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Angie’s List Inc (ANGI), Google Inc (GOOG): This Reviews Company Has a Big Problem

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Angie's List Inc (NASDAQ:ANGI)Online reviews should be a tremendously profitable product.

Users submit information and build up a valuable database of reviews. This information can then be monetized, while a dedicated user base helps a company use the network effect to insulate it from the competition.

Dead in the water

One major player in this space, Angie’s List Inc (NASDAQ:ANGI) , is dead in the water. While it recently posted its first profitable quarter (the fourth quarter of 2012), the company’s pay-to-play business model isn’t a favorite among customers.

As of the fiscal year 2012, according to data obtained from Angie’s List’s annual report, the company showed marketing expenses of $73 for each new member. This was down modestly from the year-ago period, but does not reflect increased discounting by the company to add new members. You can find a 40% off coupon code for its service all around the internet, which does not bode well for the company’s future – it’s discounting what value it pretends to have just to add new members.

The prevailing problem is the fact that it burns through customers far too rapidly. Of those customers that make it through one year of service, only 75% renew. The average membership renewal rate (which includes monthly members as well as those who have been a member for at least one year) stands at 78%.

In a best case scenario in which Angie’s List abruptly stopped all its marketing expenditures to add new members, the company would have made only $30 million in pre-tax profits in 2012, which hardly justifies a $1.1 billion valuation. That $30 million in profit would unlikely last in perpetuity, since Angie’s List’s member count decays at an alarming 22% rate each year.

Declining service revenues

While Angie’s List Inc (NASDAQ:ANGI) List markets itself as a trusted review source because it has little to no involvement with the businesses listed on the site, Angie’s List is becoming quite comfortable taking money from advertisers and partners.

In 2012, some 35,952 service providers who participated on the site spent $132.6 million on advertising, or $3,689 each. Angie’s List reports more spend per service member, however, because it accounts for the full value of the contract signed in the period, there is no way to know whether the company is receiving more revenues per service provider, or if they’re merely signing longer contracts.

Furthermore, service provider revenues exist only so long as memberships stay flat or grow at Angie’s List. With a 22% attrition rate, Angie’s List Inc (NASDAQ:ANGI) List will have to engage in national marketing campaigns year after year simply to sustain its revenue – not profit – model.

A difficult business model

Compare Angie’s List to Google Inc (NASDAQ:GOOG) . Google has a well-known and respected search product complete with nearly seamless integration of its AdWords product, which allows a marketer to place advertisements in its search results. Google does not invest heavily in a sales team to sell AdWords, nor does it invest heavily in pushing internet users to its search engine.

Angie’s List, however, has to engage in huge advertising spend to attract users, and significant sales spend to attract new service providers as advertisers.

The economics of the business simply do not allow for profits by Angie’s List in a market where there are many free review providers like Google Inc (NASDAQ:GOOG) (which arguably has a strong competitive position given its Maps App) or Yelp Inc (NYSE:YELP) (which is increasingly growing to scale in Angie’s List’s key segments).

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