For retailers, Groupon is an interesting concept, but you need to be extremely careful when it comes to your margins, so you need to selectively choose how you want to structure the deal. It makes sense for companies that provide services, or even hotels that have rooms that sit empty, but for retailers it much more difficult. You’re better off doing the discount on a loss leader product in hopes of getting people in the door rather than a straight up dollar amount promotion. Groupon charges a 50% commission on their deals. So let's look at a popular Groupon Deal that offers a coupon worth $50 off of a future purchase for the price of $25 (which in all reality is a $50 gift card for the price of $25). Let's also assume that our Groupon was a success and 400 people purchased our offer. How does the math work?
400 Bought at $25 = $10,000
Groupon Commission = $5,000
Retailer Revenue = $5,000
Total Liability = $20,000 (This is how much the coupons you sold are worth)
Assuming that our goal is to get people in the door and spend double what the coupon is worth, this is what we would need. If we are selling an item for $100 and our cost is $50 our margin is 50% which is healthy. But now someone comes in and uses their $50 card they bought for $25 so they are essentially buying the $100 but we're only getting $50 in cash. Combine that with the $12.50 cents that we received from the Groupon and the total income of that purchase is $62.50. Now our gross margin is only 20% or $12.50 profit as opposed to the $50 we would have made without the Groupon. So if the 400 people actually used it and the average price per transaction was $100 we would bring in $25,000 for the promotion for only $5,000 of pure profit.
Now, if we kept our margins in tact we would only need to sell 100 items at $100 to maintain our 50% margin and reach the same $5,000 of profit as opposed to 400 items! Essentially we would need to sell 400% more product to reach the same profit dollars.
Here is where it gets more interesting. Obviously the goal of the Groupon is to get people into the door and spend more than the face value of the Groupon, and having them spend an average of $100 per transaction at our 50% margin. But what if that average transaction was lower, like say $75? Assuming our profit margin again at 50% where cost is $37.50 the gross revenue will now only cover our costs, so the overall profit of our Groupon is $0! So anything less than $75 and we will actually lose money on our promotion.
But let's get back to the $100 where we make money. What did this promotion cost us? We already established that to make the same profit dollars we would have had to sell to 100 customers to reach the amount of profit we did with the Groupon. That means we potentially got an extra 300 people in the door which is great, that was our goal. But, in order to get those 300 people in the door we had to sacrifice profit and margin. But how much did we sacrifice? Assuming that these 300 people spent the $100 with no promotion we've sacrificed $11,250 in profit to get them in the door! This means the more Groupons sold, the higher our promotion cost.
While Groupon is a great way to get exposure, be careful in how you structure your deal. As a retailer you may want to consider limiting it to a certain amount of Groupon's sold, or to a specific product that has a very high profit margin for you. It's easy to get excited about the amount of people you expose your store to in a Groupon, but it's important to do the math and create one that makes you money and doesn't lose you money.
This article was written by Adam Blair. The race is now on in retail to leverage new technology to improve productivity and customer service. It sounds like Lowe's is well on their way to doing this.
