The Falsity of Groupon Marketing and How it May Hurt Your Restaurant Business

With being in the marketing and advertising industry, it is a requirement for me to continuously be researching new advertising tactics in order to advice my clients accordingly. I’ve always advised most my clients away from Groupon but this is the first time I’m actually writing about it.

Groupon’s Pitch

According to “Groupon Works”, their merchant blog, Groupon states:

“With over 500,000 local business partnerships globally, we understand how to effectively increase your revenue, lower your costs, and grow your business.”

Groupon gives you access to their network of advertising channels… mostly through its daily deal emails and mobile apps. Groupon has saturated the market and I give them props for that. It has come at a major expense though as can be seen through their financial quarterly reports, but that’s a whole other article. 

Here are several testimonials found on Groupon Works Merchant Blog:

Groupon PR blog is obviously focusing on one common theme: “Customers come back and spend more money than the groupon.” Would you think Groupon would put any negative feedback or include testimonials on their site that didn’t fit the message they’re trying to communicate? If you control the medium, you control the message.

So What’s the Negative?

In my own words, Groupon is more like interest on a loan. It silently siphons away money and before you know it, you’ve lost a good chunk of change. Let’s take for example this recent Groupon in the San Antonio, TX area:

Most of my friends, colleagues, and family rarely dine at Red Robin… except for when there’s a Groupon. The above Groupon entitles you to $20 for $10 (a 50% discount). How much is this costing Red Robin?

Well if Red Robin was not able to negotiate a lower fee than standard, then most likely they paid 50% of the purchase price for each groupon. In other words, Red Robin earns $5 per groupon sold; this works out to a 75% discount from their regular prices.

According to the current count of the deal, over 1,000 Groupons have been purchased for Red Robin. This is not the first time Red Robin has run this promotion. I believe they’ve run this promotion at least three times in the past 12 months; I’ve bought each one. Let’s assume an average of 1500 sold each time; that means Red Robin has effectively paid an advertising expense of $67,500 ($15 discount from regular menu prices * groupons sold) to attract 4,500 customers to its locations in San Antonio within the past 12 months. A lot can be done with an ad spend of $67,500. In addition, a good percentage of Groupon users may only take advantage of a business on a deal so the likelihood of returning is low.

What’s the Break Even Point for Red Robin

Let’s assume that Red Robin achieves a 50% customer return rate and calculate the number of return visits a new customer must make in order for the restaurant to break even. According to Red Robin’s latest quarterly report, their net profit margin (with advertising expenses backed out) is 6.5%. Using the figures above, Red Robin’s hidden advertising expense to Groupon is $67,500. So to isolate this scenario, we’re going to assume that Red Robin is not doing any other advertising except for Groupon.

The First Visit

Let’s further assume that the average ticket spend per Groupon user is $30. Red Robin’s gross sales on 4,500 customers on their first visit: $135,000. Estimated profit using their net profit margin with all other advertising expenses backed out (6.5%): $8,775.

Subsequent Visits

Now after the first Groupon, using our assumed 50% new customer retention rate (which surpasses the rate most unbiased daily deal studies have found), it leaves us with 2,250 returning customers. Assuming these customers spend the same amount on each visit, Red Robin will gross $67,500 on each subsequent visit… with a net profit of $4,388.

How Many More Visits?

Using the figures above, each one of those 2,250 customers who became repeat customers must dine at the restaurant at least 14 more times in order for Red Robin to break even. How long do you think it’ll take for the average person to visit the same restaurant 14 times? A recent study conducted on April 20, 2013 by the Pew Research Center on Fast Food Statistics shows that the majority of people in the US (64%) dine out 1-2 times per week. Assuming you end up loving Red Robin and dine out only between four restaurants all the time, you’ll be visiting Red Robin once every two to three weeks. If every one of the 2,500 returning customers does the same, it will take 7-10 months for Red Robin to break even.

Red Robin has run this similar daily deal at least 2-3 times this year. Since those returning customers are still Groupon users, they will most likely be taking advantage of the offer again… thus pushing the break-even point for Red Robin even further.

The Hidden Costs

Similar to interest on loans, there’s a hidden cost for businesses using Groupon that may not be evident from the get go. Many assumptions made above are favoring Groupon (50% return rate, very frequent dining out at Red Robin, no existing customer base cannibalizing).

Even with the favorable assumptions, a 7-10 month break-even point may be unjustifiable and is an automatic death sentence for many small businesses in the restaurant industry.

Additionally, the short-term boost in customers may lead to longer wait times, poor customer service, negative reviews on social sites, and employee fatigue creating a PR and management issue for the business.

Groupon Not a Negative for All Businesses

If a business has a large enough profit margin, then a Groupon Daily Deal may work. I used extremely favorable assumptions for Groupon in the above example. For all intents and purposes, consider a Groupon if all of the following is true:

• After all expenses, you have a net profit margin of 30-40%.
• You have 4-6 months of upfront capital for operating expenses and to cover Groupon purchased product/HR cost above net profit margin.
• Your business is not dependent on appointment scheduling.
• Company is prepared to handle a large surge of customers. (Hire, train, and stock prior to Groupon)

The Alternatives

Groupon drew the attention of many small businesses because they figured there was no risk to them. They didn’t have to “pay for advertising” such as one of their testimonials declared. However, there are essentially paying for it, just post-sale, not upfront. There are various advertising options that businesses can take advantage of that will render similar results to Groupon. The only catch though is that you have invest the funds upfront, however you get many advantages:

• You’re able to control the pace of your advertising. With Groupon, it’s all-in or nothing. The usual daily deal is sold at quantities of hundreds and thousands. Many business models are not suited for that kind of volume in a short period of time.
• You limit exposure to compulsive discounters; people always looking for that lower price and will jump to a competitor advertising a price 5% less. Daily deal sites and their audience focus on one thing… price.
• You limit the cannibalizing of your existing customer base.
• Ultimately, you may end up with a lower advertising expense. At my marketing and advertising company, JLR Group Inc, we have several full-service based clients throughout a couple of industries, all achieving decent ROI in which our average expenses account for 5%-25% of their initial (not counting repeat customer purchases) gross sales.

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