Read the book: To Group Coupon Or Not for Small Businesses
Let us say you sold cupcakes at $4 a unit. You sell 1000 a week at that price. You are considering using GroupOn to increase your sales. Here are the necessary and sufficient conditions
Necessary: The Marginal Cost of each unit must be less than 25% of full price. If this is not true GroupOn recommended 50% off promotions and its 50% cut are not for you.
Sufficient: The incremental profit from serving the GroupOn delivered customers must be more than the incremental cost to serve them. A more restrictive requirement is, this net profit must be more than what is possible through other methods.
- Cost Calculation: The stories I read on GroupOn and other Small Business stories from Times indicate they are doing cost accounting wrong. For example, cupcake stores allocate a share of all the costs, from rent, insurance to bathroom cleaners to each unit sold. That is wrong! You need to compute the true marginal cost of SELLING one more cupcake and treat everything else as fixed costs. Let us assume it is $1 for your cupcake.
- Contribution Margin: Now that you know the true marginal cost (MC) of each cupcake, Price – MC, gives its contribution margin (CM). In this case it is $4 – 1 = $3. The sum of CM from all cupcakes, $3000, go towards offsetting your fixed costs. If after covering all such costs you still have some CM left, that is your profit.
- Discount: From the vivid news stories described by small businesses and from a survey of GroupOn deals, the most common discount is 50% (or more). So the effective price drops to $2 and CM drops to $2 -$1 = $1.
- GroupOn’s Cut: GroupOn gets 50% of the deal price . This may not look like additional cost but this is the cost to sell each additional unit.
- Contribution Margin of GroupOn Customer: After the 50% cut, the contribution margin further drops to (P/2 – MC – P/4 = P/4 – MC). That is right, the new customer you acquire contribute much less than a regular customer. In the example we are using, the CM of a GroupOn customer is $1 – $1 = $0.
- Lifetime Value?: You might think you are getting the customer for life (or at least a few more times ). But there is nothing to support the claim other than hope. Sometimes it might take you years to serve these customers you acquired – either because it will take them time to visit you or because of sheer capacity limitations. If these customers are willing to buy your cupcake only because of its deal, are they likely to pay the full price? They are more likely busy searching other great deals.
- Incremental Costs: If you can serve all the new customers from the campaign with no additional investment (equipment, people, space), then it is not too bad. But if you need to hire more people, buy new oven etc, then all these costs be covered fully by the GroupOn customers. One common mistake is to distribute the new costs over all the cupcakes sold. The new costs are a direct result of these new customers and hence the CM from these customers alone must cover the costs.
- Opportunity Lost: Suppose the deal drove lots of customers to your stores and that ended up turning away some of your current and new (non GroupOn) high CM, customers. That is opportunity lost. Another aspect is, your business may already be growing albeit at very low rate due to previous marketing efforts,WoM and other reasons. These customers pay full price. If you cannot serve these new customers because you are busy handling promotion customers, that is opportunity lost. You need to calculate how many such full-price customers you are losing because of your focus on GroupOn customers.
- Opportunity Cost: This is the cost of alternative you did not take because you chose GroupOn – from time and resources you invest. Are there other channels that could have delivered you incremental sales?
So when should you consider with GroupOn?
- When MC < 25% of current price (you are selling at high price premium)
- When there are low-value customers who are not willing to pay the current price but can be served at a price P1 > MC (note P1 = P/2 according to GroupOn)
- When these customers are not easy to identify and reach
- When the incremental profit from these customers is more than the costs they incur you