Yelp fills in for Yellow Pages: The opportunity behind its success

Market Realist

Must-know: Understanding Yelp's enormous opportunity (Part 1 of 3)

Yellow Pages 

As Yellow Pages continues to recede into obsolescence, new tools for consumers to discover local businesses and services have emerged. These tools can vary from Yelp’s (YELP) platform of user-generated ratings to Groupon’s (GRPN) deal offerings to OpenTable’s (OPEN) online restaurant reservation system or even Foursquare’s check-in notifications. These tools all share a common principle in that they allow local businesses to grow sales by reaching an audience of potential customers. Yelp has had particular success in building its platform, as the stock has returned roughly 217% over one year. Yelp and Groupon are members of the Global X Social Media Index ETF (SOCL), which provides exposure to an index of social media stocks.

Growing user base

Local businesses once reached potential customers through entries in Yellow Pages, ads in local newspapers and television stations, or direct mail. However, Yelp provides a more effective tool for consumers to discover local businesses by offering reviews rather than simple directory listings or ads. The management team’s strategy is to grow the user review database until Yelp becomes the primary destination for consumers to find local businesses. Once the company reaches this status, it will be very difficult to displace, leaving it in a strong position to monetize its users by charging local businesses to advertise on the platform.

In other words, Yelp’s management recognizes that the company can benefit from a network effect in which an ever-expanding database of user reviews entrenches Yelp as the destination for local business discovery. Recognizing this strategy, investors should closely follow user engagement statistics to understand the company’s growth trajectory. The chart above depicts the exceptional, uninterrupted growth Yelp has achieved in the number of reviews on its platform. Cumulative reviews on the site are approaching 50 million and have grown by roughly 175% since the beginning of 2011. The scale of the database will be very difficult to replicate, providing Yelp with an important barrier-to-entry from new competition. As this growth continues, Yelp will be able to generate increasing revenues as advertisers seek to connect with potential consumers on the company’s platform.

Continue to Part 2

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