Editor’s note: We’ve run a lot of guest posts lately poking holes into the daily deals industry. With this one, we hear another side. Arash Pirzad-Allaei is a co-founder of KASA Capital, where heads the internet technology development of KASA’s network of websites, including daily deals site Crowd Cut.
Sure, Groupon has become the whale in this industry, but that doesn’t mean Groupon constitutes the entire industry. Sure, while Groupon may sometimes structure lousy deals for merchants, it doesn’t mean the entire daily deal business model isn’t sustainable or beneficial for small businesses. When done right, the daily deal can actually be very lucrative for everyone involved: Merchants, customers and the daily deal sites themselves.
So why should you take my word for it? It’s true, I’ve got my biases. But so many people have quickly elevated themselves to “experts” on this space that it’s hard to filter truth from the noise. My company, KASA Capital, started Crowd Cut in May 2010. We are now a top player in our markets, generating eight figures of profitable revenues. So, when I talk about the daily deal space, I do so with direct experience. I talk to merchants and customers every day. I have numbers to back my claims. I’m a player in this game, not a self-proclaimed expert who sits on the sidelines.
Let’s start by clearing up some common misconceptions:
- The average back-end split is 70/30 (merchant receiving 70%); not 50/50. Over the past year, merchants have become far more savvy, they no longer accept 50/50 splits.
- Most daily deal sites will pay credit card processing fees (2.8% – 3.5%). If a merchant fails to negotiate credit card processing fees, they have not done their homework.
- Immediate payment. Many daily deal services from Google Offers on down are paying merchants faster. Crowd Cut pays all merchants in full within 5 business days of run-date; others typically have similar payment schedules (Groupon has the longest, three payments over sixty days)
- Non redemption rates vary from 10 – 35%: there is an inverse correlation between voucher price and non-redemption rates. The bigger the voucher, the fewer that never get redeemed.
- Generally, a minimum of 60% of purchasers are new customers, at least for us: Yes, we measure this!
Most merchants participating in daily deals do not have much deal experience. This leaves them at a disadvantage to the daily deal sites when it comes to negotiating the terms of running a daily deal, and can lead to stories like “Groupon Was ‘The Single Worst Decision I Have Ever Made As A Business Owner” (also on TechCrunch). Interestingly, I find that most of the daily deal horror stories come from merchants that a) negotiate terrible deal structure/terms b) do not accurately track redemption or customer spend and c) do not clearly understand the true economics of running a daily deal. This particular post references a story about a coffee shop that signed a 50/50 deal to sell $13 value vouchers (an atrocious 2.5-times their average ticket) for $6 and claimed to have lost $10,000 after selling 890 vouchers.
But, let’s take a look at the real economics:
Total Voucher Value = (890 vouchers) X $13 = $11,570.00
Total Food Cost = $11,570 X (85% redemption rate) X (30% food cost) = $2,950.35
Income From Groupon = (890 vouchers) X ($6 voucher price) X (50% split) = $2,670.00
Cost of Deal After Food Cost = ($2,950.35 food cost) – ($2,670.00 income) = $280.35
Even if we factor in additional variable costs (such as labor, etc.) and amortize fixed costs, a $10,000 seems unrealistically high. Unfortunately, it appears that the poor deal terms and lack of preparation crippled the merchant’s ability to convert new customers into regulars, leaving a bad taste towards the quality of the daily deal model—and daily deal users. Sadly, at times this manifests into merchants and their staff treating daily deal customers like 2nd class citizens. Then they wonder why they don’t come back.
Let’s take a moment to analyze a properly-structured restaurant deal:
A restaurant sells 1,000 vouchers that are $20 for $40 worth of food with a 70/30 revenue split.
- At 1,000 vouchers, the restaurant receives $14,000 for $40,000 worth of food ($14/voucher sold given the 70/30 revenue split).
- Average restaurant non-redemption is 18%, thus numbers adjust to income of $14,000 for $32,800 worth of food when you subtract the no-shows.
- Food cost = $9,840 (30% average food cost multiplied by $32,800)
- Income after food cost = $4,160 ($14,000 – $9,840)
- We could take this further by taking into account three additional points: a) the merchant does not pay ~2.2% credit card processing on the voucher value b) a percentage of customers spend less than the voucher amount and c) a percentage of customers spend more than the voucher amount, however, that goes beyond the scope of this article.
If reservations are required (per deal terms) and proper sales limits are set, the restaurant merchant can fulfill the vouchers with minimal increases in variable costs. The economics further improve for other merchants in different market segments (rock climbing, golf, laser hair removal, and so on—i.e. merchants with lower costs of goods). In the example above, even if the restaurant merchant simply breaks even on the economic side, a minimum of 600 new customers will be walking through their doors at no cost. What other advertising options could possibly beat that?
Groupon may be the figurehead of the daily deal, but they are not a true reflection of the market as a whole. It is critical for daily deal sites to understand that a positive merchant experience is extremely important, and that more sites should work towards avoiding deals that will result in a negative experience for merchants. It’s not so difficult to reset priorities with this goal in mind and, if we do, we are likely to find that the majority of merchants will continue to reward our industry with repeat business. It’s worked for Crowd Cut.
Now, you may still be asking yourself, is it really possible to make money averaging 30% revenue splits, paying merchants within 5 days, covering credit card processing fees, and providing higher levels of customer service? Yes! For all you haters out there, remember: Hate the player, not the game. The daily deal is here to stay.