October 03, 2010

Discount / Promotion Algebra You Need To Know

Many folks contacted me last week with information about Groupon and their presentation at Shop.org.

By the way, wouldn't it have been nice if Shop.org partnered with Groupon and offered you, the loyal marketing executive, a sweet 50% discount off of the Shop.org conference registration fee? ... and did I see that Brett Michaels has a keynote at the DMA conference ... wow ... maybe the DMA will partner with Groupon and give you a sweet 50% discount so that you can hear that one on the cheap).

Well, I wasn't in attendance, so I cannot vouch for this fact ... but I'm told that it was said that losses on Groupon transactions are "made up for" on the next purchase.

This "truthiness marketing math" concept can work. Let's work through an example:
  • You lose $3 profit on your Groupon transaction.
  • You make $10 profit on the next purchase a discount-oriented customer places.
We can use this really neat tool, called "algebra", to figure out the percentage of customers who need to purchase again so that you make money.
  • -$3*(1-x) + $10*(x) > 0.
  • -$3 + $3*x + $10*x > 0.
  • $13*x > $3.
  • x > (3/13).
  • x > 23.3%.
  • NOTE: The first posting had a rate of 42.9%, which was corrected by multiple readers.
So, the Groupon customer repurchase rate must be greater than 23.3% in order for truthiness marketing math to work.

Here's the problem, dear retail and e-commerce marketing experts:
  • It can be a challenge for a retailer or an e-commerce business to get 23.3% of first-time buyers or discount buyer to repurchase.
Do the math yourself, folks. You know the amount of twelve-month profit a new discount-oriented customer delivers to your business ... right ... you do know this number ... right? So assuming you know this number, calculate the repurchase rate you need ... you do track repurchase rate of first time discount-oriented buyers ... right ... you do know this number ... right? Just do the math, and determine for yourself if this type of promotion is appropriate for your business.

If it is appropriate for your business, good for you!

But if it is not appropriate for your business, then question why the marketing punditocracy are shoving this business model down your throats lately ... stand up for yourselves and make sure that the marketing punditocracy share profitable ideas and tips!

7 comments:

  1. That algebra is not correct

    -3*(1-x)= -3 + 3*x

    and not

    -3*(1-x)= -3 -3*x

    ReplyDelete
  2. Anonymous1:47 PM

    Kevin -

    Interestingly, we were having this conversation last night as we redeemed a Groupon at one of our favorite local restaurants. I totally agree with your point.

    I think the answer is 30% though. If I lose $300 on 100 customers, then I would need 30 to repurchase at $10 profit to breakeven.

    Part of our conversation was the other, more involved, factors determine a promotions success. Our discussion also included:

    • Estimating Incremental Sales - We all know controlling for and understanding the impact of discounting sales that would have happened without the promotion is difficult. In our case, even though we go to this restaurant once every 3 months, we most likely would have gone somewhere else without the Groupon. Most small businesses are not equipped to understand and account for this dynamic.

    • Paying for the Discount - The power of Groupon is you have to pay for it. I haven’t seen the numbers, but I would guess redemption rates are significantly greater than most other types of promotions.

    • New Versus Returning Customers. For well known, frequently shopped brands, discounting is difficult to justify unless that is your business model, i.e. The Gap. For new and local niche brands looking to acquire new customers, targeted promotions can be powerful and much more effective than other advertising alternatives.

    • Larger Order Sizes – One interesting analysis would be to compare non-discounted AOS for Groupon and non-Groupon during the same period. Last night we ordered desert when we usually don’t. There is the dynamic of “I’ll spend the same and get more” around discounting.

    • Repurchase Rates Determine Winning Promos - Your point is right on and the most powerful component of this strategy. If you are planning on a loss or breakeven on promotions, you have to have a strategy in place to drive higher than normal repurchase rates for those new customers. If you don’t, you might as well put money in envelopes and mail them to your prospective customers. The outcome is the same.

    Keep the goodness coming.

    Casey

    ReplyDelete
  3. Anonymous2:29 PM

    You are correct on 42.9% number. Recent study by Rice Univ Prof says,
    "However, a significant number in our study, 48 (or 32%) reported their Groupon promotion was not profitable. For these businesses, only about 25% of redeemers purchased products or services beyond the Groupon’s value and less than 15% came back a second time to purchase products at full price."

    I maintain, even the 66% is an overestimate - not just due to sampling error but due to incorrect calculation of relevant costs and cognitive dissonance:
    Opportunity costs: This is forgone profits from other means to drive revenues including price realization, increasing customer margin, new product introduction and other promotions.
    Lost profits: These are the lost profits from sales not made to current and new full price customers. Businesses may forgo these sales because their capacity is all consumed in serving the promotion traffic.
    Incremental costs: These are the costs incurred to add people and capacity just to serve the new traffic
    Accounting: If businesses use Cash Accounting they will incorrectly recognize revenue from GroupOn promotions for the current period. If they used Accrual Accounting they may still not book the sales as part of deferred revenue.
    Cognitive Dissonance: Since they made a choice to run promotion, they are likely to believe that they made profit.

    It is appropriate only for your business when:
    You have a product with high contribution margin (price less marginal cost)
    Have excess capacity (with sunk costs and no other way to monetize it)
    There exists a segment of customers with low willingness to pay but reducing the price to include them will deliver less profit than your current profit (even though it is still profitable)
    There exists a segment of customers with low willingness to pay that you cannot reach through any other way
    You can serve these low willingness to pay customers without the full price customers knowing about it (third degree price discrimination)

    -rags

    ReplyDelete
  4. Ok, folks, the negative times a negative = a positive issue has been corrected.

    Now go ahead and spend time arguing about whether promotions have positive or negative value, using real client data!

    ReplyDelete
  5. The emperor has no clothes. The online coupons will be the death of many struggling retailers looking for a quick fix. Then many armchair coupon users vomit back the same tired, "can't get that exposure," "you have to lose some to make some," etc. You build value by building value, not giving away the store - literally to a billion dollar company willing to tell you it works. See my examination of a health club toted as a success but, like you've shown Kevin, the math doesn't work. http://www.retaildoc.com/blog/fallacy-converting-groupon-profitable-customers/

    ReplyDelete
  6. Anonymous6:31 AM

    I could imagine the groupon working for some products, like an eReader. For example the Amazon Kindle.

    Giving away cheap hardware gives you repeat customers on full ebooks, or software, ...

    ReplyDelete
  7. That's a theory, Anonymous ... do a profit and loss statement and see how many digital books the customer would have to purchase before Amazon would break even.

    If Amazon sold a $189 Kindle for $95 via Groupon, and gave $47 to Groupon, it would have to make up the difference ($189 - $47 = $142) in profit obtained from the sale of digital books.

    ReplyDelete

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