Daily Deals have skyrocketed in consumer appeal on the backs of a deep discounting formula by local businesses, in exchange for an impressive flow of new customers and a risk-free ad model. Most Daily Deal providers require a discount of 50% or more, in order to get the consumer attention.
When you cut prices this deeply, the Deal Math really matters!
We’ve organized the Math discussion into two parts. Part One (below) discusses the deal event itself – helping you assess the financial impact of the customers visiting with the Daily Deal voucher. Part Two then broadens to other things that factor into your overall Deal evaluation, including return visits and other offsetting costs and benefits.
The Deal Event Math
We’ve created a model below that can apply to your own situation. Our suggested approach is to assemble a Before and After picture to help you understand and adapt your Daily Deal opportunity!
Your Before and After Formula
We’ve used the financial concepts of Direct Cost (the variable cost associated with one customer visit) and Fixed Cost (the cost of ongoing operations, irrespective of the number of customers). From this you can derive a picture of the Total Contribution (Revenue – Direct Costs) before and after a Daily Deal to assess the impact.
Some standard labels should make the working formula a little easier to follow and apply.
- Deal Discount (DD) = List Price (LP) – Discount (D)
- Net Deal Share (NDS) is the percentage of the coupon purchase price you receive from the DD provider.
- Spend per Visit (SPV) is the average bill paid by your customer on the products you’re offering in your DD.
- Contribution Margin (CM) = SPV-Direct Costs (DC) – how much does each customer visit contribute to your fixed cost of operations.
- Total Contribution (TC) = CM x Customer Visits (CV)
Joe’s Clam Shack: Before and After
Joe’s Clam Shack is considering doing a $25 for $10 discount deal. Joe’s average normal SPV = $55, and his average DC per visit is $20. Each normal customer visit therefore has a value of CM of $35.00, which contributes to covering his Fixed Costs.
For Daily Deal Visitors, Joe hopes to bill an average of $30.00 ($55-$25), assuming a visitor with the Deal voucher will spend the same as his average customer. Plus, he receives a check from the DD provider for his portion of the $10 paid by the consumer. At a 45% NDS, this would equate to $4 per DD visitor. So, Joe’s CM from DD visitors would equal $14.00 ($34.00 less $20 CD), which would be $21 less than current customer visits.
The Volume Impact
Presumably, the Daily Deal would be instigated to increase customer visits. Let’s say Joe normally does 50 visits per night, and the Daily Deal increases that to 80 visits per night. It’s common that after a DD campaign, the DD customers can “crowd out” normal customer traffic to some degree (a combination of regular customers buying the deal, plus the reality of scheduling). So let’s assume the mix of customers after the DD campaign would be 40 regular visit customers + 40 Discount Customers.
To complete the Deal Math, we then compare Total Contribution from Normal Traffic to After DD Traffic:
Normal Traffic TC = 50 Visits x $34 CM = $1,520 per night
After DD Traffic TC = (40 normal visits x $34) + (40 DD Visitors $14) = $1,920 per night
Under this scenario, the business would improve their Total Contribution by $510/night.
You can use this approach and play with the formula to help assess the risks and as input to the Deal Structure for your Offer. For example, if the DD traffic squeezes out regular visitor traffic to the point of 80% of visitors being DD customers, the TC after the DD would be lower than before, despite the growth in customer volume.
The Importance of Design
One key factor underlying this Deal Math exercise is the ability to capture additional spending from the DD consumer on the original visit. In the next article, we discuss return visits and other factors, but hopefully you can see how critical it is to make smart decisions in your individual Deal Design (the price points and discount terms).
To reinforce this point, let’s compare the impact of a $25 coupon for $10 (60% off), versus a $40 coupon for $20 (50%). With an average SPV of $50, and a DC of $20, the lower value coupon offer with a larger % discount would result in a TC of $9.50 versus -$1.00 for the larger coupon. On the surface, this would be a lower risk deal to offer.
Lower face value coupons may, of course, attract a smaller set of buyers than larger face value offers. Most importantly, know your own costs and usage patterns, and design your offer smartly to meet your Daily Deal goals.
The Importance of Assessing Spend Behavior
The Deal Math model described above assumes that a consumer with a Deal Voucher will spend the same as an average consumer. There is some evidence that this is not always the case, as Deal Voucher consumers often spend only to the value of their voucher. This is a critical part of the Deal Math, and it’s probably smart to be conservative in assessing this situation. Adjusting the SPV for the Voucher customer is one way to factor this spend behavior issue into your own assessment.
What’s You Experience Been?
A recent study of 150 small businesses who had used GroupOn suggests that one-third of the businesses consider the deal to have been unprofitable after the fact. [you can see this and other industry articles in our Resources Page]. All to reinforce the importance of doing your math homework!
We hope this is a useful article. We also point you to another article which digs into Deal Math, as additional input to your education.
If you have any ideas on how to help everyone understand and assess the benefit and cost of a campaign, by all means comment away! Any evidence you’d like to share on your experiences on return traffic or cost issues you’ve encountered?