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
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:
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!
Other stories related to this topic:
RT @manamica: The Real Cost of Groupon and What it Means to Your Marketing Planning http://t.co/ul8wN3Gj
Is Groupon worth it? Business owner might need to think twice on promoting sales through Groupon.. Check it out !!! http://t.co/U2BoK2FZ
Im trying to decide whether Groupon is right for my company (which sells and decorates cakes) and your sums dont quite add up
for example in scenario 1 (which is similar to my business model)
you cant just associate fixed costs such as rent, wages etc into the cost of a cake (or any product for that matter)
Lets say that the company is already breaking even meaning all fixed costs are being covered by current customer/sales. Anything ontop of this is pure profit (obviously minus the direct cost in making the cakes) in your example above
£12 pastries for £6
business gets £3 from groupon
lets now say that the pastries cost £1 to produce (including the extra cooking gas/electric) then the £2.00 left goes straight onto the bottom line. in the case of 1000 groupons sold this is £2000 and thats not including any return customers which would ad further revenue (This is obviously assuming that there are no extra costs involved in making the 1000 groupons such as overtime etc)
now if your business is just about turning over a profit then this could (and i stress COULD) be a viable marketing strategy
Lucky me. I do this research B-4 I made a deal with groupon damn, sorry but Gp will be out of my bucket list.
Excellent advice and precisely what Groupon will not divulge during the selling process. I dislike deceptive sales practices.... puts Groupon in the same category as old-school used car salesmen.
The margin estimate from Times is wrong. Times article incorrectly allocates share of fixed cost to each pastry sold. That is not the right way to do the cost accounting. The rent, marketing, salary etc are sunk and are not incurred for each pastry sold. If you include just the marginal cost of making a pastry, it is likely much lower (~$2) and hence the contribution margin is $10.
There are also additional costs that are not considered, like the cannibalization cost, opportunity costs etc.
Regarding why those who ran promotion think it was profitable - because they do know the true costs, do financial accounting incorrectly or simply due to cognitive dissonance.
Author: To Groupon Or Not
Thanks for the comment JustBeNIce :). I think Groupon can be a very effective form of advertising. Companies just shouldn't consider it a direct and immediate source of revenue. And if we look at it as such what Groupon charges is less than what a TV Ad would cost, yet they offer direct inbox exposure.
Your point about "deal shoppers" is very valid and is the biggest risk in doing a groupon. At the same time, going back to what I said above, maybe doing a groupon just means getting visibility...
Mana, if you are going to do this Break Even analysis you should consider using Marginal Cost of the offering to calculate the profitability and then use that profitability target to determine what sort of retention rates one needs. Of course, this is based on the assumption that most of the traffic that one should expect from Groupon will be incremental -- which I believe would be fair one to make.
Thanks Madhur! That's great feedback. I'm working on gathering actual data from businesses to try out real-life scenarios. I'll take that into consideration for round 2.
As for the incremental traffic, I talked to 2 businesses last week - 1 in clothing retail said 80% of the grouponers were new customers, the other in the restaurant biz said 60% of grouponers were new customers. So yes, there's definitely incremental effect. At the same time other businesses are reporting the retention rate (post daily-deal) is pretty low. The ones I talked to didn't have a tracking mechanism to measure retention so they didn't know how many actually came back more than once. So it's going to be tricky to measure actual net incrementals. I guess for round 2 I will still have to build in assumptions alongside the real data...
Great article, Mana!
I just did a small deal-of-the-day site for my own business. You covered the big ideas that I think some businesses miss (like that coffee shop's well-publicized critique of Groupon a few weeks ago). I'm more on the bakery side of things, so I clicked through those articles. That 18% profit margin assumed some costs for marketing, so that situation might not be as dire. At the same time, an 18% profit margin in a food service business is to die for.
For my deal, I ended up talking ad nauseam with a business advisor about loss leaders and marketing plans. In the end, I think planning for the deal helped me make my business that much stronger and better.
In my opinion, deal-of-the-day sites are a valid tool. Each one seems to have a different gimmick, and most are more merchant friendly than Groupon. My main problem is the rush. That coffee shop should have made a better plan. On the flip side, I've heard of a few times that Groupon has published a deal for a scam artist or unscrupulous vendor.
Thanks Jim! I'm glad to hear you went thru the business exercise. It may have seemed too extensive but it's a necessary pain. I'd rather have that than dig myself in a hole.
When I did the research I found that the average profit margin in the restaurant industry is about 8%. When I used that number the results were pretty crazy, off the charts. So there's more to restaurants than "meets the eye." I need more time to think of the math there.
Another thing I learned today from a businessman who shared his Groupon experience was that if you have a high traffic store/restaurant adding 40-50 grouponers per day won't be a problem. Same in a business where you move a lot of product, like your business possibly. So even the makeup of the business counts...
Thanks for putting this together. I've had my theories on whether or not Groupon was a win/loss for various businesses but never put the effort into the math. This makes it very clear.
Thanks Leyla. A lot of folk have been saying that it varies by business. But how does it vary? Still lots of research and math that needs to be done...
I like your work here. This is helpful analysis, but wonder if you aren't asking the wrong question.
The real question isn't "will Groupon make you money"; it's "will Groupon make you MORE money than another advertising channel". We can't just compare the cash after Groupon to the cash before Groupon we also have to look at what other customer acquisition strategies we DIDN'T do because our cash was soaked up by Groupon.
A better analysis would be to look at customer acquisition cost. What does one loyal customer cost from Groupon (total loyal customers/cost of Groupon) compared to the cost of another marketing tactic (Radio ads, Adwords, Flyers, etc.)?
I think the "magic" of Groupon is that it is so easily tracked while most small businesses don't have good tracking measures for these other tactics.
Thanks Brad, you're spot on. My first recommendation in the recommendations section is to choose marketing channels wisely. I couldn't easily find the rest of the data (reliably) so I didn't want to get into much of a channels comparison.
You will see that the hypothetical CPAs I calculated are for "return customers." I am definitely recommending retailers look at the loyalty factor. For those that haven't done Groupon before it needs to start with the forecast of what it would mean to them financially and then compare that to the value of what they'd get from other channels, as well as the opportunity cost of not spending that money elsewhere.
Honestly, I don't want to offer the answers on a platter ;). I don't want to say do or don't Groupon. I just want to say, think before you Groupon.
So should I guess then that you too are not ready to advise for or against Groupon until you see the numbers?
You are correct. I think it's a much more complicated equation than most people make it out to be.
My general rule with any marketing/advertising is if someone is selling it to you, don't do it. Instead, step back and decide what is the best, most strategic use of your marketing dollar then go call THEM.
It feels like a lot of folks who choose to Groupon aren't thinking strategically about what they need to achieve with ANY marketing tactic and Groupon is just too expensive to "experiment" with.