MARK - 3480

Project Report
Disclaimer : This publication is designed to provide accurate and authoritative information in regard to the subject matter which is covered herein. The report is provided solely for informational purposes and is not to be construed as providing advice, recommendations, endorsements, representations or warranties of any kind whatsoever. Opinions and information provided are made as of the date of the report issue. We have made a reasonable effort to assure the accuracy of the information contained herein.

Abstract
From time to time we come across instances where businesses are not realizing their full potential when setting prices. Sometimes this can mean missed revenue, in other cases it can have a negative effect on the brand sending a mixed message of what it stands for. In either case, profits can be lost. In this project report, we take a look at the key factors to consider when reviewing your pricing strategy. Price is the only revenue generating element amongst the 4 Ps, the rest being cost centres. Groupon is a deal-of-the-day website that is localized to major geographic markets worldwide. We examine the profitability and implications of online discount vouchers, a new marketing tool that provides consumers large discounts when they prepay for participating merchants goods and services. In other words, we investigate how to improve upon the pricing tactics for promoting a line of products on Groupon? (Interdependence, bundling) Some commentators1 imply that the daily-deal craze Mason, CEO of Groupon, pioneered is impoverishing local economies by teaching consumers that full price is never a fair price. In this paper we analyze the profitability of deep discounts (i.e. To Groupon or Not to Groupon).

www.jeffkorhan.com/2011/06/why-groupon-is-a-bad-for-small-business.html

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I. What is Groupon?
Launched in November 2008, the first market for Groupon was Chicago, followed soon thereafter by Boston, New York City, and Toronto. Today, Groupon has over 115 million subscribers across 300 cities in more than 40 countries. The idea for Groupon was created by Andrew Mason who is currently the companys CEO. Groupon is the market leader of its industry. Masons model is transforming the way companies, specifically smaller ones, with limited marketing budgets can increase sales. With his army of staff, many recruited from the improv scene, their objective is to concoct witty pitches for deals-of-the-day. Masons aim is to do for local e-commerce what Amazon did for the normal consumer goods.

a. Groupons Business Model

The company offers one "Groupon" ("group+coupon") per day in each of the markets it serves. The Groupon works as an assurance contract. It means that if a certain number of people sign up for the offer, then the deal becomes available to all; if the predetermined minimum is not met, no one gets the deal that day. This reduces risk for retailers, who can treat the coupons as quantity discounts as well as sales promotion tools. For the merchants who choose to do business with Groupon an online "Word of Mouth" is largely appealing. Their offer will spread like wild fire across the Web as Groupons customers share it with friends using tools like Facebook and Twitter, further increasing their brand's exposure. Given the appeal of their offers, users quite often pass the information along to others, which translates to the potential for even more customers for your business. On the other hand vouchers will be exclusively delivered to the thousands of opt-in email subscribers, who look forward to receiving Groupons daily email. Gauging the number of hits on Facebook and Twitter is varied because each offer will get a different number of hits based on interest.

b. Groupons Revenue Model

Groupon charges a flat rate of 50% of the voucher price: if a restaurant offers a $20 voucher for $40 of food, Groupon retains $10a large fee relative to Groupons marginal costs of voucher provision. We are struck by the large fees that leading discount voucher services charge to participating merchants. However, competition among discount voucher services may drive down these fees.
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Heres how revenue of a Groupon deal is split up: Deal offering must be priced at maximum 50% of its original cost. Minimum length of time a deal can be run for is 24 hours. Companies may specify a minimum order quantity, before which reached deal is invalid. Groupon takes 50% of any coupon sold Taking all of the above in account, a coupon has to offer merchandise at a mere 50% of its original price. This will lead to extra customers if the offering is good, but does the company profit from these visitors? Taking into account cost of goods sold, which vary from 30% 50% of any deal, companies walk away with only 25% of the original cost of their offering, minus any credit card and processing fees.

