3 Input 4 Mean demand, = 5 Standard Deviation of Demand, = 6 Average spend per table = 7 Revenue from Groupon per table = 8 Marginal cost per table = 9 Cost per unused table, c = 10 Margin per table used by regular customers, p = 11 Salvage Value per unused table, s = 12 Cost per empty table, C = 13 Cost per regular customer turned away, C = 14 Number of tables committed to Groupon 15 Number of tables available for regular customers, 0 = 16 Service level to regular customers = 17 Total margin from Groupon 18 Expected profit from regular customers (Eqn 2.3) = 19 Total expected profit = 20 Expected number of idle tables (Eqn 2.4) = 21 Expected number of regular customers turned away (Eqn 2.5) = 22 Average lost margin from regular customers turned away = 23 24 Input 25 Mean demand, = 26 Standard Deviation of Demand, = 27 Average spend per table = 28 Revenue from Savored per table = 29 Marginal cost per table = 30 Cost per unused table, c = 31 Margin per table used by regular customers, p = 32 Salvage Value per unused table, s = 33 Cost per empty table, C = 34 Cost per regular customer turned away, C = 35 Number of tables committed to Savored 36 Number of tables available for regular customers, O = 37 Service level to regular customers = 38 Total margin from Savored reservations 39 Expected profit from regular customers (Eqn 2.3) = 40 Total expected profit = 41 Expected number of idle tables (Eqn 2.4) = 42 Expected number of regular customers turned away (Eqn 2.5) = 43 Average lost margin from regular customers turned away : = Case 1: To Savor or to Groupon? Mr. Chang, the owner of Enter the Dragon, a high-end Asian restaurant in Chicago, was puzzled by the choices put before him by the Groupon sales representative. He could offer a daily deal at Groupon (a $60 coupon for $30) that would be seen by hundreds of thousands of Groupon subscribers in the Chicago region, or he could offer a more tailored discount at Savored, a restaurant reservation site also owned by Groupon. The business had been slow lately, especially during weeknights, and Mr. Chang wanted to spur demand. He wanted to make sure, however, that he did so in a way that actually increased profits. He estimated that demand on weeknights was normally distributed, with a mean of 50 and a standard deviation of 30. Given a capacity of 100 and only a single seating per table per night, there were empty tables on many nights. Groupon and the Daily Deal Launched in 2008, Groupon expanded rapidly on the basis of its daily deals. The daily deal amounted to a 50 to 70 discount coupon for a product or service offered by a local business. Groupon broadcasted the deal to its subscribers; if the number of buyers exceeded a threshold, the deal was finalized, and the company shared about half the revenues with the local business while keeping the rest as its commission. The local business thus received about 20 to 25 cents on the dollar of retail value. Customers who purchased a coupon using the daily deal then contacted the local business for their product or service. At restaurants like Enter the Dragon, Groupon buyers tended to get their reservations as soon as they purchased their coupon, which was well before customers tried to get their reservations. The popularity of the daily deal among subscribers led to rapid growth at Groupon. After rejecting a $6 billion offer from Google, the company went public in 2011. Its stock has had a turbulent journey since then. After opening at $25, the stock hit a low of $4 by the end of 2012 before recovering to $10 by early 2014. The price drop could be partly attributed to the higher marketing costs and negative publicity from some retailers who had used the daily deal. Some complained that "the financials just can't work," whereas others called Groupon the "worst marketing ever." Retailers complained that while Groupon brought in new customers, the margins were terrible because the 20 to 25 cents on the dollar recovered from a Groupon deal was much lower than the revenue the new customers provided. A viral blog post by Jay Goltz on the New York Times site offered retailers a way to evaluate the benefit of the daily deal. He suggested that retailers think of Groupon as advertising. Instead of writing a check to the advertising agency, retailers using the daily deal chose to lose money on sales. Thus, the only calculation that mattered was the cost per new customer acquired from a daily deal. The blog post suggested the following eight key metrics to decide whether the daily deal was cost-effective advertising:2 (1. Incremental cost of sales. 2. Size of the average sale. 3. Percentage of coupons redeemed. 4. Percentage of coupons purchased by current customers. 5. Number of coupons purchased per customer. 6. Percentage of new coupon customers who become regular customers. 7. Value of all Groupon subscribers seeing the daily deal. 8. Current cost to acquire new customers through advertising.) The value of the daily deal depended on these numbers. In an example described on the blog, Mr. Goltz focused on a restaurant that sold 3,000 coupons with a face value of $75 for $35 (the restaurant received only $17.50, with Groupon keeping the rest as commission). He assumed that the restaurant spent 40 percent (of normal revenue, not discounted revenue) in incremental cost; customers spent, on average, $85 ($10 more than the coupon); only 85 percent of the coupons were redeemed; 40 percent of the coupons were purchased by current customers; two coupons were purchased per customer; and about 10 percent of the new customers came back to the restaurant. In this case, the restaurant received a check of $52,500 ( = 3,000 17.50) from Groupon and additional revenues of $25,500 ( = 3,000 0.85 10) because the customers who came to the restaurant spent $10 more than the face value of the coupon. The incremental cost of serving these customers was $86,700 ( = 3,000 0.85 85 0.40). The restaurant thus lost $8,700 on this deal. If viewed as an advertising expense, it was necessary to evaluate the number of new repeat customers that the deal brought in. Given that 2,550 ( = 3,000 0.85) coupons were redeemed and each customer bought two coupons, the deal was used by a total of 1,275 customers. Given that 60 percent of these were new customers, the deal brought 765 ( = 1,275 0.6) new customers to the restaurant. If 10 percent of them would in return, the deal effectively brought in 76 new repeat customers. The restaurant then had to decide whether spending $8,700 to bring in 76 new repeat customers was more effective than other forms of advertising. Savored and Restaurant Discounts Groupon acquires Savored, a restaurant reservation engine, in September 2012. Savored offered discounts of up to 40 percent at upscale restaurants as long as customers made the reservation online in advance. Restaurants could vary the discount offered by the time of day and day of the week, with larger discounts for less popular times. Restaurants could also vary the number of tables available at the discount price. After studying a restaurant's traffic patterns, Savored suggested times when discounts should be offered. For example, all Saturday night slots at the Capital Grille on Wall Street were discounted because it attracted a workweek crowd, whereas the Fatty Crab in the West Village in Manhattan offered only a Saturday discount at 11 p.m. Savored had helped restaurants manage their idle capacity effectively. Le Cirque, an upscale Manhattan restaurant, had eliminated its cheaper pre- theater menu because Savored reservations filled those slots.] Case 1: To Savor or to Groupon?