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

Yelp (NYSE: 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 (NASDAQ: ANGI  ) seem to be suffering the same problem. Interestingly, (NYSE: CRM  ) , 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 (NASDAQ: TRIP  ) , 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.

Salesforce spends roughly 50% of its revenue on marketing expenses, and the percentage inched up to 52% last year. The Software-as a-Service (SaaS) company saw its marketing expenses jump 47% in the fourth quarter of fiscal 2014 to $639.8 million, compared to a 37% revenue growth. The company's sales crew swelled from 5,300 in 2011 to over 9,000 currently. It's little wonder that the company saw its net loss expand to $111.6 million during the quarter.

Meanwhile, Angie's List has been in business for 20-odd years and has never once turned a profit. The company reported a healthy 39% revenue growth in the first quarter of 2014 to $72.7 million, accompanied by a $3.8 million net loss. Its selling expenses swelled 33% year-over-year to $26.1 million, while its marketing expenses increased 19% to $23.5 million.

TripAdvisor does not suffer from a profit problem like the other three companies, despite spending tons of cash on sales and marketing. The company spent 39% of its 2013 revenue of $944.7 million on marketing expenses, compared to 32.8% of 2012 revenue spent on marketing expenses. The company finished the year with a profit of $205.4 million.

TripAdvisor's edge seems to be the fact that it derives 47% of its revenue from The Priceline Group and Expedia. Relying on these two online travel giants for close to half of its profits provides the company with excellent revenue visibility.

In contrast, Yelp relies on just 74,000 active advertisers, mostly small businesses, out of around 55 million listed businesses for its revenue. TripAdvisor's revenue growth of 24% is not in the league of Yelp's, but is still highly impressive given that the company is solidly profitable.

Foolish bottom line
Yelp could see a few more years of negative earnings, unless it can figure out a way to keep its marketing expenses and operating costs down. The company might also benefit if it can work out a formula to get a few elite customers in its ranks in the way that TripAdvisor has done.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 06, 2014, at 11:16 AM, steve777999 wrote:

    That's what they said about Amazon too and it's up over 20,000 %, with nearly 300 % of that being in the last 5 years. I'd advise to catch this new rocket now before blastoff. YELP is getting some big partners and would be a good fit for many big companies. It's growth is great and I think it's commendable that they focus on growth to maintain leadership and attractiveness in these local/global reviews. Just the way Amazon focused on growth in it's early years. Great buying opportunity on YELP right now.

  • Report this Comment On May 06, 2014, at 1:38 PM, sanoran wrote:

    Yelp needs an army of telephone sales people to harass and pressure small businesses to sign up. The extortion tactics that Jeremy Stoppleman is using to extort money from the poor small businesses is not cheap.

    As soon as Jeremy Stoppleman stops harassing small businesses, his income will drop.

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Related Tickers

8/28/2015 4:05 PM
YELP $23.96 Down -0.02 -0.08%
Yelp CAPS Rating: **
ANGI $5.21 Up +0.14 +2.76%
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CRM $70.25 Up +0.31 +0.44% CAPS Rating: **
TRIP $70.60 Up +0.26 +0.37%
TripAdvisor CAPS Rating: ****