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There are a lot of skeptics when it comes to whether merchants should use group buying sites like Groupon.

For good reason too: there are enough horror stories to demonstrate that heavy discounting and lots of customers can be a really, really bad combination.

But the viability of group buying sites themselves is increasingly called into question. Groupon, the 800 pound gorilla of the space, went public last year, giving everyone a glimpse into is finances. Finances which showed lots of revenue but heavy losses.

Apparently, building a group buying business isn't just expense for Groupon. Amazon-backed LivingSocial is considered a strong number two in the market and some believe it to be better managed.

But thanks to Amazon's most recent K-10 filing, we now know that LivingSocial eats up money too. In 2011, LivingSocial pulled in $245m in revenue, but had $686m in operating expenses and $117m in other expenses, leaving an operating loss of over a half a billion dollars. Geekwire adds some much-needed detail:

A person familiar with LivingSocial says the revenue would have been significantly higher had it included the company’s full international results for the year, which were boosted in part by a series of overseas acquisitions. In addition, the bottom line was impacted by heavy marketing expenses, as the company sought to grab market share, and those expenses were concentrated heavily at the beginning of last year.

The losses also reflect non-cash items such as stock compensation for employees, as the company grew from 600 employees to 5,000 over the course of the year, and expanded from three international markets to 20.

This makes the LivingSocial financials look a little bit less bad, but they're hardly attractive, raising the question: is this really substantial profit potential in this market?

Perhaps, but both Groupon and LivingSocial hint that it's not exactly easy. From customer acquisition to international expansion, it takes a lot of money to make a lot of money in this space. While the paper version of the yellow pages might be effectively dead, employing thousands of sales representatives to lure local merchants into doing deals isn't exactly a capital-efficient business either.

The bad news is that things could get worse. Merchants are increasingly hip to the downsides of discounting, and the commoditisation of these sites will only place further pressures on margins, as group buying companies are pushed by merchants to reduce their commissions. That could be bad news for LivingSocial, even if it eventually does manage to catch up to and dethrone Groupon.

Patricio Robles

Published 2 February, 2012 by Patricio Robles

Patricio Robles is a tech reporter at Econsultancy. Follow him on Twitter.

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