News Column

Chicago: A New Hub for Digital Business Startups

April 4, 2012

Phil Rosenthal


Whenever Chicago is discussed as a new hub for digital business startups, boosters inevitably cite Groupon because it has become unbelievably big, unbelievably fast. Critics inevitably stress the unbelievable part.

Management of the discount Web giant has not done any favors for itself or this city, whose reputation as a startup incubator has become tethered to it, with what the company acknowledged last week. It's facing its latest accounting screw-up, formally conceding "a material weakness in its internal controls."

This "weakness" most recently showed up as a revised, bigger loss in the fourth quarter, a three-month stretch that analysts expected would deliver the company's first profit.

Groupon said it underestimated the amount of money it needed to set aside for customer refunds. The foul-up occurred because the company was unprepared for the fact that higher-priced transactions required a greater reserve.

But it's an all-too-familiar stumbling block for Groupon Executive Chairman Eric Lefkofsky, Chief Executive Andrew Mason and the venture they co-founded less than 31/2 years ago and is valued at $9.7 billion. And it continues to undercut faith in a business model far too many already view with skepticism.

"Whenever you have a young company, especially with young leadership, there are wizened old faces that are skeptical about the young guys pulling off what they've set off to do," said James Post, a professor at the Boston University School of Management.

"Groupon's had a tremendous run. Most observers would say they're at a critical point in their life history, and the thing about critical points is they can go one way or the other," Post said. "It's going to be the skill of that management team that makes the difference."

Many have made big bets on Groupon, despite all the questions about its sustainability. There are the businesses that use it as a marketing tool, and the consumers who use it as a way to save cash. Then there are the investors who saw an IPO introduced at $20 in November rise as high as $26, only to see a decline exacerbated by the most recent revelations. Shares are now down to about $15.

Beyond the market's shaken confidence, the Securities and Exchange Commission is said to be looking into this latest gaffe, as are investors' lawyers.

Few stakeholders, however, have as much riding on the nascent company as Chicago and its hopes to become a Midwestern hub for tech startups.

Less than 5 percent of this city's tech talent is with Groupon, estimates Matt Moog, founder and chief executive of and a leader in Chicago's digital startup scene. But he concedes Groupon casts a far larger shadow when outsiders look to whether this is a fertile place for an entrepreneur to launch a company worth $10 billion to $20 billion.

"If you're looking at our national reputation, it's important that Groupon succeed," Moog said. "This is a setback. But is it more perception than a substantive problem with the business? If there were fewer merchants (participating in Groupon deals) or there were fewer consumers taking advantage of the deals, I'd worry about that a lot more than I would worry about a short-term accounting issue."

Taken in and of itself, that might be all it's seen as. But that means disregarding that this is a company that has gone without a chief operating officer since Margo Georgiadis returned to Google just five months after Groupon hired her away last year.

This is a company that filed a series of revisions to its IPO documents, including a restatement of revenue and the discarding of an accounting method it created to show its revenue in a better light. Never mind Mason's end around on pre-IPO quiet-period rules with a staff email -- almost immediately leaked -- that sought to counter critics questioning Groupon's prospects and business model.

"As a Chicagoan, I'm really sad, because we're proud when somebody does good here," said Francine McKenna, an expert on the accounting and auditing industry who writes the Accounting Watchdog column for Forbes. "We love promoting our companies, especially homegrown success stories, and this is embarrassing.

"Because they're growing so fast, because they're trying to take a less conservative approach when they're developing these numbers, because they want to shine the best possible light on what they're doing, they got caught short. There was nothing they could do but admit they screwed up."

The question is whether this is merely part of an exceptionally difficult birthing process, not uncommon among tech firms where growth outstrips the ability to establish proper controls, or something more. History says it could go either way.

"What we see is part of a pattern," Post said "The growth story is so powerful and exciting and energizing for people that that's all they want to talk about and that's what they focus on, the expansion. Meanwhile, you've got to have people who are overseeing the business and the financial controls. ... Where are the adults who are going to keep an eye on running the business in a way that's going to meet regulatory and investor standards? But it's not very exciting to say we've got to hire some more accountants or some more auditors.

"Even someone as talented as (the late Steve) Jobs, who ultimately built the most valuable company in the world, there were points in time when (Apple) didn't have the kind of adult supervision needed. ... With an investment community out there looking to put big money on the table, you're legally and ethically responsible to do certain things that meet those investor expectations."

Moog points to billions of dollars in revenue at Groupon, if your confidence in those figures also remain unshaken, and the potential he sees in Groupon to grow beyond the daily deals for which it's best known.

"The bigger question is: Can they pull off this bridge from 'We are a discount driven daily deals site' to 'We are a full-service marketing platform that does loyalty and inventory management'?" he said.

All we've heard from Groupon management to date is a statement attributed to Chief Financial Officer Jason Child saying the company remained "confident in the fundamentals of our business, as our performance continues to highlight the value that we provide to customers and merchants."

Groupon has to do better than that. It must give everyone a reason to remain calm and confident. Greater transparency and fewer surprises would be a good start. Addition of a seasoned hand or two among management ranks surely would help. Critics as well as boosters need to see more to believe more.

"Groupon is not the first company to face this problem," Post said. "They won't be the last, and it's a surmountable problem. But they have to take it seriously and not try to discount it or marginalize it and say it doesn't matter. It does matter and it's going to matter legally, and it's certainly going to matter in terms of investor expectations."

And, like it or not, we're all invested.

Source: (c) 2012 the Chicago Tribune. Distributed by MCT Information Services

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