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Nov 10

The real reason why merchants use Groupon

If you haven’t heard of Groupon, it’s a site which emails users an offer each day. The offers provide deep discounts (around 50%) on all manner of things – meals, consumer products, services, and so on – based on the premise that there’s power in group buying.

This premise would intuitively lead you to believe that Groupon can get these discounts because it’s able to buy in bulk. The upside for the merchant is they get a guaranteed chunk of revenue, and also introduce new customers to their business. However, when you think about it a bit more, you start to wonder how merchants can make any money when they discount their goods by 60%. Surely, their margins can’t be that high? And then you have to factor in Groupon’s cut – which has to be significant for it to earn its multi-billion dollar valuation.

It turns out that Groupon actually splits the sales revenue 50:50, which means that merchants cop a markdown on their goods or services of about 80%. There are very few businesses in the world – especially when it comes to consumer goods – that have that kind of margin, so the conclusion is that the merchants lose money. Why do they do it?

You see, for the merchants, it’s not about making a profit on these deals. For merchants, the value proposition is advertising. Groupon is a marketing channel for merchants, not a sales channel.

This post on NY Times’ blog does a great breakdown of all the factors weighing into whether it makes financial sense for a merchant to use Groupon:

There are eight key calculations you need to consider to determine whether this is a better advertising vehicle than something else you may already be doing:

1. Your incremental cost of sales — that is, the actual cost percentage for a new customer. If you are giving boat tours and have empty seats, your incremental costs for an additional customer are next to nothing. If you are selling clothes, your incremental costs might be 50 percent of the sale price. Food might be 40 percent. In any case, don’t include fixed costs that you would be incurring any way.

2. The amount of the average sale. If the coupon is for $75, will the customers spend more that that? I have seen more than one retailer complain that nobody spends more than the value of the coupon. That’s unlikely but I am sure it can feel that way, and that is my point: Keep track.

3. Redemption percentage. You don’t really know until the end, but from my experience and from what I have heard, 85 percent is a good guess.

4. Percentage of your coupon users who are already your customers. I’m sure this number varies tremendously depending on the size of your city, how long you have been around, and the type of business.

5. How many coupons does each customer buy? (The more they buy, the fewer people are exposed to your product or service.)

6. What percentage of coupon customers will turn into regular customers? Again, it can seem as if they are all bargain shoppers who will never return without a discount, but that’s almost impossible. Is it possible 90 percent won’t return? Sure.

7. What is the advertising value of having your business promoted to 900,000 people — that’s the number on Groupon’s Chicago list — even if they don’t buy a coupon?

8. How much does it normally cost you to acquire a customer through advertising? Everything is relative.

  8:52pm  •  Business & Finance  •   •  Tweet This  •  Add a comment