August 31, 2014

GroupOn ROI – the Math

UPDATE 7/16/10: I’ve added an Excel calculator to make it easier to determine how GroupOn might work for you. It’s very simple, but uses all the logic described in this post.

UPDATE 7/16/2010 – I’ve also added a new post with real world numbers with a Groupon Case Study.

How do you know if GroupOn is right for you? I like numbers quite a bit and became obsessed with this, so I’ve put together an ROI calculation to try to answer this question. This post includes the calculation I came up with towards the beginning and the detailed breakdown of what everything means for any masochists that like that sort of thing.

At a very high level, the GroupOn pitch seems questionable. They want you to sell a certificate through GroupOn (say $30) for a deep discount (say $15) and they are going to take a percent of the income (say 50% or $7.50). In this example, you are getting 25% of what you would normally. Why would anyone do this?

  • New Patrons – This is the biggest reason. If you can get new patrons into your organization with a deep discount and they keep coming back and spending big bucks, there is a lifelong value.
  • Cash flow - You get paid the day after the promotion which can help out if you need to buy that new oven or make payroll. Since the certificate is valid until the expiration date, you can expect the loss to be spread out over a period of time – although most of it will probably be pretty soon.
  • Unredeemed certificates - there will be some people that pay for the deal, but never actually use the certificate. That’s just free money.
  • Average ticket value exceeds offer -If you limit the offer to one certificate per table (for example),  what if they bring friends and buy a boat load of food – only getting a deal on the first $30? Nice.

There is one additional cost to also consider, though.

  • Brand value. How do you think offering this type of outrageous deal will affect your image? You might decide this is positive, negative or not a concern.

Define your numbers

So should you do it? Let’s ignore the immediate Cash Flow benefit and make some assumptions.

  • Offer Amount (O) – you are going to offer a $30 certificate and only allow one  to be redeemed per table
  • Sell Amount (S) – the purchase price for these certificates will be $15
  • GroupOn’s Cut (G) – GroupOn’s cut will be 50% of the sell price… for every $15 certificate, they get $7.50 and you get $7.50
  • Margin (M) – your margin is 50%, i.e., if it costs you $20 to make something, you are going to sell it for $30.
  • Average Ticket (A) – the average ticket of people using the offer will be $50
  • Redeemed Certificates (R) – only 80% of certificates will be redeemed
  • Total sold (T) - you expect to sell 500 of these
  • New patron percentage (N) – you expect 40% of the people taking advantage of the offer to be new patrons (the remainder are people that are already patrons). This is a number that you pretty much have to make up, but 40% seems pretty good.
  • New Patron Lifetime Value (L) – We’ll say the average patron will spend $150 with you (beyond the offer) over a period of 1 year (if you choose 2 years, 3 years, etc, your ROI will be spread over that period). Determining this value is a science on its own so good luck coming up with the right number.  Taken in conjunction with your Margin, this can be used to determine profit from your average patron.
  • Brand Value (V) – Some organizations worry that offering such deep discounts will damage their brand and make them look “desperate.” Others might think there is an overall brand benefit that is not captured in the lifetime patron value. This variable is intended to capture this “fuzzy” influence and represents how the promotion will affect revenue over a period of 1 year (if you choose 2 years, 3 years, etc, your ROI will be spread over that period) SEPARATE FROM INCOME RELATED TO NEW PATRONS. If you think it will increase revenue over time, choose a positive number, but since I have heard concerns about the negative effects, I will choose a negative number and that I am making up – -$4,500.

GroupOn ROI Calculation

Here it is… the total long term profit you can expect from this promotion is:

Total initial income … + … Loss from certificate redemption … + … New patron Benefit … + … Brand Damage

T*(S-G*S) …. + …. R*T*[(A-O)-(A-O)/(1+M) - O/(1+M)] … + … T*N*(L-L/(1+M) … + … (V-V/(1+M)) = PROFIT

or ….

