January 20, 2011

LivingSocial / Amazon Social Commerce Promotion Profitability

Well, I've been pummeled with comments over the past two days.
  • What do you think of the LivingSocial / Amazon deal?  That one worked, huh?
  • I guess you were wrong about social commerce, Amazon just proved that it works!
  • You have to keep in mind that Amazon invested in LivingSocial, so it is a win-win.
  • You have to understand that this is how modern marketing works.
  • You have to give people something of high value in order to grow your business.
  • Even Snooki tweeted about this, so it really did work.
  • You really don't know the financial arrangement between the two companies, so it could work.  Since Amazon owns a part of LivingSocial, it probably nets out at no-cost for Amazon.
  • Why are you against social commerce?
  • Why do you hate promotions?  They work, customers love them, and they help brands grow.
  • Discounting doesn't hurt loyalty ... look at Woot, they have great customer loyalty and they do discounts as well as anybody.
Many of the comments are valid.

Twitter and Blogs have changed how we evaluate whether a marketing strategy works.  Today, something works if it is Popular, and if it is backed by a Strongly Worded Opinion (SWO).  

In the real world, the following equation holds:
  • Actual Data > Popularity + Strongly Worded Opinions.
In many companies, the Marketing head and the Chief Financial Officer sit down with a pen and a pad (or even a spreadsheet).  They run a series of scenarios.  They ask critical questions.
  1. If we give away $13,000,000, how will we get our money back?
  2. Will we get our profit back in the short-term, or in the long-term?
  3. Will the promotion generate new customers, or will we have to find a way to get profit from existing customers?
No matter what the relationship is between Amazon and LivingSocial, $13,000,000 (less those who do not redeem the promo) just vaporized.  You cannot ignore this fact, no matter how many Strongly Worded Opinions are offered, $13,000,000 just disappeared.  This isn't the Fed, folks, we can't quantitatively ease our way into generating $13,000,000, we'll have to do hard work to get it back.

And it is possible to get the money back.  Here's a scenario where we more than make up the costs of the promotion.  I assume that customers will spend 50% more than the $20 gift card they purchase for $10, I assume that 30% of the purchases would have happened anyway, without the promotion (yielding a 70% incremental rate).  I assume net sales, gross margin, and pick/pack/ship percentages based on publicly available information and 10K statements.  I make very crude assumptions for new/existing customers, and for 12-month profit estimates. I assume that by improving an Amazon buyer from 10 purchases to 11 purchases, you increase long-term profit from those customers by $2.   

If you don't like the assumptions, choose your own and run your own numbers!!!!!




Sample Scenario


Promo Demand   $20,000,000
Add-On Item Demand (50%)   $10,000,000
Total Promotional Demand $30,000,000
Incremental Demand (70%) $21,000,000
Net Sales (96%) $20,160,000
Gross Margin (25%) $5,040,000
Less Promo Cost $13,000,000
Less Pick/Pack/Ship (6%) $1,209,600
Short-Term Profit ($9,169,600)


Total Participants 1,300,000
New Amazon Customers (5%) 65,000
Existing Amazon Customers (95%) 1,235,000


Additional, Incremental 12-Month Profit:  Amazon, From Existing Buyers ($2) $2,470,000
12-Month Profit:  Amazon, New Buyers ($20) $1,300,000
12-Month Profit:  LivingSocial ($15) $18,525,000
Short-Term Profit ($9,169,600)
Total Profit $13,125,400



If I can show that the net relationship is profitable, then I support the promotion.


That's the point of all of this.
  • Actual Data > Popularity + Strongly Worded Opinions
Demonstrate that it is possible, or even probable, that the twelve-month payback of a promotion is greater than the money lost running the promotion.  Do the math.  This isn't calculus, this is simple math ... addition, subtraction, multiplication, division.


And when you run the math, you may be surprised to learn that your Strongly Worded Opinion is, in fact, correct!

8 comments:

  1. Anonymous12:08 PM

    Enjoyed the breakdown.

    ReplyDelete
  2. I wonder what the "breakage" rate (those who don't redeem, or redeem for less than $20 then let the remaining funds expire) is on this promo. Probably quite small, but still pure profit for Amazon.

    ReplyDelete
  3. Well, I am certainly not the numbers genius that you are but I do think there is another option to consider in this and that is doing the numbers not for a company's P&L but for the current/future valuation and/or funding.

    There's do doubt that many VC's have too much money and too few places to invest it in these days...

    ReplyDelete
  4. Anonymous --- glad I could provide enjoyment in your life!

    Will --- agree, you'll have some breakage that adds profit to the Amazon cash register.

    Amy --- you are correct, the strategy does impact valuation/funding, so it's always fun to see folks bump that top line up to aid in valuation, good point.

    ReplyDelete
  5. Another great post, Kevin. I love your point about "Actual Data > Popularity + Strongly Worded Opinions." Now that I've actually received this deal and seen how the redemption works, I doubt there will be 70% incremental sales. Basically, you just apply the gift card to your account and if will deduct from it on your next purchase or purchases. I will end up using it on my next purchase from Amazon (one that I would have done anyway). While this will no doubt spur some people to buy something extra now, my experience tells me that the number will be relatively low. Furthermore, and this is just a somewhat educated guess, the promotion was probably as popular as it was because it was Amazon and most people knew they would be buying something at Amazon at some point.

    I think the overall value here is really about getting Living Social some press and a lot of new enrollees. All of the sudden, they are on the same playing field as Groupon. Is that worth $13 million? Don't know. Maybe.

    Anyway...there's my two cents.

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  6. It sure takes a lot of 'maybes' and 'hopefullys' to get to a long-term profit. I can understand (somewhat) how a new, service-based business could get to value using this type of promo. But it seems exceptionally hard for a retailer to give it all away and get there. You're also assuming that Living Social received nothing but press from this (unless I'm doing the $13 mil wrong).

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  7. Jay --- that's the point of the p&l ... if you are a retailer, run the numbers above ... any of the readers could have taken the retailer portion of this p&l and observed how hopeless the situation is.

    And Kevin, yes, you doubt the incremental rate is 70%, somebody else says it is 90%, somebody else says it is 50%. Plug your favorite number in, and see what the simplistic model tells you!

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  8. @Amy: Well, same here I am not a number genius also. You're not alone.

    @Kevin: I'd agree with most of the comments you've shared above in your post. Amazon is really true! No debt just amazon revenue!

    ReplyDelete