II. What Groupon has got to offer? A large customer base:

The number of Groupon subscribers has already more than doubled in 2011, up to 115 million in June from only 51 million in December of 2010.2 The number of merchants has skyrocketed as well up to 135,247 through June 2011, from only 12,468 in the first half of 2010.Owing to Groupon's market being primarily composed of female customers, (Exhibit1A) the deals are often focused on the health, fitness and beauty markets. Marketing has always been about looking at demographics and understanding what sells in specific markets. Groupon states that their customers are socially active, both online and off. 68% are between18-34; 50% have a bachelors degree, 30% graduate degree; 49% are single, 33% married; 77% women, 23% men. 66% read Groupon write-ups every day and use Groupon primarily as a guide to explore their city. (Exhibit1B) For all businesses, the attraction to Groupon is primarily their large customer base, which is comprised mostly of females with a lot of disposable income.

Opportunity for Mass Advertising:

Groupon caters to niche markets and unusual services: whale watching, personal trainers, teeth whitening, and groupons for independent bars and restaurants are all featured on the site. Most are posted with quirky descriptions which target the young and cynical Internet crowd.

http://therealtimereport.com/2011/08/12/groupon-doubles-subcribers-in-2011-but-only-20have-made-purchases/
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Many of the smaller businesses dont have the funds to create larger marketing campaigns and are limited in ways to attract more customers. With thousands of people checking out Groupon every day, smaller businesses can get noticed. Smaller businesses can then make use of the service and know that they will make up the deep discount through an increase in business. If the interest level is not met, the business doesnt risk losing any money at all. In a typical case, if a company wants to test, offering a discount to draw in new customers, they do so rather blindly. If (say) only 2 people take you up on the offer, it probably wasnt worth the effort let alone the cost you would incur if you have to communicate the message through traditional media channels.3 The minimum threshold gets around this merchants can select whatever price / quantity combination makes sense for them, and walk away (without paying a penny) if the threshold isnt met.

Opportunity for Price Customization/Discrimination:

More broadly, the Internet provides a technology infrastructure for frequently updating prices, and tailoring them to individual customer's price sensitivity. Although some of the price customization techniques that are used might be unfair to the general public who do not have access to these discounts, the general principle underlying price customization is sound: maximize profitability by precisely matching prices with the perceived value that customers get from a product. Within a model of repeat experience good purchase, we examine a mechanism by which discount voucher services can benet aliated merchants: price discrimination. Our report reveals that a discount voucher service is more likely to be protable for afliated rms, all else equal, if customers using that service have valuations substantially dierent from - in particular, lower than - those of other customers. But notice the diculty as the voucher service grows: As more consumers use vouchers, voucher-users necessarily come to resemble average consumers so the use of a voucher comes to convey less information about a consumers valuation. Thus, as voucher services grow, their aliates will have to rely on voucher advertising rather than voucher price discrimination.

III. Cardinal problem

Some businesses have argued that the Groupon offering deep discounts for daily deals, usually with a maximum number of coupons available disproportionally benefits consumers more than businesses. These firms complain that discounts purchased on Groupon, for example, are great for attracting large crowds of customers who never materialize on the promise to become regular customers. This type of situations leaves the firm at a loss, having provided goods or services 75% below their retail price and without the returning customers to make up for it. http://www.inc.com/guides/201101/how-groupon-works-for-small-businesses.html http://www.groupon.hk
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Over one-third of the companies that run Groupon deals do not make a profit4. Clothing store GAP ran a Groupon deal earlier in 2011 that lost them over US$ 8M in revenue. (Exhibit1D). GAPs Groupon deal offered $50 worth of merchandise for $25 at any GAP store in the United States, a deal quickly snapped up by the general public with over 445,000 coupons sold. Groupon brought in a large influx of customers to GAP stores during the deal; this may not have been a good thing for the company. We can see using the calculations (Exhibit1D), GAP requires each new customer to make almost four visits to the store and spend $50 per visit just to break-even, something that is unlikely given the type of customer Groupon deals tend to attract. The upside for Gap is a little less cut and dry. Yes, it was a splashy marketing campaign coupled with the opportunity to push out inventory, but $25 off $50 is a deep cut to margins especially, when you consider that Groupon typically takes a 50% cut. Thus, from Gaps perspective, the retailer is effectively dolling out 75% off discounts on sale and nonsale items. That raises a red flag. For large companies such as GAP, it may be worth attempting a Groupon deal simply because they can afford to undertake the monetary loss for the additional exposure provided by Groupon. However, for smaller companies, a Groupon deal can mean substantial losses leaving the owners struggling to break-even5.