500 * ($15 – .5*$15) … + … .8*500*[($50-$30)-($50-$30)/(1+.5)] … + … 500*.4*($150-$150/(1+.5) … + … (-$4,500-(-$4,500)/(1+.5)) = $3,750 … – … $5,332 … + … $10,000 … – … $1,500  = $6,918

For the purists out there, this is not technically ROI, which is defined as (gain from investment – cost of investment) / (cost of investment). Fine.

Cost of Investment

The cost of investment is:

What it costs you to redeem certificates … + … what it costs you to fulfill purchases beyond the limits of the offering … + … your cost of fulfilling lifelong purchases … + … brand value

R*T*(O/1+M) … + … R*T*(A-O)/(1+M) … + … T*N*(L/(1+M) … + … V

or …

.8*500*($30/(1+.5) … + … .8*500*($50-$30)/(1+.5) … + … 500*.4*($150/(1+.5)) … + … $4,500 = $37,833

NOTE: You should move the brand value to Gain calculation if you think it will be positive.

Gain from Investment

The gain can be determined as:

Initial revenue from offer … + …. income from sells beyond the limits of the offering … + … income from life long purchases

T*(S-G*S) … + … R*T*(A-O) … + … T*N*L

or …

500*($15-.5*$15) … + … + .8*500*($50-$30) … + … 500*.4*$150 = $41,750

Official ROI

ROI = ($41,750 – $37,833)/($37,833) = 10.35%

KEEP IN MIND THAT THIS ROI IS FOR THE PERIOD YOUR CONSIDERING FOR BRAND VALUE AND PATRON LIFETIME (if you’ve entered a value assuming 1 year, 2 years, 3 years, etc, this is the ROI for that period).

Also keep in mind that these are hypothetical numbers. Your numbers will most likely be different.

Calculation details for Masochists

TOTAL INITIAL INCOME

How much money do you receive from GroupOn the day after the sell? This is the total number of certificates sold minus GroupOn’s cut, or:

T*(S-G*S) = 500 * ($15 – $15*.5) = $3,750

AMOUNT OF LOSS BASED ON REDEMPTION OF CERTIFICATES

For every certificate redeemed, you are going to have to give away a certain amount of inventory, service, etc (O=$30), but the cost to you will be less than the certificate amount because of your margin:

O/(1+M) => $30/(1.5)=> $20 (what it costs you to redeem a certificate)

You also will be able to make a profit on the average ticket amount above the offer amount, or the total income above this amount minus the cost:

(A-O) – (A-O)/(1+M) => ($50-$30) – ($50-$30)/(1.5) => $20-$13.33 = $6.67 (additional profit per redeemed certificate based on assumed Average Ticket)

So for each certificate redeemed, your profit is most likely negative:

(A-O)-(A-O)/(1+M) – O/(1+M) = $6.67 – $20 =  – $13.33

But some people will not redeem their certificates, which means free money for you! Taking into account the total number of certificates sold (T=500) and the redemption rate (R=.8) leads to an updated equation of:

R*T*[(A-O)-(A-O)/(1+M) - O/(1+M)] => .8*500*[($50-$30) - ($50-$30)/(1+.5) - $30/(1+.5)] = -$5,332.

So at this point, you have gained initial income of $3,750 and, over the course of several months, it is forecasted to cost you $5,332 leading to a net loss of $1,582… but there are some additional potential benefits.

NEW PATRON BENEFIT

We’ve talked about the obvious income and costs, but there are other benefits. The idea of paying for a print ad seems pretty reasonable because it might attract new patrons and you’re willing to pay money for it, so why not GroupOn? It is advertising and seems pretty effective at getting people to show up.

