It’s all about the numbers…

This post on TechCrunch by a fellow who runs a daily deal aggregator really got under my skin. It wasn’t so much that he was trumpting the daily deal model as much as he was providing completely unrealistic numbers.

If you take a peek in the Facebook comments, you’ll see a nice, long response by yours truly. Yes, I’ve finally decided to weigh in publicly on the rage that is Daily Deals (Groupon, Living Social, etc).

I’ve reposted my response below for posterity, but let me be clear: there’s a place for daily deals but they are not a panacea. They can be one of the most expensive ways to acquire new customers and retailers need to be careful.

Here are my three (3) rules for evaluating deals:

  1. Always make a decision on the numbers – There are some things you might do just for the fun of it. We usually refer to this as “doing it the brand”. However, deals where you are putting real money on the table need to be evaluated using metrics and realistic expecations.
  2. Always cut your expectations in half – If it turns out you’re right, then you can be pleasantly surprised.
  3. Always be blunt when someone tries to make you violate #1 or #2 – You can’t blame the partner if you didn’t stick to your guns.

If it looks too good to be true it probably is, but that doesn’t mean there’s not something to it.

Now that I’ve said all the tough guy stuff, let me also say that I’m not exactly shy about business. I’m always up for trying new ideas and testing new channels. I mean, ThinkGeek grew by 55% last year. Don’t think I’m being cocky here either. A lot of people worked very hard to make this possible. What I’m saying is that we certainly didn’t accomplish results like that by running away from new business.

So, here are my three (3) rules for testing new sources:

  1. Limit Your Exposure – A test is only a test if you can control the size of the deal.
  2. Avoid One Way Streets – Can you back out of the deal if something goes wrong or shut down the test early? if not, you’re probably going to regret it.
  3. Measure Everything – If you can’t track the test, you can’t say it worked. If you don’t measure the results, you’ll be n the dark about true impact of the rollout. Measure everything you can.

Maybe this isn’t a perfect formula but it’s working pretty well.

Got an opinion? Drop way down to the comments and tell me what you think.

Appendix: The Daily Deal Reply

Here’s what I had to say:

Sorry but your numbers are unrealistic for most if not all retail businesses.

The deal hunters of the world are interested in only one thing: deals. They won’t pay more, and they’re more likely to take advantage of low margin products (to maximize the value of the deal). There’s nothing wrong with that of course, but retailers really need to think this through using realistic data.

Here’s a analysis of your post and model:

Overage: The example in your post assumes a 50-100% overage rate. In the retail world, that simply does not happen. Ever. Your Excel model is a little more realistic, but 14% is too generous for forecasting. In selling to a discount-minded audience, the best you can realistically expect is 5%.

COGS: In your Excel model, you assume 40%. This may be true of service business but not true in retail. Even most apparel businesses don’t get close to that number. In addition, discount-minded customers rarely buy items where you’ve got great margin. They look to maximize the deal by buying items on sale or items with razor thin margins where they can’t get a deal anywhere except by using that coupon.

Commission: Your Excel model assumes a 40% commission. That’s not happening with any deal network. 50% is the floor and it goes up from there.

Using your model, if I change overage, COGS, and commission to realistic numbers the merchant loses $3 per customer.

But I can’t really stop there…

In your model you assume three (3) repeat visits for new customers. You also assume that the “conversion-to-repeat” will be static. In other words, there’s no entropy over time of the original 20% who return. This is unrealistic. First, for forecasting purposes you shouldn’t assume more than one (1) repeat visit. If you can’t make money from an acquisition after the second sale, you’ve got a bad channel. Second, over time, the number of customers who return from the initial acquisition is going to degrade. Not only that, but it’s going to degrade very sharply. You’re going to go from 20% on second purchase to 5% to 4% and then probably level off after that at 2% of the original batch of customers… if you’re lucky.

I’ll meet you half way though and only change repeat visits to 1.5 and ignore the entropy factor. Now, I’ve lost $5.90 per customer.

You also recommend that businesses provide a second incentive to a discount-minded customer. You’ve brought in a deal hunter to your shop and converted them to a customer and then you reinforce the discount mindset by offering a second deal? I’m sorry, but this is really bad advice. There’s nothing wrong with bringing in deal hunters, but retailers need to understand what that does to their margins. They also need to understand that it is very, very difficult to convert a deal hunter to a full margin customer, and by very difficult I mean impossible.