IV. Pricing strategies to get the most out of your deal !

We will evaluate how affiliated firms that choose to run deals on Groupon can improve upon the pricing tactics they use for promoting a line of products on Groupon. Our method of study is to review past deals and calculate the merchants profits in those deals. Using these results we will compare and assess the profits they would have made if one of the below mentioned pricing tools were used. We will go further and provide recommendations for the same. They can choose to opt for one of these strategies to maximize their profits: A. Product-Line Interdependence B. Pure Bundling

http://www.businessinsider.com/blodget-groupon-analysis-2011-8 http://www.retaildoc.com/blog/groupon-worst-marketing-business/
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A. Product-Line Interdependence
By taking advantage of the product line principle, companies can offer major discounts on their premier product to take advantage of increased sales for complements of that product. Discounts ensure more visitors to the store and while in the store, there is a reasonable chance that customers will buy one or more other items. Complements are where one products sales favourably affect another products sales. Some examples of how complements work are listed below:

Product that are used together, for example a mobile phone and calling plan, printer and ink cartridges, car and petrol Add-ons and special features, for example extra storage space on a computer or customized design for a motor bike. Cross selling, for example popcorn at theatres Store traffic and loss leaders, which is essentially selling a product at a lower price in order to attract customers to the store.

The example that this report will talk about uses suits for men as the main product. Complements for a suit are shirts, ties, shoes, cuff links and so on. Suit deals are quite common on Groupon as companies have realized the benefits they can obtain from using a Groupon deal to obtain both increased profits and increased exposure. Assumptions made:

We are unable to tell if people purchasing the Groupon deal are new customers or existing customers taking advantage of the discount. Existing customers purchasing is bad for the business as it discounts a product for customers that would have paid the full amount anyways. Coupon redemption rate ranges from 50% upwards on Groupon deals, and this rate increases based on the value of the coupon sold. The writer of Groupon: Why Deep Discounts Are Bad for Business, Bob Phibbs estimates a redemption rate of 95% for Groupon deals valued at over $500, however it is impossible to calculate redemption rate for a specific deal unless you work for the company. Thus, we have theoretically assumed a 100% redemption rate. If the redemption rate is less than this, the profit of the company increases. We cannot be sure of how much additional business the Groupon deal brought from future purchases from customers that did not buy the first time round. If happy customers tell their friends about the positives of the deal, or if suit buyers decide to
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use Rahul Karan simply because they have heard of them through the Groupon deal, we cannot calculate this parameter.

We are unable to determine the administrative costs of running a Groupon deal and having to deal with the sudden influx of deal hungry customers, both in a monetary and in a non-monetary terms (for example, extra pressure placed on employees).

In our example, we will look at Rahul Karan garments, which is a store that specializes in suits for men and women. Rahul Karan ran a deal in October 20116, offering a suit at just $999 - a discount of $1200 off its regular price. A total of 106 Groupon deals were sold, meaning that the loss in profits just from the Groupon deal amounted to $127,300. Looking at that figure, one would think that it would be foolhardy for any company to run a Groupon deal. However, we have not yet taken complements into account. By using the main product (mens suit) as a loss leader, Rahul Karan attracts new customers to their store, customers who may have never even heard of them before they ran the Groupon deal. Now lets look into the actual statistics to see whether Rahul Karan made a loss or not on this deal. Statistics from a similar deal run by Luxury Plus state that customers that come into a store looking to buy a suit from one of these Groupon deals have an 80% chance of buying a shirt, 60% chance of buying a tie and 50% chance of buying shoes, which are valued at $500, $250 and $800 respectively7. The variable cost of the suit normally sold for $2200 amounts to $800. Net profit through mens suits alone: -$31,853 (Exhibit3A) We observe that Rahul Karan garments apparently made a loss of almost $32,000 (Exhibit 3A) on their Groupon deal by selling mens suits at a discounted price. Looking at the raw statistics, it seems like it would make no business sense whatsoever to run a Groupon deal. However, thats before we take complements into account. This deal actually made them complimentary profits of $78,440 (Exhibit 3B) through sale of other products. This brings their net revenue to -$31,853 + $78,440 = $46,587. Rahul Karan benefits greatly from the increased sales of complements, going from a heavy loss to a profit nearing $50,000. However, there is still more money to be made... Rahul Karan will see $19,080 (Exhibit 3C) in additional revenue from purchases from future visits by those who took advantage of the Groupon deal. That takes our total revenue from this Groupon offering to $46,587 + $19,080 = $65,667 http://www.groupon.hk/deals/hong-kong/-999-for-a-men-s-suit--or--1299-for-a-ladies--suitat-rahul-karan--up-to--2600-value-/715900152
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http://articles.latimes.com/2009/jun/14/local/me-lopez14