You’ve made an assumption about how much the average new patron will spend at your organization over their lifetime (L=$100). So the amount of profit you expect to make from the average new patron, after you take into account the costs associated with the transactions is:

L-L/(1+M) => $150 – $150/(1+.5) = $50

When taking into account the promotion by GroupOn, people sharing the information with friends, buyers bringing friends with them to redeem certificates, etc., you expect a certain number of new patrons tied to the number of certificates sold (T=500) and a New Patron Percentage (N=.4). This results in an expected increase of profit of:

T*N*(L-L/(1+M) => 500*.4*($150-$150/(1+.5)) = $10,000

There are 3 major things that should be noted:

  1. The lifelong value of a customer is hard to determine and we kind of made up the actual number. We also made up how we calculated the number of new patrons your promotions will generate.
  2. It might or might not take into account the viral nature of new patrons bringing along friends and introducing them to your organization. This is potentially a chain reaction that can greatly amplify this number.
  3. Lifelong value is something that can build up over a very long time. This is not a quick income event and will likely be spread over a period of years.

With that being said, the running tally of the GroupOn benefit is now at a Net Profit (over time) of $10,000 – $1,582 = $8,418 in profits.

BRAND DAMAGE

Do these deep discounts damage a brand’s image and lead to reduced sales? I don’t know, but we’ve assumed it does and have pulled out of thin air a number to represent the decreased regular income from running this promotion (V=$4,500). Since this is “top line revenue,” to understand the impact on the bottom line, we need to consider your Margin.

(V-V/(1+M))=> (-$4,500 – (-$4,500)/(1.5))=-$1,500

Additional Comments

This was a lot of work so please let me know if I made any mistakes. Also, if anyone wants to build a calculator to run these numbers, let me know!

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Comments

  1. wow that is dorky – I love it. I need to look closer but I could give you some data from Grindhouse….

    1) 4 months after we were featured on Groupon we’ve had about a 50% of the Groupons actually redeemed. They expire after 6 months, but most of the redemptions were in the first 2 months. We probably get 1-2 redemptions per day now.

    2) I’d say probably 75% were new customers, but this # goes down if you’re not a new restaurant.

    3) Although we sold ~1,200 Groupons, I’d guess that about 25-30% of people bought 2 Groupons, so you need to take that into account when valuing each new customer. Of course some Groupons are more expensive and people would be less inclined to buy 2 of them.

    3) You have to also take into account that most people will either be a few dollars over or under than the Groupon’s face value. In either case the retailer benefits – either by giving away less or capturing more revenue from the customer.

    • Marcel Crudele says:

      It’s nice to have some real data – I was making everything up ;) Thanks for the info Alex! Some comments on your points…

      1) So my redemption rate assumption seems high based on Grindhouse’s experience (that’s good for owners)

      2) I thought about the new customer benefit being greater for a new business than an older one, but decided to let people make up their own number. Anyone else looking at this … Alex says about 75% for a fairly new restaurant.

      3) I avoided having to take into account multiple purchases by linking the new patron percentage to total number sold. That way, new patrons might be people that bought one or more certificates, people that came along to cash them in, people that heard the WoM but took no action, whatever – it’s WAAAAAAY to complicated for me to calculate that so I just put in a fudge factor :D

      4) The average ticket price takes into account that people will, on average, go over the promotion amount, but I didn’t consider the spending less issue. I’ll let someone else model that – I had to sleep for 2 days after the effort this post took.

      Honestly, after going through this exercise, I realized that some of the factors are almost impossible to reasonably determine. I think it might come down to looking at the worst cast scenario (everyone redeems every certificate for the exact amount of the certificate) and then doing a gut check on what the upside feels like.

      It seems like your gut check is that it was worth it. Yeah?

  2. Mark says:

    Another Groupon benefit that you didn’t quantify: The advertising value of being on Groupon. Groupon New York has about 250,000 people on its email list. Putting aside actual sales, the value of reaching all of these people (assuming a $10 CPM and 40% open rate) is $1,000. So add that to the calculation. And $10 CPM is probably too low. These people aren’t just seeing a display ad, they’re seeing that your business has been approved to advertise on Groupon. People who subscribe to Groupon emails presumably attach a premium to that.