So, my advice to retailers is to be very careful about the offering and very conservative on the forecasting. If you can, limit (i.e. eliminate) your exposure on low margin items or stacking discounts. Deals are great, just be smart about it.

To help, I’ve uploaded this version of the model using the more realistic assumptions to Google Docs and made it public to the web. Interested parties can download it here.

8 thoughts on “It’s all about the numbers…

  1. Jamie:

    Worse, yet, there’s some price perception to consider here. If you continually off your customer’s deals – they will begin to devalue your product’s worth – which is terrible if you’re trying to sell premium products. Consider for years that Arby’s deep discounted their premium Roast Beef sandwich and continually ran promotions for 5 Roast Beef sandwiches for $5 when they were regularly $2.25 a piece. Over time, what do you think customers thought that premium product cost?

    This can affect the whole brand as well. If you’re known for selling discounted products to hit a low entry point than over time, consumers will just think you’re selling junk.

  2. How true, how true.

    The conversation over on TechCrunch was certainly interesting. I found that a lot of people had a hard time thinking about people as clearly defined groups. They wanted to talk about outliers instead. That’s a pretty common mistake too. Group dynamics are a lot more important than individual opinion, especially when it comes to dealing with offers of a certain scale.

  3. Jaime,
    Really enjoyed the discussion you started over at Techcrunch & thought I would comment here. Overall I agree that Vacanti’s numbers are optimistic, I gathered some deal stats myself here. But your figure of $5.90 lost per customer doesn’t sound that bad to me. I work with a lot of local businesses who pay $10, $20, $50 or more per lead through other marketing channels. Yes, some of them may be losing money, but growing a local business is challenging no matter how you slice it.
    I think Vacanti’s comment is spot on, “surprise and delight daily deal customers.” Too often I cash in a deal and am treated like a second-class customer by the person serving me. IMHO deals are not about making money, but about getting new customers. No marketing method has positive ROI if you treat your customers poorly. Anyway, thanks for keeping it interesting. Cheers.

  4. Thanks, Nico! Glad to participate. 🙂

    I agree that there’s always going to be some sort of loss in acquiring new customers. That’s part of the gig.

    The catch on this one is that the model was baking in lifetime value to show the net positive return over time. So, the loss of $5.90 is AFTER the customer comes back to buy again.

    Losing money on the initial acquisition is OK. Losing money over the lifetime of the customer is not.

  5. But if I understand your model correctly, you are saying that if I get 100 customers in the door, 19 will come back once, and in total I can expect 8.5 more visits from that group ever. It also assumes that none of those customers will bring nor refer friends. In my experience, that’s a pretty dismal LTV calculation. In any case, I agree that deals are a bad fit for businesses with low repeat visit rates.
    I will try to shut up now, but I *am* a bit obsessive about marketing & LTV.

  6. Well, it might be different for local retail businesses but for online it’s pretty accurate.

    The real point behind my modification of the original model provided by the author was to inject a little sense of reality into the all the EXCITEMENT!!!1! (TM) that was being tossed about on the daily deal model. Just a few numbers tweaked and suddenly you’re losing more than you were gaining under his assumptions.

    I wanted people to realize that they needed to focus on the metrics core to their business to weigh the model accurately. My numbers of course may not apply to someone else’s business, and that’s perfectly ok as long as my advice spurred them to take a hard look at the assumptions they had in place.

    In the end, every business has different metrics and each business owner needs to know what those are and not be swayed by the hype.

  7. “In the end, every business has different metrics and each business owner needs to know what those are and not be swayed by the hype.”
    Amen to that. I am trying to combat the hype myself with the post linked-to in my first comment. I might be nit-picking numbers a little, but I came here in the first place because I liked your comments and respect your approach. Keep fighting the good fight!

  8. Jamie, I could not agree more. I have advised clients to exercise caution before any type of discounting. The airlines present a clear example of how the strategy can lead to price wars. When you win customers on price you also risk losing them on price. I have read accounts of companies who lost big with daily deals. When I dug into their stories, most did not even know their own internal costs and had lacked a solid strategy for the daily deal. Being a small business does not excuse the business owner from knowing or learning the fundamentals of running a business. You must know the numbers, and have a clear identification of your market and the competitive landscape when considering any type of discounting strategy. Thank you Jamie for your keen, thoughtful analysis.

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