What Groupon Ought to Say About Capacity Utilization

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Let’s face it it isn’t often that one can get a lesson on capacity utilization while attending to one’s nails. But alas, as a regular customer of a small nail salon down the street, I enjoy engaging with the technicians over the burning platform of the day (though admittedly the only thing burning in a nail salon involves a pot of wax).

My technician — we’ll call her Sandy to protect the innocent — informed me that the salon owner decided to try Groupon. I asked Sandy what she thought of it, and I could tell by her pause in replying that she didn’t think the program offered a lot of value. From her perspective, she found Groupon customers don’t tip as well and most don’t end up as regular long-term customers; she felt that regular customers represent the most profitable ones.

Crunching the Groupon Numbers

So we chatted about a few scenarios and did a little math. Let’s say the Groupon cost the nail salon $22 (regular price: $50) per person (the salon charged the Groupon customer $28). Of that $28, Groupon likely received half, or $14. So the nail salon pays $22 per person on the deal plus $14 per person to Groupon, or $36 per person. Let’s say the salon gets 100 customers as part of its Groupon deal (they probably received many more, but for simplicity’s sake, we’ll stick with 100) for an acquisition cost of $3,600 (discount plus Groupon’s cut).

Now let’s imagine the annual value of a regular customer. A regular customer might spend on average $15/week for a manicure and $30/twice per month for a pedicure or $15 x 4 + $30 x 2 = $120/month, which equates to a customer revenue stream of $1,440 per year. So in reality, the nail salon would need to obtain at least three loyal regular customers (out of the 100) to pay for the investment. Sandy thought that of the 30 that had used a Groupon, only one would become a regular customer. Extrapolating that to 100 customers gives us three regular customers for the $3,600 investment, or $4,320 in annual revenue, resulting in an ROI of $720.

But Wait, That’s Not the Whole Story

Sandy mentioned one additional issue Groupon customers can opt to use their discounts during high traffic weekend hours, sometimes resulting in a Groupon client taking the place of a walk-in customer or a regular loyal customer (both pay full prices). So we must look at the additional opportunity cost. Let’s say one technician can see 11 clients in a day. If all 11 clients paid full price, that would yield the shop $550. If three of those clients can’t get in because a Groupon client has taken that person’s place, then the shop has lost an additional $108 ($50/reg price -$14/Groupon price x 3 = $108). If you have three technicians, who all lose three regular clients, we can see the impact of the multiplier effect.

Forget New Customers Look at Capacity Utilization

Doing the math, we’d venture to say Groupon provides some value to companies trying to gain “valuable new customers, guaranteed, according to its website value proposition. But we decided to take a different tack, one echoed in this piece relating to capacity utilization. If a nail salon has regular operating hours from 10-6 each day, the shop has overhead, or hard fixed costs it incurs, whether anyone shows up or not. All nail salons have “slow times. If the Groupon could only be redeemed during the “slow times, we could ignore the opportunity cost issue (e.g. there is no loss of a regular high-paying customer because that customer is not in the salon) and just look at the incremental revenue the salon can pull in. In this case let’s say they see two Groupon customers per day for one week – $14 (net gain) x 2 per day x 5 days per week = $140/week. Sure, they may also incur a bit more additional cost (e.g. nail polish, cotton balls, etc.), but the cost to serve one customer probably represents less than $0.50. Remember, the labor has shown up anyway.

For a services business, this may make some sense. But we can see plenty of reasons why it would not work for a company that sells goods such as a manufacturing organization. Razor-thin margins for products with a highly volatile raw material component render many a discount program unworkable.

–Lisa Reisman

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