  3. Marcel Crudele says:

    Thanks for the thoughts Mark. I have a feeling you might have some ties to Groupon ;) The information is welcomed regardless!!!!!!

    The focus of the post was how much money makes it into the pocket of the business. This is slightly different than what they might pay for CPM since that is money spent that has no measurable tie to money in the bank (not to say it doesn’t have a lot of value, just that it is difficult to measure). That value is captured in the NEW PATRON BENEFIT section which applies a “magical” number to calculate this. To Alex’s point, the assumption is that you will gain new patrons that might be people that:

    * purchased one or more certificates

    * went with a friend that purchased certificates

    * saw the promotion (through Groupon, a Facebook post, direct invite, etc), but didn’t buy a certificate (CPM applies here)

    * on the even longer tail, ended up going with a person that became a passionate patron 4 months after the promotion

    I used a 40% rate tied to the number of certificates sold (as a measure of influence). The way it’s formulated, this is a fuzzy, black box number – I have no idea how you would calculate it, but it’s there for people to consider. I would expect this to vary dramatically based on the type of business – helicopter rides, might not have as many new patrons as a restaurant. Also, to Alex’s point, new businesses would most likely have a much higher percentage.

    Another thing that is explicitly missing is revenue generated from people that don’t become life long patrons, but do visit a few times. This factor can be taken into account with the average new patron value.

    I will say that I have yet to hear from a business that regrets their decision to do a Groupon promotion. I also think that very few business owners will labor through the above calculation, but it was kind of a fun exercise to try out.

  4. SOR says:

    Hi

    Interesting use of numbers. I wonder how many business owners think this through. My guess is not many. Would like to see more, especially case studies.

    • Marcel Crudele says:

      I think you’re right about that ;) I did the write up mostly for my own benefit because I really wanted to understand the model and effectiveness. I figured, since I was going to do the work, I might as well get a blog post out of it.

  5. Ulysses Simons says:

    Here’s some who regretted their Groupon experience:
    http://www.spaboomblog.com/2010/dont-sell-your-soul-to-the-discount-devil

    >>I will say that I have yet to hear from a business that regrets their decision to do a Groupon promotion.<<

    • Marcel Crudele says:

      Thanks for the link Ulysses! In my Excel spreadsheet calculator, I included a variable for affect on brand (positive or negative) because of concerns I’ve heard from high end restaurant owners about this very thing. It’s true that I have never heard a complaint about participating in a GroupOn Campaign, but the link shows there are people out there that were unhappy with their experience. I love getting the other side of the story!

  6. JMO says:

    Interesting analysis. I played some with the spreadsheet and found that if I ignored the unredeemed certificates, the long term customers, and any value from new customers, I could find a break even point with the following formula:

    A – (O – O/M)*(1 – S / ((1/G)*O)) = 0

    If you know your Average cost and your Margin and assume Groupon’s take (G) at 50%, you can toy with the Offer price and the Sale price to find a result greater than 0. The higher the Average cost (A), the better chances of finding a match for Sale price (S) that it 50% or more less than Offer (O).

    • mcrudele says:

      Wow! You actually used the spreadsheet? Awesome!

      One of the issues with what you described is that GroupOn wants to make sure that the offer is tempting to consumers so they want some decent sized numbers (this also helps their per transaction revenue) … seems like the trend is around “$30 for $15.” However, I think you’re right if your Average Ticket price happens to be pretty big. Let’s say you sell antique furniture and your average ticket is $500 with a decent margin and you offer a “$50 for $25.” GroupOn might make you profit from the very beginning.

      I had come to the conclusion that for most businesses, it’s difficult to determine if GroupOn is a good option, but for new businesses that aren’t concerned about damaging their brand with a deep discount, it seems to make sense. This was based on customer acquisition costs and a built in guarantee that GroupOn certificates would all come from new customer exposure (since it’s a new business).

      To that, I guess I need to add… “or if you are a business with reasonable margins and a large average ticket compared to the GroupOn Offer.”

      Great insight!

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