The Real Cost of Groupon and What it Means to Your Marketing Planning

This post was published quite a while ago, however you will still be able to use the formulae below to estimate the returns or losses from using Groupon or other types of services like Groupon.

Is Groupon worth it?

We geekily set off to do the math. We created 2 scenarios, we researched sales numbers, and did some math to forecast the results.

The data confirms Groupon deals come with a significant price tag but can be profitable under the right circumstances. Think before you Groupon (and think before you jump into any large marketing investment). Yep, the data both proves and disproves most web chatter (see list of articles down the page).

HOW BIG IS A BIG PRICE TAG AND HOW CAN I MAKE GROUPON WORK FOR MY BUSINESS?

First let’s look at how Groupon works:

Groupon will demand your deal be at least 50% off the regular price. Next, you have to pay Groupon 50% of the purchase price (unless your offer is less than $10 in which case Groupon keeps 100% of the revenue). So if you agree to sell a $100 Groupon for $50 after paying Groupon $25 you will have just $25 to pay wages, and overhead. From The Real Cost of Doing a Groupon

Our assumptions:

80% of Groupons will get redeemed (20% will expire unredeemed)
30% of Groupons will be used twice (yep, by cheaters)
We measure results based on gradual retention (10% will return 20 times, 10% 10 times etc as a example)
We also measured results based on Groupon’s reported retention rate of 22%
Used published industry average margins
We measured cost per acquired retained customer not cost per Groupon since that cost is evident
1-year measurement period

SCENARIO 1: The Gourmet Cupcake and Coffee Shop

Mary has a cupcake and coffee shop with profit margins of 18.2%. She runs a Groupon, $6 for $12 worth of pastries! Groupon wants to keep the entire amount (they keep full amount if under $10) but Mary negotiates a 50/50 deal. She gets a flood of customers, a few very busy weeks and gets a check for $3,000 from Groupon. As the rush tapers off a few of the customers start to return. Mary does the books and realizes:

Some used a groupon multiple times increasing her cost

Since her shop’s profit margin is 18.2% instead of making $2 per $12 sale, the Groupon cost her $7 per sale, for a total of $7,196

176 customers came back (Groupon says 22% return a second time)

The cost to acquire each of those 176 customers was $41

Mary concludes she needs 176 customers to return 20 times each ($12 purchase) to recoup her costs. Mary still has a ways to go until she makes a profit.

Here’s how we did the math:

We used a big spreadsheet 🙂 but here’s a summary:

According to a NY Times article a gourmet pastry shop can have margins as high as 18.2%. That’s $2 for every $12 sold. The other $10 goes to the cost of making the pastry, business overhead etc. But now the business only gets $3 instead of the $10 it needs to cover costs so it’s $7 short on every sale, that’s approx $7,000 cost for 1,000 Groupons sold.

Groupon’s 22% customer retention estimate (on top of our earlier assumptions of breakage etc) means approx 176 customers will come back for every 1,000 groupons sold. And we’d need each to come back 20 times and purchase $12 worth of pastries (176 customers X 20 purchases X$2 profit) for us to make up the $7,000 loss from the original groupon.

Realistically we would expect to see a gradual retention rate – some customers will return more frequently than others. In an optimistic scenario where 40% of customers return at different frequencies, it would take 10% to return 20 times, another 10% to return 11 times and another 20% to return 5 times to recoup costs.

SCENARIO 2: The Diamond Ring Jewelry Shop (warning, it’s an extreme case)

John has a jewelry store with a profit margin of 46.50% (National Jeweler’s 2010 Profit Survey average). John sells 500 Groupons, $250 for $500 worth of jewelry. He gets a flood of customers, a few very busy weeks and receives $62,500 from Groupon. After a while a few of the customers return. John does the books and realizes:

Half purchased $750 on average, $250 more than the Groupon

The Groupon cost $77K

The higher sales reduced the campaign cost to $12K

88 customers came back (Groupon says 22% return a second time)

The cost to acquire each of those 88 customers was $131

John concludes he only needed 50 customers to return once ($500 purchase) to recoup his costs. John made a profit.

Here’s how we did the math:

It’s mostly the same math as in the first scenario. We replaced the profit margins, the groupon value, and units sold. The spreadsheet did the rest. We added a new assumption, that half of the people will purchase 50% above the Groupon value. This may be a stretch, but this whole scenario was built to be a stretch.

