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The Questionable Economics of a “Good” Groupon

June 25th, 2011 | Posted by Jonathan Marek in Restaurants

This article in the New York Times, plus my interview in Fast Company, got me thinking again about Groupon economics.  To be clear, I’m talking here about the Daily Deal type offers, not more sophisticated customer-targeted, location-based, fill-up-empty-seats-right-now types of offers.

Here’s the crux, a restaurateur describing a successful Groupon in which a consumer receives a voucher for $14 worth of food by paying Groupon $7 ($3.50 of which Groupon pays the restaurant) :

“You don’t make money on the deal,” Mr. Massari acknowledged, “but in the end we are even.”

That’s because “people spend more than on the coupon amount,” he said. “They’ve been ordering about double the $14 from us. And people usually bring other customers, who are paying full price.”

Beyond that, among those who are redeeming coupons, “80 percent have come back without a coupon,” he said.

Let’s think through each piece of that, imagining for the moment we sold 1000 Groupons:

  • The revenue the restaurant gets from the Groupon is $3.50 (25% of the face value), or $3500 total
  • This restaurant asserts that those customers spend double the $14, and bring other full-price guests.  That seems very optimistic, but let’s grant the “double the face value” number including other guests.  So that is another $14 in sales, or $14,000 total
  • Variable costs (food, incremental labor, supplies, etc.) may run up to 65% of gross sales.  Let’s give the benefit of the doubt and call it 50%.  That would be $14,000 in incremental food cost [(14000+14000) * 50%]
  • So, total pretax profit impact would be $3,500 [$3,500 + 14,000 – 14,000]
  • Plus, then we get the benefit of the “80%”of Groupon customers who come back

Sounds great, doesn’t it?  The problem is: we don’t know how much of that is incremental and how much is from customers who would have come in otherwise.

Often, in retail and restaurants, we see that a very large percentage of offers are redeemed by existing customers not new customers.  Larger chains can quantify this effect through testing, but let’s imagine the following breakdown:

  • 250 of the Groupons are bought by new customers
  • 250 are bought by existing customer who will use the Groupon for incremental trips
  • 500 are bought by existing customers who will use the Groupon for trips they would have made otherwise

For a chain restaurant, in our experience, the distribution above would actually be pretty good.  (BTW, for a new non-chain restaurant that needs to build awareness, results may differ greatly.)

  • For half of the Groupons (the 250 new customers and the 250 returning customers making an incremental visit), we capture the full incremental margin above, or $1750
  • For the other half, these guests would have spent $28 but instead we only received $17.50 ($3.50 + 14.00).  So we lost $10.50 per guest, times 500 guests, or -$5250 (no change in food costs)
  • So we are $3,500 in the hole!

But what about the 80% of Groupon customers that return?  Well, that’s believable — after all, 75% of the Groupon customers in our example were already customers!  So we converted ~20% of the 250 new customers, or 50 repeat-visit new customers.

So, each one of those 50 customers will need to make 5 more visits, ordering $28 worth of food (at 50% flowthrough margin).  And that’s just to breakeven, given fairly optimistic assumptions on a Groupon touted as successful.  And, in chain retail (versus restaurants), flowthrough margins are often much slimmer.

Of course, one could refine and test these assumptions.  But this math is why we question the economics of Daily Deals for chain restaurants and retailers.

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