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Rahul Karan nets almost $66,000 in profit from the Groupon deal despite reducing the contribution margin of each suit sale from $1,400 to $499.5. This is an example of how your primary product can effectively be used as a loss leader on Groupon, with lost revenue made up by other sources.

B. Bundling
Merchants who opt to promote their products or services on Groupon are not maximizing their profits, creating money left on the table and pass-up profit. Thus, firms should consider using an alternate pricing strategy, such as bundling, when offering their products on Groupon. As stated previously, Groupon usually withholds a 50% share of the products sold, so the more units sold by the firm, the more profit the firm will make and a greater return Groupon will receive. Currently, firms are offering products individually on Groupon when they could be implementing bundling to a greater extent in order to improve profits. Bundling is a combination of items that are to be sold as a single product. By taking advantage of this pricing strategy, companies can insure purchase of several products as opposed to sale of a single product. We will examine one of the deals Groupon offered in August 2011 in-depth to evaluate and recommend how other merchants can benefit from this pricing strategy. The deal offered customers a 70 HKD Movie Ticket at UA Cinemas for steal at only 38 HKD. 8 To simplify our calculations, we have made five key assumptions (mildly unrealistic) as follows: 1) All theatres operate to full capacity. 2) Each Movie Ticket is purchased in the evening so as to keep the price constant across all our purchases. 3) 58% 9 of consumers who buy a movie ticket also buy a popcorn combo. This result has been obtained through consumer survey. 4) Consumers who purchase the bundle, instead of buying products individually, will receive a 10 HKD savings. 5) All prices are fixed, and there are no variable costs. http://www.groupon.hk/deals/hong-kong/-38-for-one-movie-ticket-to--let-the-bullets-fly--atua-cinemas--worth-up-to--70-/715828087 9 http://www.sodahead.com/fun/do-you-buy-popcorn-at-the-movie-theater/question-1984425/
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There are a total of nine UA Cinemas in Hong Kong, which we divided into four segments based on the actual price offered for a single evening movie ticket according to CityLine10. Locations selling a movie ticket at the same price were grouped together accordingly. The segment size was calculated by adding the actual number of seats in each segment and dividing it by the total number of seats among the nine theatres. (Exhibit 2A) On CityLine, prices among each segment are 75, 85, 95, and 110 HKD respectively. Using 38 HKD as the lowest WTP (i.e. the WTP for Segment 1), we can derive the WTP for the other UA Cinema locations charging higher prices by increasing the 38 HKD price offered on Groupon incrementally in the same way the actual ticket price increases. For example, the price increase between Segment 1 and Segment 2 is 10 HKD ($85 - $75), so Segment 2s WTP on Groupon would be 48 HKD ($38 + $10). (Exhibit 2B) To find the WTP for the Popcorn Combo (2 large soda drinks and regular popcorn) at UA Cinemas, a reference price of 63 HKD was used as the lowest WTP among all consumer segments11. Also, among 108 items sold on Groupon, the average discount was 56%. Therefore, by multiplying 63 HKD by 56%, we obtain the lowest price (35.38 HKD) that should be advertised for a Popcorn Combo on Groupon. As for the WTP for Segments 2 - 4, it was obtained by creating a common ratio for Segment 1 of a Popcorn Combo to a Movie Ticket ($35.28 / $38) and individually comparing it to the movie ticket prices of Segments 24. (Exhibit 2C) Right now, UA Cinemas is selling a Movie Ticket on Groupon as a pure component, resulting in a total profit of 9656.30 HKD. Similarly, if the company were to sell the Popcorn Combo individually, it would gain a total profit of 5199.63 HKD. By conducting a pure component pricing strategy, UA Cinemas will make a total profit of 14,855.93 HKD minus the 50% share obtained by Groupon. However, if UA Cinemas were to utilize the pricing strategy of pure bundling, they will be able to increase their profits to 16,526.68 HKD among all four segments. Bundling is able to reduce the pass-up profit among 42% of consumers who may not have purchased the Popcorn Combo along with the Movie Ticket. Since Pure bundling eliminates the risk of consumers not purchasing the Popcorn Combo, it increases UA Cinemas total profits by 1670.75 HKD and Groupons share of the profits by 835.38 HKD. If firms like UA Cinemas were to fully utilize bundling when advertising their products on Groupon, then not only would they increase profits for themselves, but they would also increase profits for Groupon by improving their profit margin. (Exhibit 2D)

