Capacity Concerns in doing Daily Deals

In my critically acclaimed book, “To Group Coupon or Not: Small Business Guide to Groupon and LivingSocial“, I introduced a 4C model to evaluate the relevance of Daily Deals to small businesses. One of the 4Cs is Capacity. We have seen many stories on how stores that did outrageous deals (or as Groupon says in its Ads, ridiculously low prices) were run over by  a mob of deal seekers. Very recently a British cupcake bakery was in the news for the same reason.

It is likely that these are extreme cases (that is why they are reported in the national news media). Most businesses may not see a mob scene. The limited takeaway here should be, these businesses did Groupon like Daily Deal promotions without understanding their capacity utilization and suffered the consequences. Your small business should not do the same mistake.

The questions small business owners need to consider are

  1. Should I be doing the 50% off daily deal given my current capacity utilization?
  2. What is the arrival pattern of deal seekers compared to my regulars?
  3. Can I manage their arrival rate to better utilize my daily excess capacity?
  4. What are my new capacity costs, opportunity costs and gains if I did a daily deal?

When I was explaining my Groupon calculator and capacity utilization to a Small Business consultant, she remarked,

But small businesses, especially salons and cupcake bakeries do not know what capacity utilization is or how to measure it. How should they do it?

Mind you, there are sophisticated capacity utilization software used by Airlines and Hotels. The methods should be simple enough for most small businesses to not only understand and but also practice. For starters, I will refer you to a children’s show on PBS Kids called Cyber Chase.

Cyberchase

Past Perfect Prediction

Convinced that the last piece he needs to activate his powerful new machine is hidden in Slider’s garage, Hacker threatens to evict the teen unless he pays up on an old debt. Enter the kids and Digit. As a way to raise the money, they convince Slider to open the garage for business – just like his dad did. They do, but quickly discover that there’s more to it than meets the eye. Can they unlock the past to find the key to saving Slider’s future?

The kids run some sort of oil change garage to raise money. They have to order Cryoxide, the raw material that costs $15 a can (marginal cost) and expires at the end of the day (capacity cannot be carried over). They charge $32.5 for the service. They place an order for Cryoxide the previous day and it gets delivered next day morning.

The key here for these kids is to understand current capacity utilization and use that information to place future orders so they don’t end with either excess capacity (which is a loss in this case) or shortage (which is lost opportunity). Here is how they go about finding their capacity utilization

  1. They find one receipt from their father’s files that shows a sale of 66 cans. Based on this data point the kids expect to serve 66 customers  – good start
  2. As it turns out they could use only 30 of the 66 cans. The excess capacity of 36 cans is a loss.
  3. They quickly figure out that that was just one data point and it was also from a Saturday whereas they started work on Monday.
  4. Their initial search gives them one past receipt for each day of the week – getting better
  5. Not satisfied with the data-set they search more and find receipts for the whole month – getting better. (Note the 30 number)
  6. They find the average demand across these 30 days use that information to place an order for each remaining day of the week – not bad at all, (roughly right beats precisely wrong)

Measuring your businesses capacity utilization is no different from this. Here is how you go about it:

  1. Data Collection: Like the kids’ father who kept receipts, you need to start collecting data on daily sales. You likely have this data already. You need to include in this data, weekday vs. weekend classification and exceptions like holidays.
  2. How many days worth of data is needed? The number 30 is not an accident. It is a rule of thumb for assuming that the data is normally distributed. In your case you need at least 30 days worth of data. That said, this should be a continuous process. You don’t stop collecting data after 30 days.
  3. Simple Estimate:  A simple estimate of capacity utilization is to calculate the average across these 30 days. You can use that as an approximate for future demand. You are not going to be that far off. You can stop here if you want to.
  4. Refined Estimate: You not only calculate the average but you also calculate the variance – how much the individual days differ from the average. You can use the average and variance to make statistical prediction about future capacity utilization (ask me how).
  5. Further Refinement: You can take it to next step separating your weekdays and weekends. Since you only have 2 weekend days vs. 5 weekdays, you will need to collect receipts over 4-5 month period. Once you have that, then you do Step 4 above for weekdays and weekends and use that to predict your future capacity utilization

This procedure only describes how to find your current capacity utilization. It gets complex when you do a Daily Deal. All your careful capacity management based on past receipts are not useful when suddenly 1000 people show up to buy your cupcakes. This is when you end up turning away your loyal regulars and more.

Now returning to the original capacity questions you need to consider before doing a deal

  1. Should I be doing the 50% off daily deal given my current capacity utilization?
  2. What is the arrival pattern of deal seekers compared to my regulars?
  3. Can I manage their arrival rate to better utilize my daily excess capacity?
  4. What are my new capacity costs, opportunity costs and gains if I did a daily deal?

Ask me how you can answer these.

Paper Napkin Math for Adding a Sales Channel

Some call it the Distribution Channel, I call it the Sales Channel.

A sales channel is for reaching customers and selling them your product.

If you made and sold cupcakes, your cupcake store is a sales channel.Customers walk in to buy your cream filled cupcakes and other goodies.

Suppose you want to reach customers who do not come to your store but are already visiting another store. You can sell to those customers if you make your cupcakes available in that store by cutting a deal with that store. For example, if you sell your cupcakes through local Whole Foods, that is yet another sales channel.

Your goal here is not about bringing those who buy the cupcakes at Whole Foods back to your store but to reach them where they are. For providing you this access, Whole Foods (or any other sales channel) will take a cut of the sales. That is the cost of hiring the sales channel.

