Groupon hit by higher expectations As Groupon seeks to expand beyond half-price deals on $20 manicures and $50 sushi dinners into the realm of $2,000 laser eye surgery and $1,200 memory foam mattresses, it is encountering new risks that are hitting its bottom line. "Higher ticket items create higher expectations," says Greg Sterling, a senior analyst with Opus Research. Groupon admitted on Friday that it had failed to predict how many people would return these new high-priced deals and demand refunds. The young online deals company, which went public amid great fanfare in November, was forced to revise its fourth-quarter financial results, sending it back into the red for the period. Operating income was reduced by $30m, changing its $15m profit to a $15m loss, after Groupon had earlier heralded the quarter as producing its first operating profit since it embarked on its big international expansion 18 months before. Revenues dropped by $14.3m. The company says it relied on historical patterns of returns on traditional deals, rather than forming a predictive model to take into account the effect of doctors rejecting certain candidates for health procedures, or people simply changing their minds. "People forget we're a new company," Groupon told the Financial Times. It's one of those things where, OK, we're still growing up as a company. Now that we figured that out, there's no reason to think it's going to happen again. But investors do not appear to be so forgiving. Groupon's share price dropped in after-hours trading on Friday following the embarrassing restatement of its accounts, and was down 17 per cent on Monday. The shares were down another 6 cents at $15.21 on Tuesday, below their initial public offering price of $20 and far below their peak of $31.14 in November. One shareholder filed a lawsuit against Groupon on Tuesday claiming the company had misled investors about its financial results and business practices. Since announcing plans for its IPO last year Groupon has been striving to overcome a volley of criticism, including from federal regulators who forced the company to change how it originally calculated its revenues and presented its net income. It is incredibly young, incredibly cash dependent. It is building a business model with few barriers to entry, attracting tons of competitors and, because it's so young, there's no definitive proof of value in the long term," says Jed Williams, an analyst with BIA/Kelsey. There's already a high level of risk in the model. That doesn't mean it won't work," he warns. "But couple that with accounting "snafus" like these and it inserts more risk for investors." Other analysts remain optimistic about Groupon's continued growth and dominance in the daily deals market. Mark Mahaney, at Citigroup Investment Research, calls the company's revenue and cash flow "extremely impressive." Groupon admitting to a material weakness in its internal controls "doesn't change our view of the company's market opportunity and competitive position," he wrote in a note to investors. But "with hyper-growth comes unusual execution/organisational challenges. Groupon management and investors are learning this the hard way. The more Groupon expands into new markets, the more risks it faces, in marketing, litigation and competition. In addition to high-priced local services deals, Groupon has been moving into retail goods, apparel and electronics, landing it in "Amazon, Walmart, and Best Buy territory," Mr Williams says. Groupon faces other big competitors as it offers more expensive travel packages and luxury items that are not discounted. It must also overcome its branding as a strict discount provider. "I got a Groupon offer for microdermabrasion," one regular Groupon customer from Oakland, California, told the FT, referring to a highly technical medical skin treatment. But then I thought, do I really want to do a Groupon for microdermabrasion? I decided not to buy it. When people do buy those high-priced items, they bring a more sensitive mentality to the purchase that not only raises the likelihood of them demanding a refund if the experience does not match expectations, but also increases the risk of legal action. "People wouldn't sue over a bad meal, but they might sue over something that costs several thousand dollars," says Mr Sterling. And whenever there's a litigation risk, there's class-action risk. Groupon is in the process of settling a class-action lawsuit brought by customers who claim that the expiration dates it puts on its vouchers are illegal. In question is whether the company's vouchers are considered coupons, which can expire, or gift cards, which, according to a federal law, cannot expire in less than five years. Rather than have the courts give a definitive answer, Groupon wants to settle the claim separately. In a proposed agreement filed in a federal court in California on Monday, Groupon would create an $8.5m fund to pay customers who bought vouchers and did not use them before the expiration date. "This issue will come up again," Mr Sterling says. With liabilities on the books for five years, and more expensive deals on offer, it makes sense that Groupon "didn't want to see this litigated to a final decision."