The Mathematics Behind Groupon

November 21, 2010 10:35 pm

Like most people, we were convinced that the Mathematics behind Groupon would be interesting. So when we got an opportunity to use a Groupon at a local restaurant, we decided to do a deep dive into this one offer, and get a blueprint of the economics behind Groupon.

The offer we have considered for this deep dive is this one:

Groupon Banana Leaf Deal

So this is basically an offer where the Groupon buyer pays $8 for $16 Worth of Vegetarian Fare and Drinks at Banana Leaf in Columbus.

And here is the fine print:

1. Expires May 18, 2011
2. Limit 1 per person, may buy 2 additional as gifts. Limit 1 per table. Dine-in only. Tax and gratuity not included. Not valid with other offers.

A total of 856 groupons were bought. So the amount collected by Groupon in a single day on this offer was 856*8=6848 USD. 50 percent of this goes to Groupon, and 50 percent goes to Banana Leaf. So the next day, Banana Leaf Restaurant must have collected 6848 / 2 = 3424 USD.

Now from Groupon’s perspective this is a simple profit model – it must be reasonably simple for them to make good margins out of the 3424 USD., given that they must be seeing efficiencies in making deals like this happen (the only other cost being operational costs on running the website etc).

Now let us look at this deal from the perspective of Banana Leaf restaurant, purely from a revenue perspective. At this point, for the next paragraph, we do not make any assumptions on the margins that Banana Leaf is making on each table.

The good thing is, they got an immediate cash inflow of 3424 USDs. Out of the 856 Groupons bought, assuming that 80 percent of Groupons get used, they have a liability of 685 Groupons to be served. Since most of these would be used in Groups, and they allow only one Groupon per table so they can assume that this would bring in an additional revenue of 685*3*12 = 24660 USDs (assuming an average bill of USD 12 per person. But out of this, they would be paid only 13700 USD (since each table would use a Groupon worth 16 USDs). Adding this to the 3424 USDs they collected on the day of the Groupon Offer, the total revenue would come to 17124 USDs. So one easy way of summarizing the Groupon Mathematics from the restaurant’s perspective is this: For a 24660 USD revenue, the marketing cost is – hold your breath – 7536 USDs. 30 Percent !!

Now for the margins. One can easily argue that at such high marketing spends, the restaurant would definitely see a huge hit on margins. So, why will any restaurant (or for that matter, any business) offer anything on Groupon?

There is a simple two-point explanation:

1. If you are running at 30 percent plus margin (that can scale) – Groupon is a tremendous opportunity to get the word out and get busy for a week or so.

2. If you are low on margin, Groupon is an opportunity to “give it your best” and retain the customers who walk in – you are making a bet that the lifetime value of a customer will justify one loss making transaction.

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2 Comments for “The Mathematics Behind Groupon”

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