Sales Channel unlocks value for you. It helps you reach new customers and likely different willingness to pay for your product.

These new customers are a different breed. They may not value your product the same way those who walk into your store do. The price they are willing to pay may be higher or lower.

For some sales channels, like GrouponLive, it is lower because of the way they have been trained to expect discounts. The You need to discount your cupcakes 25% (or more) and also give another 25% or more to Groupon as sales commission for making this sales possible.

You may be able to sell 1000 additional cupcakes per day with this new sales channel. But should you do it?

When is a sales channel profitable? Only when every sale is profitable. You need profit on every cupcake sold. If not, you are better off not adding the sales channel.  As the saying goes, you cannot make it up in volume if you are losing money on each unit.

 

Yet Another Groupon Clone Level Up: Cost of Buying Loyalty

LevelUp is yet another Groupie – a Groupon clone. In their website copy and videos they go after Groupon. Look at their use of Groupon logo but with the words Daily Deal.

LevelUp says they address the biggest problem of Groupon and other Daily Deal sites – People buy the “ridiculously large discount”, try it once and never come back.

LevelUp say they have solved the problem for small businesses with their model – Level Up. People  Try (Level 1), Like It (Level 2) and Love It (Level 3).

LevelUp puts money behind this claim as well – they do not get paid unless people move up the level. So should your business do it?

I do not understand the subtle different between Like and Love. But that bigger question is how do those who try the discounted coupon move to higher levels? With bigger and better coupons.

The deal levels are called Good, Better and Best. They tell their subscribers,

“Had a great time? Then “level-up” and go back with an even better deal!

So they incentivize people to go back by giving them BIGGER discounts than the first time.

In other words, those who try with discounted coupon do not become a regular customer who is happy to pay full price but just a regular drain on profit.

Anyone can BUY loyalty by giving away price discounts. What will happen if the promotion is withdrawn? What is the cost of that FALSE loyalty?

LevelUp still does not address the key problem – How can a small business convert the deal seeker attracted by steep price discount into a full price customer?

In the case of Groupon and LivingSocial, I discuss their role as a Marketing
Channel and Sales Channel. As a Sales Channel all these sites are very good ways to off-load excess capacity that cannot be inventoried and businesses can protect against cannibalization.

In case of LevelUp it can never be a Sales Channel with its increasing discount levels.  Your business can hire LevelUp only as a Marketing Channel – which requires you to do the hard math before accepting their promise of Delivering Loyal Customers.

My first book: To Group Coupon Or Not

You have seen my posts on Groupon and the hidden costs of doing a promotion that gives away 50% off to acquire new customers. I have written a eBook, To Group Coupon or not, to help Small Business owners understand the math and metrics of such a deal. The book link is http://book.MathMarketer.com

The book received great reviews from two established Pricing experts, Mr. Reed Holden, Author of Pricing With Confidence and Mr. Ronald Baker, Author of Pricing With Purpose.

I understand you read my blog for Marketing, Analytics and Pricing and you most likely are not a small business owner. It is still a great read if you want to understand the hidden costs of any promotion and how and when to add a new sales channel.

I would appreciate if you  can give it a plug – write about it in your blog, tweet the book link and tell your business owner friends about it.

Thanks.

Imagining the Groupon Vs. Barnes and Noble Conversation

Plug for my book: To Group Coupon Or Not: Small Business Guide to Groupon, LivingSocial and Others is now available!

Two weeks back it was LivingSocial that captured the attention cycles of social media with its Amazon deal – they gave away $20 worth Amazon gift card for $10. When it all ended, in less than 24 hours they sold 1.2 million gift cards. Potentially many of them are new subscribers – I was one of them.

Not to be outdone, two days back it was Groupon’s turn to run very similar campaign but with Barnes & Noble (competitor to Amazon in books, eBooks and eBook readers). Very similar deal. I cannot tell the number of coupons sold from the deal web page.

Here is a completely hypothetical description of  how the deal conversation between the Groupon and Barnes&Noble business development managers would have went (B&N conversation assumes I am their biz dev guy):

Groupon: You saw the great deal Amazon did? They did $10 million in gift card sales in one day.
B&N: Yes, we were wondering about that.
Groupon: Think of how many of your sales they probabaly took because of that.
B&N: Well, we don’t think so. Those could all be Amazon customers already.
Groupon: But you can do just that to them, you can take away their sales.
B&N: How is that?
Groupon: Give away $20 worth of products for $10 with us. We have lot more subscribers, your deal will could sell lot more than 1.2 million.
B&N: Would that not cost $10 to $12 million for us and not to mention your fee.
Groupon: Customers who buy the gift cards usually spend more.
B&N: How much more will they spend? Can you give us 90% confidence interval estimates  what percentage spend at least $20 more?
Groupon: It has worked for many of our customers, more than 90% say they will try again.
B&N: So we read a theory by Iterative Path that Amazon did not have to pay some or all of the $10 discount and the same for the fee to LivingSocial.
Groupon: But that is just a hypothesis, there is no evidence.
B&N: Very true. But it is likely. Didn’t LivingSocial gain more from the deal? Is it not the same case here? You will get many new subscribers or at least big visibility in media. We are not convinced we get much out of a $15 million spend. If you paid for the deal completely and pay us $5 for every new subscriber you get, we will do the deal.

Could this have happened?