Here's Why It's So Hard for Yelp to Make a Profit

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Yelp reported mixed first-quarter fiscal 2014 results that showed that the company is still growing its top line at a brisk pace but has not yet figured out how to turn a profit. Revenue grew an impressive 66% year-over-year to $76.4 million compared to the first quarter of 2013, while the company reported a narrower net loss of $2.6 million, or $0.04 per share, compared to a loss of $4.8 million, or $0.08 per share, in the first quarter of fiscal 2013.

Other key takeaways from the report were that cumulative reviews grew 44% year-over-year to 57 million, average monthly unique visitors increased 30% to 132 million, average monthly mobile unique visitors jumped 52% to 61 million, and the company's active local business accounts increased by 65% to 74,000.

The report was therefore quite OK, if you omit the net loss part. However, the question that begs for an answer is ''why is it so difficult for Yelp to make a profit 10 years since it started doing business? Could its business model be fundamentally flawed?''

The cost of high revenue growth
Yelp is not alone in this conundrum of high revenue growth but no profits. Its counterparts in the review business such as Groupon and Angie's List seem to be suffering the same problem. Interestingly, , a leading Customer Relationship Management (CRM) systems company, is experiencing a similar affliction, and for the same reason.

All these four companies share a similar tag line: high revenue growth, but no profits. However, the fact thatTripAdvisor , a leading travel review company, is highly profitable perhaps proves that the problem is not the review monetization business model per se.

The biggest problem with Yelp is that its marketing expenses seem to be growing in tandem with its top line. The company spent $38.35 million in sales and marketing expenses in the fourth quarter of 2013; that figure increased 16.13% to $45.12 in the first quarter of 2014.

Although Yelp's year-over-year revenue growth of 66% looks impressive, its quarter-over-quarter revenue growth was just 8%. This implies that marketing expenses grew at twice the rate of revenue. The company's product development costs also increased by 18% compared to the previous quarter to $13.98 million, while General and Administrative costs fell marginally by 2.2% to $13.17 million.

The high expenses came from a revenue ratio problem that dates back to the days when the company was still a private entity. The revenue line (blue line) and total operating costs line (green line) in the chart below appear to be in lockstep.

Source: Yelp S-1

Yelp also sports unusually high stock-based compensation figures. The company rewards its management pretty generously, and this keeps diluting its shares each quarter. Yelp's share count has been rising sharply. The company's share count grew 3.35% between the fourth quarter of 2013 and the first quarter of 2014. This growth can be chalked up to the company's executive compensation.

As I pointed out above, Yelp's high operating costs and marketing expenses problem is not unique to review companies alone. has been growing its revenue at a fast pace as well, but it has also remained in the red for ten straight quarters.

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