I recently attended a talk at the Boulder Chamber a few weeks ago on the economics of Groupon, Living Social and other group purchasing services. Since I am an avid fan and consumer of these promotions, I was curious how the economics of this recent phenomenon played out for the advertiser.
The speaker analyzed a typical deal: For $8 he bought a $20 credit at The Wave Car Care Center. For these sorts of deals, Groupon typically keeps 50 percent of the revenue. That means that The Wave gets $4 for each $20 credit it pushes out to customers.
In this particular promotion, it sold 3,197 $20 coupons for instant gross revenue of $12,788. Looks good, but let's assume the base cost of goods is $12 per car. That covers equipment, staff, electricity, maintenance, insurance, etc. That's $8 profit for each $20 car wash, which seems reasonable.
Now, however, they're only making $4 for each $20 car wash. So instead of making $8 profit, they're losing $8 per customer. Multiply that by 3,197 and what might have seemed like a really valuable promotion to its marketing team seems to translate into a loss of $25,576.
Before you immediately conclude that all group purchasing deals are a disaster for the merchant, there are additional factors to consider, factors that can explain why this promo might be a home run for The Wave.
The biggest of these factors is Groupon (and Living Social, a very similar alternative group purchasing organization) estimates that 10 percent to 30 percent of coupons purchased expire without being used. Let's pick 15 percent.
That means 498 of these coupons won't be used at all. That's $1,992 in pure profit. In addition, on average, 20 percent to 25 percent of people who use a group discount promotion become long-term customers, which means the calculations have to be based on the lifetime value of a customer.
The next factor to consider is customer acquisition costs. If print ads, radio spots and direct-mail fliers translate into a customer acquisition cost of $10 per customer, then "losing" $8 per new Groupon customer translates into actually lowering your customer acquisition costs by $2 per customer. Of course, the key here is to know your customer acquisition cost. But that’s another subject for another blog.
Finally, how are you going to categorize the expense in your profits and loss? If you're already spending $10,000 per month on advertising, skipping two months of print ads to test Groupon might prove an excellent use of your funds and the "loss" isn't actually any sort of loss at all.
A successful local pet store, Whole Pets, is very happy with its decision to use a Daily Deal. The owner, Carol Kuzdek, said she has done a $10 for $20 deal twice, and both times it resulted in bringing lots of new customers into the store and in people spending more then they would normally spend. She doesn’t know how many new customers come back for a return visit, which would be quite helpful to track since that is the main reason a store would invest in such an expensive promotion in the first place. Carol said 87 percent of her coupons were redeemed, and she would be thrilled to do it yet a third time.
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