Daily Deals - The accountant's perspective - Part 1

So this blog started with me fired up about writing an incredibly interesting deep dive into the algebra of Groupon/Daily Deals.  See, I was one of those weird kids who actually enjoyed math class.  Then I asked my wife to proofread it.  First, she looked like she was about to doze off.  Then she came to and pushed forward with a look like she was being tortured.  The net of the humbling conversation that followed was a simple quote: “Normal people don’t really want to go back to the hard part of middle school and early high school math!”  So with the Groupon math being way past the high end of what is stomachable for a casual reading blog, I needed something to make this blog readable even for people who have no desire to relive algebra.  Enter…Pop music!  With 2011 just past and all the yearly radio countdowns still close in the rearview mirror, I figured I would do the impossible and combine Groupon/Daily Deal math with quotes from 2011’s greatest pop songs.  So buried in the math are quotes from some of 2011’s chart-topping pop songs.  I at the same time hate and thank my kids for the fact that I know these songs.  See if you can find 4 quotes and identify the respective songs.  If you can, you should feel very proud inside but admit this accomplishment to exactly no one.  Just like enjoying math class as a kid, knowing the lyrics to catchy, shallow pop songs is not something to share with the masses.

To the blog...And it goes like this…

Groupon and other Daily Deal providers – Are they a valuable tool to help grow your business?  Or are they a trap that will cost you a small fortune and maybe even your business?  When considering doing a Daily deal for the first time, you have to be thinking - I’m gonna run right to, to the edge with you…But is it the edge a cliff?  Or retail glory?  There are currently votes in both directions.

If you are a local retailer trying to understand the math behind the Daily Deal and deciding if you want to go that route, then this melody was meant for you.

The opportunity to reach a huge number of customers that are geographically relevant and instantly drive a bunch of business is enticing.  But the discounts that you must offer to play the game make it challenging to do it profitably.

Developing a Groupon or other Daily Deal plan and assessing its success requires some numerical analysis.  Profit or loss from a Daily Deal offer is driven by three sources:
1) Profit/loss on the initial deal.
2) Profit on any upsell of the initial deal redemptions.
3) Profit on future sales of sales to new customers gained by the campaign.

The first number is fairly straightforward to measure simply, but unfortunately the simple math is incorrect. 

The simple math is:
Profit/loss per redeemed Daily Deal = Daily Deal price paid by customer – Daily Deal fee paid to deal provider – Cost of goods for amount of deal

For example, if a restaurant issues a Daily Deal where a customer gets $40 of food for only $20 and the Daily Deal fee is an additional $4 and the cost of goods for $40 of food at menu price is $15, then the profit per redeemed Daily Deal is $1 ($20-$4-$15) per redeemed Daily Deal.

The merchant also earns a larger profit for any unredeemed Daily Deal purchases.

Profit for unredeemed Daily Deals = Daily Deal price to customer – Daily Deal fee(basically you do not pay the cost for the food for the unredeemed offers)

Using the example above, the profit for unredeemed Daily Deals is $16 ($20-$4).

If you multiply the number of redeemed Daily Deals X Profit per redeemed Daily Deal and then add the number of unredeemed Daily Deals X Profit for unredeemed Daily Deals, then you know the profit/loss from the initial Daily Deal sale and redemption.  Right?  Actually…wrong.

This formula assumes (incorrectly) that the Daily Deals were purchased by customers who would not have purchased without the Daily Deal offer.  But in reality, a large percentage of Daily Deal offers are redeemed by customers who were going to come anyway.  For customers who were going to come anyway and pay full price, you lose money on the Daily Deal equal to the Daily Deal discount and fee.  This is money that goes to the customer in unnecessary savings and Daily Deal provider in fees that customers would have happily paid to you if not for the availability of a deal. 

Simple example:
A restaurant sells 100 Daily Deals.  The Daily Deal is good for $20 of food for a cost of $10.  The Daily Deal provider’s fee is $3.  The cost of goods for $20 of food at menu price is $6.  Of the 100 Daily Deals purchased, 20 go unredeemed, 40 are sold to regular customers who eat at the restaurant weekly regardless of available discounts and 40 are redeemed by new customers.

The simple, incorrect math says:
Profit on unredeemed Daily Deals = 20 X ($10-$3) = $140 profit
Profit on redeemed Daily Deals = 80 X ($10-$3-$6) = $80 profit
Total profit = $220

This suggests that the sale and redemption of the initial Daily Deal is profitable by itself.  Plus you get the value of upsells on top of the $20 Daily Deal.  In addition, you hopefully get new regular customers from those who tried you first via the Daily Deal offer and decided to come back.  It’s a huge success!  Right?  Wrong again.

Correct math says:
Profit on unredeemed Daily Deal = 20 X ($10-$3) = $140 profit (same as before)
Profit on redemptions by new customers = 40 X ($10-$3-$6) = $40
Loss on unnecessary discount to regular customers who purchased Daily Deal = 40 X ($10+$3) = $520
Total loss = $340

The loss on unnecessary discount to regular customers is a little tricky and worth deeper discussion.  You do actually earn the same profit on the initial deal as if they were new customers.  But you need to think of things relative to if you did not do the Daily Deal.  If you did not do the Daily Deal, these customers would have come anyway and you would have received the full $20 for their purchase not the $7 that you received after the customer takes a $10 discount and the Daily Deal provider takes their $3 fee.  This is money that could have been in your pocket.

This is obviously a huge difference!  The simple (but incorrect math) suggests that you are plus $220 before you consider the effect of upsells and returning customers.  The Daily Deal seems like a no-brainer.  But when you correct the math for some of the discounts that are really just giving away money unnecessarily, the initial return suddenly swings to a significant $340 loss.

But this is not the entire story.  Smart merchants often price Daily Deals to allow significant room for upsell.  The upsell revenue comes at regular menu price (since you cannot usually combine a Daily Deal offer with another coupon or offer) and therefore a solid profit margin.  In addition, the elephant that you are really chasing is winning new customers.  Even if the initial Daily Deal offer loses money, if it gains you a bunch of new customers, it can pay off.  If those new customers come back and pay full price week after week, then an initially unprofitable Daily Deal could correctly be considered a wise marketing investment with a significant long-term payoff.

My aim is to post a part 2 by early next week that will dig into the numbers for these bigger picture items.  So if the math in this blog was too much to bear, you better run, better run faster than my bullet (my next blog).

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Matt Karash (VP Sales and Marketing @ Social eMotion) mkarash@social-emotion.com