The higher sales boosted revenue on the first Groupon visit and lowered net campaign cost to $11,600 (to be specific). Since the margin for each $500 sale is $233, John only needs 50 people (50×233=11650) to break even.

CONCLUSIONS AND RECOMMENDATIONS:

Pick your marketing channels wisely. Daily deals can be an expensive acquisition channel but so can be media-buying, PPC and direct mail.
Build the cost into your yearly marketing budget, where it belongs.
If you didn’t plan this as part of your marketing budget consider your options:
Your marketing can’t start and end with the groupon. Have a long term plan to bring grouponers back. It‘s your job to turn those new customers into loyal customers. So make sure when they walk out after using their groupon that they have in hand (or mind) an incentive to come back.
Accept the fact that daily deals may attract “deal seekers” not “loyalty seekers” as part of the channel demographics. Find ways to use this knowledge to your advantage.
Start executing that loyalty marketing plan the moment they walk in groupon in hand. It’s possible to get someone 20 times if they are truly loyal. So make them loyal.
Use lower margins to estimate (estimate on the conservative side) – It’s possible your margins may decrease as you do a Groupon. The flood of new customers may require adding staff and other costs that will lower your margin.
It’s highly probable a Groupon will increase your brand’s profile. Businesses have reported increased site traffic that lasted far beyond the days of their groupon, which is an indicator of increased brand awareness.
Still not sure? Give us a call or shoot us an email. We’ll put the spreadsheet to work using your own numbers. Heck we’ll do it for free! (we love math that much ) :).

UPDATE (Dec. 2010): We received so many email inquiries for help and sharing our spreadsheet that we are finding it hard (time-wise) to offer the help to everyone but if you write a comment or question here on the blog we will be able to answer them one by one.

During this time we also talked to more businesses and found a few real Chicago stories although everyone is a bit hesitant to share their numbers. A couple of them stood out:

1. A Chicago Neighborhood Apparel retailer:

I was walking down the street in Nov. and a super-cute hat in an apparel store caught my eye. I also noticed a liquidation sign and so I couldn’t help going in. Inside they had a Groupon sign, so of course I took the opportunity to ask a few question. The owner was manning the store, as it is common in many small businesses. She said she didn’t know how many of the Groupon-ers returned, she had never thought to track it. She also didn’t know how many of the Grouponers were new customers but she assumed about 60% of them were. She said the Groupon was a big success.

I bought my hat (an adorable bamboo fiber hat, at a price that I later regretted, but I was more preoccupied with the Groupoon story), and mentioned I was sad they were closing and leaving the neighborhood. Which I was (I am a huge believer in the good local economies can bring to all of us). The owner turned obviously uncomfortable and uttered something about tough times.

So I felt too bad to ask my big big question – Since they were forced to close the business why did she consider the Groupon a big success? We may never know…

2. A Chicago Neighborhood Nail Salon:

I frequent a somewhat exotic and very cheap nail salon, mostly for their eyebrow threading services (am I giving away too much?). During one of my early December visits the owner was talking about her Groupon deal. I almost flipped out of my chair in excitement. I only had to ask her, “tell me about it” and she enthusiastically told me the whole story.

According to her, the Groupon sales reps tried to convince her to do a mani/pedi deal not a waxing deal. She did the math and she figured that a mani/pedi would take too long and would clog up her system. To paraphrase her, if she offered a mani/pedi deal she wouldn’t be able to take in her walk-in regulars, or even schedule them in. That seemed like bad business to her. So she pushed back on Groupon.

Then the Groupon sales person (again according to her) tried to get her to increase the upper limit of the Groupons. She once again did some simple math (off the top of her head) and figured out at 1/2 hour per service it would take her 26 weeks of straight 8 hours per day, 7 days a week, to service all the (forecasted) groupons. Again, that seemed like bad business to her so she pushed back.

Eventually she got her way and she was content with it. But she didn’t make any claims of success. It was too early she said.

What amazingly different approaches! there were two things that amazed me about the differences in the two stories:

1. One of the business women came across as being in control of her Groupon deal. The other had a lot of unknowns. When you are a small business owner you can’t leave expensive decisions in the hands of others.

2. Some of the simplest math can help make smart decisions. Many get intimidated by numbers but as a small business owner you can’t afford fearing and avoiding numbers. This actually holds true for all marketers too. You have to be able to do some basic math to get directional guidance. If you then feel that you should get into more detail hire a professional analyst but as we saw here even the simplest math can help.

Are you a business that has a daily deal story? Leave a comment. We’d love to hear all stories!

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