Yelp Has A Google Problem

| About: Yelp (YELP)
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Reading Yelp's (NYSE:YELP) IPO prospectus, it's hard not to notice the irony in Yelp righteously proclaiming their CEO testified before congress regarding Google (NASDAQ:GOOG) stealing user reviews. Yelp seems to be upset that Google would attempt to index and summarize its 25 million user-contributed reviews (28% of which are perceived as less than authentic) into its own product. Based on the risks outlined in the IPO prospectus, Yelp believes Google constitutes a major threat to its ability to make money in the local-business-review market. What Yelp seems to take for granted however is the large degree to which they need Google's cooperation in order to maintain and grow their business.

Unlike the oft-reported "halo-effect" between Facebook (NASDAQ:FB) and Zynga (NASDAQ:ZNGA) in which the two companies acting together make each other stronger and more profitable, Google has little to gain from its relationship with Yelp. At the same time, Yelp's business absolutely depends on Google letting them have preference over Google's own offerings.

Google Local is much like Yelp in that it allows users to leave reviews for local businesses. Google Local also lets users find specific types of products and services in their local area and lets business owners interact with customers directly. Other peripheral services like Google Offers almost directly mirror Yelp Deals, while Google Maps is integrated heavily into both Google Local and Yelp.

Yelp essentially lives on top of the combination of Google Maps and third party business data providing an alternative database to which users feed reviews.

The Yelp business model seems sound until you realize the degree to which Yelp relies on Google to funnel organic search visitors (those that are provided at no cost) to Yelp. The links in Google's search results generate over 50% of Yelp's search engine referral traffic while taking users away from Google's own offerings. Yelp admits they don't have any notable user acquisition expenses because of this relationship with Google. Unlike Groupon (NASDAQ:GRPN) which sends users deals through email bypassing Google's portal, Yelp relies on free links from Google to bring in visitors.

If Google decided tomorrow that it would favor users being directed to its own review system where Google makes money selling ads, Yelp's business would instantly be in serious trouble.

In my review of Yelp's competitors, I have found over 20 relevant local review sites that offer all the same business review capabilities as Yelp. Many of these competitors actively encourage Google to aggregate their content. The indexing of user reviews leads to more traffic as Google often only posts teasers of full reviews along with direct links to the original review company's site.

In addition, the review company sites themselves often aggregate each others reviews providing a much larger range of local business feedback. Ultimately you get the same reviews on any site with companies competing for the best tools and interface. It seems clear that as time progresses, Yelp's continuance in desiring a closed site in an environment where others are sharing reviews will make them less relevant.

After taking into account the potential disadvantages Yelp has in review breadth, one should also consider another difference between Yelp and Google: the way in which each generates revenues. Google offers Adwords to businesses on a mostly self-service platform that integrates directly into Google Local and Google Maps. Advertisers have come to widely adopt this platform as is evidenced by Google's tremendous search engine advertising success. Yelp on the other hand relies on a large team of salespeople to call local businesses offering them 3, 6, and 12 month advertising plan commitments at a cost of $300 to $1000 per month.

Yelp's sales force is expensive and eats away at any potential profits. Last year over 100% of Yelp's revenues were consumed by the costs of running the site, sales and marketing, general and administrative costs, and its charitable contribution, leaving a large deficit for a company determined to grow. The sales and marketing expense alone was 65% of revenue which is proportionally the largest reason why Yelp has never earned a profit. Yelp's reliance on sales people demonstrates an obvious inability to draw in enthusiastic customers with minimal staff in the way Google does.

Yelp's 20+ established competitors, owned by a range of companies like AT&T's (NYSE:T) and IAC's (IACI) Citygrid Media are calling the same businesses and selling the same high-cost advertising plans for their own sites. The well established competitors will be working to take away Yelps market leading position while Yelp poses no obvious barriers to letting others overtake its lead. The sales business model itself can be rather simple as well: hire commissioned sales people to sell $300 to $1000 per month advertising plans and offer 50% of revenue to each sales representative. The potential for bringing in large numbers of commission-only sales people is very high and requires virtually no capital.

Finally, even if Yelp ultimately does succeed in taking on its competitors and Google, their eventual downfall may come from the fact that they don't own any technology patents. Companies like Google hold large patent portfolios both for licensing income and to deter potential legal attacks. In this comparison, and in many others, Yelp doesn't stand a chance against Google.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.