2008 (partial year of operation) and 2010, losses also increased, yielding a negative slope h = -0.637. Since Costs = Revenues Profits, the negative profits means that costs were increasing as revenues increased. The situation reversed itself and a positive slope was established between 2010 and 2011, see Table 2.

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Appendix II: Bibliography

Related Internet articles posted at this website Since the Facebook IPO on May 18, 2012
The first article listed below discusses a little known mathematical property of a straight line. Figures 1 to 3 in this article provide the philosophical basis for considering the significance of the significance of a nonzero intercept c as it applies to many problems in the real world. We make observations (x and y values of interest to us) to deduce y/x, usually called rates, ratios, or percentages. 1. http://www.scribd.com/doc/102000311/A-Little-Known-MathematicalProperty-of-a-Straight-Line-Strange-but-true-there-is-one Published August 4, 2012. Financial data (Profits-Revenues) analysis and Generalization of Plancks law beyond physics. 2. http://www.scribd.com/doc/95906902/Simple-Mathematical-Laws-GovernCorporate-Financial-Behavior-A-Brief-Compilation-of-Profits-RevenuesData Current article with all others above cited for completeness, Published June 4, 2012 with several revisions incorporating more examples. 3. http://www.scribd.com/doc/94647467/Three-Types-of-Companies-FromQuantum-Physics-to-Economics Basic discussion of three types of companies, Published May 24, 2012. Examples of Google, Facebook, ExxonMobil, Best Buy, Ford, Universal Insurance Holdings 4. http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-it-can-bedestroyed Detailed discussion of Apple Inc. data. Published June 7, 2012. 5. http://www.scribd.com/doc/95140101/Ford-Motor-Company-Data-RevealsMount-Profit Ford Motor Company graph illustrating pronounced maximum point, Published May 29, 2012.

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6. http://www.scribd.com/doc/95329905/Planck-s-Blackbody-Radiation-LawRederived-for-more-General-Case Generalization of Plancks law, Published May 30, 2012. 7. http://www.scribd.com/doc/94325593/The-Future-of-Facebook-I Facebook and Google data are compared here. Published May 21, 2012. 8. http://www.scribd.com/doc/94103265/The-FaceBook-Future Published May 19, 2012 (the day after IPO launch on Friday May 18, 2012). 9. http://www.scribd.com/doc/95728457/What-is-Entropy Discussion of the meaning of entropy (using example given by Boltzmann in 1877, later also used by Planck to develop quantum physics in 1900). The example here shows the concepts of entropy S and energy U (and the derivative T = dU/dS) can be extended beyond physics with energy = money, or any property of interest. Published June 3, 2012. 10.The Future of Southwest Airlines, Completed June 14, 2012 (to be published). http://www.scribd.com/doc/102835946/The-Future-for-SouthwestAirlines-The-Unknown-Story-of-Rising-Costs-and-the-Maximum-Point-onProfits-Revenues-Curve Published August 14, 2012. 11.The Air Tran Story: An Important Link to the Future of Southwest Airlines, Completed June 27, 2012 (to be published). http://www.scribd.com/doc/102832984/The-Air-Tran-Story-The-Merger-andMaximum-Point-on-Profits-Revenues-Graph Published August 14, 2012.

12.Annies Inc. A Single-Product Company Analyzed using a New Methodology, http://www.scribd.com/doc/98652561/Annie-s-Inc-A-SingleProduct-Company-Analyzed-Using-a-New-Methodology Published June 29, 2012 13.Google Inc. A Lovable One-Trick Pony Another Single-product Company Analyzed using the New Methodology. http://www.scribd.com/doc/98825141/Google-A-Lovable-One-Trick-PonyAnother-Single-Product-Company-Analyzed-Using-the-New-Methodology, Published July 1, 2012. 14.GT Advanced Technologies, Inc. Analysis of Recent Financial Data, Completed on July 4, 2012. (To be published).
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15.Disappearing Brands: Research in Motion Limited. An Interesting type of Maximum Point on the Profits-Revenues Graph http://www.scribd.com/doc/99181402/Research-in-Motion-RIM-Limited-WillDisappear-in-2013 Published July 5, 2012. 16.Kia Motor Company: A Disappearing Brand http://www.scribd.com/doc/99333764/Kia-Motor-Company-A-DisppearingBrand, Published July 6, 2012. 17.The Perfect Apple-II: Taking A Second Bite: A Simple Methodology for Revenues Predictions (Completed July 8, 2012, To be Published) http://www.scribd.com/doc/101503988/The-Perfect-Apple-II, Published July 30, 2012. 18.http://www.scribd.com/doc/101062823/A-Fresh-Look-at-Microsoft-After-itsHistoric-Quarterly-Loss Microsoft after the quarterly loss, Published July 25, 2012. 19.http://www.scribd.com/doc/101518117/A-Second-Look-at-Microsoft-After-theHistoric-Quarterly-Loss, Published July 30, 2012. 20.http://www.scribd.com/doc/103027366/Groupon-Analysis-of-Profits-RevenuesData-and-its-Business-Model, Published August 16, 2012. The current article is the latest revision to clarify the concept of a work function. 21.http://www.scribd.com/doc/103265909/A-Brief-Analysis-of-Groupon-s-ProfitsRevenues-Data Published August 19, 2012.