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http://www.cityline.com.hk/eng/movie/byMovieStep2.jsp?eventKey=57117 http://www.uacinemas.com.hk/eng/twin-combo-buy-online-$10-save

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V. Final Verdict
In the course of this report we saw that Groupon can provide merchants with a customer base of young, well educated and influential individuals (majority of women) who are always looking for new experiences in their city. From the marketing perspective, such demographics are hard to reach but very profitable since these segments of customers have disposable income because of limited family spending. But we must look at the costs that affiliated merchants must bear. Psychologically, it might be hard for consumers to become regular customers and have to pay twice for a product or service theyve already experienced for half the price. The best solution is for firms to offer such a high quality or differentiated product, service, and/or customer experience that customers will want to come back. Groupon promotions offer the most benefit for businesses in which the promotion does not cannibalize sales to existing customers thats why it is most successful in Spa, Salon and food industries. Groupon's key pitch to merchants and small businesses is that it is the perfect alternative to traditional advertising in the newspaper and on television. What they fail to publicize is that a third of the merchants cant break-even their sales through Groupons voucher service. Therefore, Groupon should encourage firms to sell their products as a bundle for two reasons. First, there will be less money left on the table and pass-up profit for firms if they are able to sell two products simultaneously as opposed to individually. Second, bundling can increase the amount of profit not only for the firm but for Groupon as well. As seen in the UA Cinema Movie Ticket example, Groupon would have gained approximately $835 if it had encouraged the company to bundle its products, and that is just from the promotion of one item. If Groupon forced more companies similar to UA Cinemas to bundle their products, then the involved parties would be able to improve their profits. Another aspect to review is that Groupon should publicize the added profits through sales of complementary products when merchants choose to use their voucher service. We contemplated the benefits of product-line interdependence through the case of Rahul Karan clothing store. With the use of such a pricing tool, this small-business netted a profit of $65,667 from this Groupon campaign but only when one takes complements into account. Rahul Karan also sees other non-monetary benefits such as exposure of its company to a new audience. Groupon has millions of customers that are willing to spend money on an appealing deal and even if only a small percentage of those decide to shop with Rahul Karan, the business benefits heavily. Group buying will remain a win-win business model that should only improve over time for both local business owners and consumers. Unless businesses have the expertise of using pricing tools efficiently they might not benefit from using services like Groupon or other online discount voucher services given its high expenses and disadvantages. Thus, it may be in a merchants best interest to spend their hard earned money promoting their business through other channels.

