(This is the second of a two part post.  The first part contains a profile of a startup.  This part contains numbers and analysis related to that startup.)

First, some background.  I became interested in the mobile coupon business space a few years back when I started thinking about how mobile coupons could effectively be applied to a college campus.  I approached Artia Moghbel, a friend who had started an on-campus discount card (The Pirate Card) and together we wrote up a business plan for Morningside Mobile [PDF] which won second place in Columbia University’s B-plan competition.  Essentially Morningside Mobile (MoSiMob) was Dodgeball crossed with a mobile couponing service and applied to the microcosm of a college campus.

I spent that summer teaching myself the basics of Ruby on Rails and preparing a variant of Morningside Mobile called FreeFoodFone.  But our calculations had relied on using Email <-> SMS gateways to get around high SMS gateway costs.  It turns out this workaround isn’t technically feasible and the service never got off the ground.  Over the next year, I watched Social Monkey, a similar idea to Morningside Mobile (launched by some Tufts University students), which shutdown about a year after launch.

Here’s the big issue:  SMS text messages cost 3 cents to send.  Each. That doesn’t sound like much compared to, say, the 20 cents you would pay the US Postal Service for a direct mail campaign.  But it adds up quickly: sending 1000 text message advertisements costs $30.  Therefore any type of mobile SMS advertising has a cost basis of $30 CPM (truly COST per thousand). If you get a 1% response rate to your mobile advertisement, that works out to a $3 cost of reaching that one responsive customer — and that’s not including the actual cost of the coupon discount.

Now let’s look at some figures provided by Mobile Spinach.  Although they declined to share specific rates, Mobile Spinach says they can routinely get double digit CPMs.  Let’s assume the best case and round it up to a $100 CPM.  Most of the company’s campaigns are between 500 and 1000 text messages.  This means that at best, the average campaign runs between $50 and $100 dollars.  That’s tiny.

What’s the Achilles heel of any hyperlocal business based on advertising?  Small deal sizes and high overhead. The large overhead cost of closing deals makes a local ad business tough to scale effectively.  Let’s look at this on a micro-level by considering the cost of a salary.  Let’s say an entry level salesperson earning $50,000 a year.  They work 50 weeks/year, which means a salary of $1000 a week, $200 a day, or $25 an hour. As shown earlier, Mobile Spinach’s ad campaigns are $100 each on the upper end.  Even if this sales person could close an advertising deal every two hours (a herculean task), the sales people would be burning up half of the company’s incoming revenue.  Add to that the $30 of cost from sending the SMS messages, and there’s not much leftover.  Sure, some of the business is repeat business (there’s longer term value once the relationship is formed) — but it’s still tough to make the numbers work.

Let’s look at this from a macro perspective: At full scale, Mobile Spinach envisions 500,000-750,000 users of the service across 30 cities. They also say that at the absolute max, they’ll send 10 messages/month to users — any more, and the service becomes overwhelming and annoying. Let’s assume every ad is sold at a $100 CPM, which works out to 10 cents per text message. 3 cents of that goes to pay for the SMS message, and 2 cents goes to pay a commission for the Tastemaker (20%). That leaves 5 cents per message. They’re sending at maximum 10 messages per month to each user.  Essentially, after we’re accounted for the cost of goods sold, this works out to a per-user income of $0.50 each month or $6 each year.

Assuming a reasonable $8 customer acquisition cost for the company, it will take more than a year of usage to start earning a profit (and even longer if a reasonable churn rate is factored in). If they succeed in their upper goal of getting 750k users on the service, at $6 annual income per customer, the company will have $4.5 million to pay the salaries of all their staff plus overhead costs. Mobile Spinach plans to have 60-70 sales people at full scale.  At a low figure of $50k/year, a sales force of 70 people would cost $3.5 million in salary alone, not to mention benefits, insurance and overhead.  It’s tough to see the numbers working.

In the end, there’s really only two business models based around coupons. You can be in the business of selling coupons to consumers like The Entertainment Guide. Alternatively, you can be in the business of coupon delivery: Newspapers and companies like Valpak (owned by a newspaper company) have done this successfully for years. There are many companies working on the delivery of mobile coupons: Cellfire, 8coupons, CouponAlbum.com, CouponChief.com and CouponMountain.com just to name a few.  But none have taken off.

Why not?  It’s hard to say.  The truth is that SMS messaging has existed for years.  Mobile Spinach could have been built six years ago.  There’s no recent technological change or evolution that opened up the market opportunity  But the company thinks they’ve figured out the issues that have plagued typical SMS coupon services.

Most coupon services are bothersome and overwhelming.  Mobile Spinach tries to solve this problem by offering ‘exclusive’ offers and also by letting users pick exactly the type of deal they’re looking for:  For example,  within the ‘restaurants’ category are the following sub-options:  ‘$$$$’ or ‘$$$’ or ‘$$’ or ‘$’ and fast food, vegan, seafood, grill, deli/bakery, italian, asian, american, organic and health food.  This level of specificity sounds great to the end user, but specificity and exclusivity are the opposites of scalability — and scalability is key to a technology startup. By breaking down their deals into tons of small categories, the company has created a thousand different chicken and egg problems for themselves: creating a critical mass of merchant in each niche AND creating a critical mass of users interested in that niche.  In my humble opinion, the company should sharpen their focus: pick a single niche, dominate it, and then expand horizontally from there.

Additionally, the company is trying to build their user base from scratch.  But companies with large existing mobile user bases would seem to make a perfect fit for Mobile Spinach’s mobile couponing product.  Why not partner with a company like loopt?

Basically, the mobile couponing business is an extremely tough business to scale well.  I like mobile spinach’s gusto and ‘dial-down’ approach, but at the end of the day I’m still vexed by these three issues:

1)  the high cost of sending SMS text messages.
2) the difficulty of convincing consumers to share their mobile phone numbers.
3) the high overhead costs of closing numerous small local deals.

This last issue concerns all types of hyperlocal companies:  Yelp, Outside.in, Patch.com, GoMobo, Grubhub, and Yodle just to name a few.

Local is a tough business.

As usual, readers, I’d love to hear your comments and questions.  So let’s have ‘em!

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