****************************************************************** The Unemployment Problem: Evidence for a Universal value of h in the unemployment law.

22.http://www.scribd.com/doc/100984613/Further-Empirical-Evidence-for-theUniversal-Constant-h-and-the-Economic-Work-Function-Analysis-ofHistorical-Unemployment-data-for-Japan-1953-2011 Single universal value of h for US, Canada and Japan in the unemployment law y = hx + c, Published July 24, 2012.

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23.http://www.scribd.com/doc/100939758/An-Economy-Under-StressPreliminary-Analysis-of-Historical-Unemployment-Data-for-Japan, Published July 24, 2012. 24.http://www.scribd.com/doc/100910302/Further-Evidence-for-a-UniversalConstant-h-and-the-Economic-Work-Function-Analysis-of-US-1941-2011-andCanadian-1976-2011-Unemployment-Data Published July 24, 2012. 25.http://www.scribd.com/doc/100720086/A-Second-Look-at-Australian-2012Unemployment-Data, Published July 22, 2012. 26.http://www.scribd.com/doc/100500017/A-First-Look-at-AustralianUnemployment-Statistics-A-New-Methodology-for-Analyzing-UnemploymentData , Published July 19, 2012. 27.http://www.scribd.com/doc/99857981/The-Highest-US-Unemployment-RatesObama-years-compared-with-historic-highs-in-Unemployment-levels , Published July 12, 2012. 28.http://www.scribd.com/doc/99647215/The-US-Unemployment-Rate-Whathappened-in-the-Obama-years , Published July 10, 2012.

**************************************************************** Traffic-fatality and Teen pregnancy problem 29.http://www.scribd.com/doc/101982715/Does-Speed-Kill-Forgotten-USHighway-Deaths-in-1950s-and-1960s Published August 4, 2012. 30.http://www.scribd.com/doc/101983375/Effect-of-Speed-Limits-on-FatalitiesTexas-Proofing-of-Vehciles Published August 4, 2012. 31.http://www.scribd.com/doc/101828233/The-US-Teenage-Pregnancy-Rates-1 Published August 2, 2012. 32.http://www.scribd.com/doc/102384514/A-Second-Look-at-the-US-TeenagePregnancy-Rates-Evidence-for-a-Predominant-Natural-Law Published August 8, 2012. ******************************************************************

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About the author V. Laxmanan, Sc. D.

Email: vlaxmanan@hotmail.com

The author obtained his Bachelors degree (B. E.) in Mechanical Engineering from the University of Poona and his Masters degree (M. E.), also in Mechanical Engineering, from the Indian Institute of Science, Bangalore, followed by a Masters (S. M.) and Doctoral (Sc. D.) degrees in Materials Engineering from the Massachusetts Institute of Technology, Cambridge, MA, USA. He then spent his entire professional career at leading US research institutions (MIT, Allied Chemical Corporate R & D, now part of Honeywell, NASA, Case Western Reserve University (CWRU), and General Motors Research and Development Center in Warren, MI). He holds four patents in materials processing, has co-authored two books and published several scientific papers in leading peer-reviewed international journals. His expertise includes developing simple mathematical models to explain the behavior of complex systems. While at NASA and CWRU, he was responsible for developing material processing experiments to be performed aboard the space shuttle and developed a simple mathematical model to explain the growth Christmas-tree, or snowflake, like structures (called dendrites) widely observed in many types of liquid-to-solid phase transformations (e.g., freezing of all commercial metals and alloys, freezing of water, and, yes, production of snowflakes!). This led to a simple model to explain the growth of dendritic structures in both the ground-based experiments and in the space shuttle experiments. More recently, he has been interested in the analysis of the large volumes of data from financial and economic systems and has developed what may be called the Quantum Business Model (QBM). This extends (to financial and economic systems) the mathematical arguments used by Max Planck to develop quantum physics using the analogy Energy = Money, i.e., energy in physics is like money in economics. Einstein applied Plancks ideas to describe the photoelectric effect (by treating light as being composed of particles called photons, each with the fixed
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quantum of energy conceived by Planck). The mathematical law deduced by Planck, referred to here as the generalized power-exponential law, might actually have many applications far beyond blackbody radiation studies where it was first conceived. Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.

Cover page of AirTran 2000 Annual Report

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