Cannibalization, Breakage, and Exposure: Calculating the Value of a Groupon

4/14/11

The humble coupon has become the epicenter of an Internet startup mania, the height of which I believe we witnessed when Groupon rejected a $6 billion buyout offer from Google last December.

In the wake of Groupon’s vertiginous arc, a mob of copycats has followed. With names like Weforia, LivingSocial, Tippr, and LevelUp (SCVNGR), they have proliferated to the point where deal aggregators like DealGator and Yipit now have currency. Relatively well-established Web companies like Google and Facebook, for whom bargain shopping is hardly a core competency, have leapt into the melee. It is, by all accounts, a contemporary gold rush.

Yet, there remains an open question: how valuable is Groupon as a service? Let’s say you run a local retail outfit, or a hospitality venture; will you benefit by offering some kind of social buying deal? While Groupon claims 97 percent of its featured retailers would want to repeat the experience, an independent study conducted by Rice University professor Utpal Dholakia says that at least 30 percent of businesses surveyed thought the Groupon they ran was unprofitable.

It’s worth noting that the survey relied on self-reported yes/no responses, and while it seems churlish to suggest business owners don’t really know if they’re making money or not, I think it is reasonable to point out that many small to medium businesses don’t have the resources to do the kind of closed-loop analysis necessary to definitively calculate return on investment (ROI) on promotion efforts.

Having conducted such an analysis for a local hospitality venture, I thought I’d walk through some of the potential benefits—and dangers—attached to social buying deals, and conclude with a fairly simple but effective method for calculating the ROI of a social buying deal. For the sake of brevity, I’ll assume we all understand the basics of group buying.

Cash Up Front… Sort of

One of the attractive parts of the Groupon-style deal is that it delivers a substantial pile of cash up front, before anyone actually walks into your establishment demanding goods or services at ludicrously discounted rates. This will sound tremendously appealing to anyone who’s struggled with balancing cash flows. Of course, it’s not all upside. First, Groupon takes a 33-50 percent cut for itself off the top of all revenues gathered from the sale of the Groupon. Second, the company delivers the remaining revenue in thirds—immediately and then after 30 and 60 days.

Breakage

Another benefit, though one you won’t find on the public portion of the Groupon site, is breakage; that is to say, the rate at which consumers will buy a Groupon and then never redeem it. The company’s representatives claim a roughly 30 percent breakage rate on average. This can go a decent ways towards alleviating the pain of offering your wares at bone-crushing discounts.

Exposing Yourself

Groupon claims to deliver “huge exposure” for its featured business customers. One such customer reported approximately 250,000 impressions resulting from being featured on Groupon. To do a rough, back of the envelope style calculation, I looked up what Facebook would recommend … Next Page »

Ryan W. Cohen is an MBA candidate and graduate fellow at Babson College, where he studies information markets and digital strategy. Follow @

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