In the post Il Customer LifeTime Value (CLTV) dei Grouponers we  identified the drivers to generate profitable Groupon offers by means of  the Customer Lifetime Value (CLTV) formula. Normally  CLTV measures the effect of a brand new marketing action to a specific target, e,g,  a new couopn to a group of non-active customers.

In order to model the complexity of a real Groupon offer, unfortunately, the CLTV model cannot include two elements: the cannibalization, and the impact due to limited resource  for serving customers. Thus, we use  an Excel  simulation over 12 months of the  Net Present Value (NPV), applied  to the example of the restaurant with limited seats discussed in Groupon crea valore per i commercianti?. Our model model estimates the profits for the merchants and uses the Monte Carlo  simulations to evaluate their sensitivity to the different model inputs, understanding which parameters of a Groupon offer are the biggest profit generators and the value destroyers.

Cannibalization: a Groupon offer does not reach only new prospects,  because the merchant cannot slect his target out of the Groupon list  (ie by eliminating any existing customer). Many active customers could be Groupon members  leveraging the discount instead of buying at regular full price.  The parados is that the more Groupon is famous, the more its list already contains existing customers of the merchant, thus rising potential for cannibalization. The net effect is that together with the revenues out of newly acquired Groupon customer, the deal can also generate lost revenues out of the existing customers. The second problem is the limited serving capacity of some types of businesses. A restaurant, for example, has a limited number of seats and Groupon coupons are time bounded. If the dealer has already a large customer base,and its goals is just to saturate the residual capacity, it must  carefully investigate if the new prospect are not saturating on peak the limited seats at the expense of fully paying customers. The phenomenon must not be neglected: the study How effective are Groupon promotions for businesses  shows that the more the offer is aggressive, the higher the demand by new customers. Typically,  coupon redemption occurs immediately after purchase and shortly before the deadline where buyers accelerates usage, creating peaks of  x5 x7 times the normal demand. During such periods, the cannibalization can have a major impacts for businesses.Conversely,  business with no issues on capacity such as SPA or  swimming pools can truly benefit of the new prospect demand without impacting revenues out of full priced customers.

Taming this cannibalization requires  Yield Management:   offers should be made on for low traffic days or proposing different discount between peak and off peak periods.It could seem trivi9al, but small and medium business don’t always think about this before a contract negotiation with Groupon, with unpleasant economic impact afterwords.

Our Excel considers the restaurant cash flows over 12 months with the following hypothesis:

  • Maximum capacity of about 5000 meals per month (50 seats with 80% saturations over 4 shifts/day for 22 days/month);
  • Existing loyal customers are 4000,  with buying frequency 0.5 meals per months (1 meal every 2 months, saturating around 2000 meals a month) with a normal churn rate of 3% per month;
  • Groupon offer generates new customers for x5 times the regular customers, spread  across obver four month deal duration;
  • Customer retention rate for new Groupon acquisions is 30% (the first time):
  • Deal is for a meal with full price of 50 Euros andprofit margin of 20%;
  • the customer acquisition cost (SAC) is 37.5 Euro as mentioned in  Groupon crea valore per i commercianti? ;
  • 30% of existing customers also redeem the offer (rate of cannibalization);
  • 40% of Grouponers buys extra items out of the bundled packaged, with 20% revenues on top of the basic menu;
  • discount rate of 10% (cost of cash) for NPV calculation.

With these assumptions we can calculate the monthly cash flow and differential NPV for the merchant, ie the difference between   issuing the Groupon deal or not.   This NPV will tell us whether the offer created value or not.   Simulation results are shown in the above infograph: (1) are the revenues per existing customer and (2) per newly acquired Grouponers. Graph (3) shows the impact on consumed meal and the trend for the restaurand cash flows: obviously, in the first 4 months, meals increased from an average of 2000 to around 5000 of the theoretical capacity; Thanks to the retention rate on new offer, they reach an average 3400 per month, dropping afterwards for the same organic churn affecting pre-offer customers.

More important we see still in (3)    that the restaurant cash flows are negative during the peak usage; this is caused by the discounted meals being in loss for the thin margins (20%) affecting restoration business. Cash flows turns back to positive only when Grouponer comes back in subsequent purchases from the fourth month onwards. Graph (4) shows the total differential NPV  and its sub-component.

The first conclusion is that with 20% profit margin, the offer does lose value for the merchant ant the total overall net loss ( 95,000 euro over 12 months) is quite significant. It was better not to launche the deal.  Looking at the NPV subcomponenets, we see that profits from new Groupon customers converted into regular customers do not compensate the cost of subsidization across all the Groupon redemptions . Definitely a large value destruction. But where did we go wrong ? What should we do to avoid this? To this goal, the more interesting graph(5)  shows results of Monte Carlo simulations. Here we modeled the uncertainty affecting the model inputs using gaussian distributions around the averges values discussed in bullets above. Running the simulations shows which inputs can impact the NPV more, so where we do need to pay greater attention.  Clearly, the single  most important driver explaining  the NPV variance is the profit margin of the business. The second driver of value destruction (i.e. negative correlation) is the magnitude of the  Groupon fee, followed by the Grouopn prospect  retention rate, ie how many new Grouponer will really come back to the business after the initial deal redemption.

Graph (6) shows what would happen if the same business simply had a profit margin of 40% (clearly not a restaurant):  the same offer would create value after 12 months for +140 KEuro, i.e. about 11.5Keuro/mese more than withouth the offer. Here we note that the NPV positive because the margins out of full meals can offset the subsidization.The tornado chart for sensitivity (7) shows a slightly different scenario than before: since prospects now have a positive CLTV, the key profitability drivers after the profit margin and the retention rate  is the total number of new prospect converted into customers. Not surprisingly, with these better margin, profit is created for each new acquired user and not destroyed anymore. Acquistion turn to be valuable not a problem. In both scenarios,   we see that the cannibalization is not a singificant factor and extra revenues have a minimal contribution as well.

The bottom line is that there is an enormous sensitivity to the profit margin: this explains why Restaurants and Spa have very different sucess and opinion of using Groupon (Groupon crea valore per i commercianti? ). You should really investigate your margin and your cost structure across variable and fixed costs before doing this. In the next post, Groupon: decalogo pratico di valore per commercianti ,  we will turn these consideration into practical suggestions for merchants to negotiate a good deal with Groupon.

Published by Carlo Arioli