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|
Exhibit 1A

Appendix

Exhibit 1B

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Exhibit 1C

Exhibit 2A 12

Seating distribution = (total # of seats in each facility) / (total # of seats combined)

12

http://www.uacinemas.com.hk/eng/main/HomePage

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Segment 1 (Cityplaza, MegaBox, TMTplaza): (1076 + 562 + 572)/ 6529 = 33.85% Segment 2 (Shatin, Citygate): (453 + 1142)/ 6529 = 24.43% Segment 3 (Times Square, Langham Place, iSquare): (813 + 1146 + 531)/ 6529 = 38.14% Segment 4 (Windsor Cinemas): 234/ 6529 = 3.58%

Exhibit 2B
Market Segment Segment Size (% based on 6529 total seats) 33.85 24.43 38.14 3.58 Movie Ticket (WTP in HKD) 13 38 48 58 73 Popcorn Combo (WTP in HKD) 35.28 44.56 53.85 67.77 Total Cost of Buying Products Separately Bundle (with $10 savings) 63.48 82.56 101.85 130.77

1 2 3 4

73.48 92.56 111.85 140.77

Exhibit 2C

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http://www.cityline.com.hk/eng/movie/byMovieStep2.jsp?eventKey=57117

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Popcorn Combo (2 large soda drinks and regular popcorn) Price: Segment 1: $63 x 56% (average discount) = $35.28 Segment 2: ($35.28/$38) = (x/$48) x = $44.56 Segment 3: ($35.28/$38) = (x/$58) x = $53.85 Segment 4: ($35.28/$38) = (x/$73) x = $67.77

Exhibit 2D
Pure Component Pricing: Total Profit when only buying Movie Ticket assuming full capacity: Segment 1: $38 x (33.85+24.43+38.14+3.58) = $3800 Segment 2: $48 x (24.43+38.14+3.58) = $3175.20 Segment 3: $58 x (38.14+3.58) = $2419.76 Segment 4: $73 x (3.58) = $261.34 Total Profit among all 4 Segments: $9656.30 Total Profit when only buying Popcorn Combo : Segment 1: [$35.28 x (33.85+24.43+38.14+3.58)] x 58% = $2046.24 Segment 2: [$44.56 x (24.43+38.14+3.58)] x 58% = $1709.63 Segment 3: [$53.85 x (38.14+3.58)] x 58% = $1303.04 Segment 4: [$67.77 x 3.58] x 58% = $140.72 Total Profit among all 4 Segments: $5199.63 Total Profit when buying Movie Ticket and Popcorn Combo individually: Segment 1: $3800 + $2046.24 = $5846.24 Segment 2: $3175.20 + $1709.63 = $4884.83 Segment 3: $2419.76 + $1303.04 = $3722.80 Segment 4: $261.34 + $140.72 = $402.06 Total Profit among all 4 Segments: $14,855.93 Pure Bundle Pricing: Total Profit when buying Movie Ticket and Popcorn Combo: Segment 1: $63.48 x (33.85+24.43+38.14+3.58) = $6348 Segment 2: $82.56 x (24.43+38.14+3.58) = $5461.34 Segment 3: $101.85 x (38.14+3.58) = $4249.18 Segment 4: $130.77 x (3.58) = $468.16 Total Profit among all 4 Segments: $16,526.68 Gain in profits through the use of Pure Bundling as opposed to Pure Component pricing strategy: $1670.75

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Exhibit 3A
Profit made from Groupon deal: Deal price: $999 Take away 50% as Groupons cut: $999 x 0.5 = $499.5 Variable cost of a suit is $800 => $499.5 - $800 = -$300.5 x 106 = -$31,853

Exhibit 3B

Item

Price Variable cost Margin Purchase likelihood Total $100 $50 $200 $400 $200 $600 0.8 0.6 0.5 $320 $120 $300

Shirts $500 Ties $250

Shoes $800

Total contribution from complements: ($320 + $120 + $300) = $740 x 106 = $78,440.

Exhibit 3C
Percentage of customers that become regulars at Rahul Karan clothing store: 20% Average number of visits every customer makes to Rahul Karan clothing store per year: 2 Average HKD spent per visit to Rahul Karan by a regular customer: $600 20% of (106 x $450 x 2) = $19,080
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(assuming a 25% variable cost)

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