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September 13, 2011

The economics of LivingSocial/Whole Foods-like deals

Filed under: daily deals, groupon, livingsocial — Rakesh Agrawal @ 6:20 pm


As expected, today’s LivingSocial offer of $20 Whole Foods gift card vouchers sold out at 1 million vouchers sold.

This is a great marketing move that created buzz around the Internet, for a while was the top term on U.S. Google trends, generated news stories by Reuters, The Washington Post, Mashable and others. They even got your resident daily deals curmudgeon to say nice things about the deal.

But many people fail to understand the economics behind such deals. If the deal is structured like other such deals, it’s a customer acquisition tool. As a grocery store (even a high-priced one often referred to as Whole Paycheck) Whole Foods doesn’t have the margins for deep discounts. It’s operating margin is 5.5%. A more mainstream chain like Kroger has operating margins of 2.7%.

LivingSocial is likely spending $20 for each $10 paid by consumers. In a best case scenario, they were able to negotiate a bulk purchase discount and get the gift certificates for $18 or $19 each. That’s a net loss of $8-$10 per customer. (LivingSocial spokesman Andrew Weinstein declined to discuss the deal terms.)

This loss is increased by:

  • Customers who are already LivingSocial customers. If you’re already a customer, there’s no reason for you not to buy one. It’s essentially free money! Every existing customer who buys one should be subtracted from the total customers when you’re calculating customer acquisition costs. The Amazon gift certificate promotion was more cost effective — there was a smaller base of users who were already LivingSocial customers.
  • Customers who get free vouchers under LivingSocial’s 3 and free program. If you get 3 of your friends to buy, yours is free. Given how much tweeting and Facebook activity was going on, I estimate that 5-15% were given out for free.
  • Customers who fraudulently purchase multiple vouchers. (Groupon and LivingSocial merchants face this all the time. Customers will set up multiple accounts to exceed stated limits.)

This loss is decreased by:

  • The number of vouchers that are unredeemed. From the legalese: “Whole Foods Market code shall not be deemed purchased by the purchaser until claimed • Whole Foods Market codes will be available for purchasers to claim for ninety days following the offer period. If code is not claimed within 90 days following offer period, code will be deemed forfeited, and purchasers will be refunded the full paid value ($10) of the Whole Foods Market code in Deal Bucks to be used on livingsocial.com” Effectively, you’re buying a special gift card for LivingSocial that can be turned into a Whole Foods git card. If you don’t convert it, it’s a zero acquisition cost. In that case, you would either not use it or buy another deal on which LivingSocial would have margin.

Running deals like this puts LivingSocial in the same boat as merchants who run LivingSocial deals: customers will come in for the almost-too-good-to-be-true offer, but won’t return for the normal offer. I would buy the Whole Foods deal every single day. I also bought the Amazon and Fandango deals — all of which were likely sold at a loss. But I rarely buy anything else.

Groupon CEO Andrew Mason called out LivingSocial’s tactic of buying revenue in his controversial email to employees:

Living Social’s U.S. local business is about 1/3rd our size in revenue (and smaller in GP [gross profit]) and has shrunk relative to us in the last several months. This, in part, appears to be driving them toward short-sighted tactics to buy revenue, like buying gift certificates from national retailers at full price and then paying out of their own pocket to give the appearance of a 50% off deal. Our marketing team has tested this tactic enough to know that it’s generally a bad idea, and not a profitable form of customer acquisition.

Asked to comment on that, Weinstein responded, “we haven’t commented on Mr. Mason’s memo, except to say that any claims about our financial metrics should be treated with skepticism, as no other companies have access to our internal numbers.”

Is it worth it?

By my estimates, Groupon spent $24.08 for each new customer acquired in the second quarter. Between giving money to Google for advertising and giving money to consumers, I’d rather give money to consumers. Then there’s the value of all of the press LivingSocial received today, much of it from reporters who don’t understand the economics.

Given the timing, the bigger reason to do it is to put lipstick on the LivingSocial hog. As a company that is rumored to be on the IPO path, the Whole Foods gift card giveaway improves these metrics:

  • Total number of customers. (If you bought the deal you’re a customer.)
  • Conversion rate of list subscribers to customers. (Again, every one who buys this is a customer. This increases the percentage of list subscribers who have bought something.)
  • Repeat customers. One of the things I knock Groupon for is more than half their customers have never purchased again. But if you bought both the Amazon deal and the Whole Foods deal, you’re a repeat customer!
  • Gross revenue. If LivingSocial books revenue like Groupon does, they just generated $10 million in revenue! They just grew revenue for the quarter by $10 million. Magic.
  • Total vouchers sold.

Investors should be smart enough to look past such shenanigans, but most don’t look at such details when evaluating financials.

I look forward to reading and analyzing LivingSocial’s S-1, if there is one.

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10 Comments »

  1. Rocky, what about the economics from Whole Foods’ point of view? Did running this daily deal from WFM’s perspective make financial sense for them?
    Stuart

    Comment by Stuart Liroff — September 14, 2011 @ 9:52 am

  2. This is a win for Living Social. $10 compared to $24.xx for a new, paying customer. Groupon is paying ~$5/email, LS is paying $10 for a paying customer. Not to mention the press and social mentions generated from a huge nationwide deal like this – I think it’s a good move for acquisition.

    Comment by Justin Cener (@crowdseats) — September 14, 2011 @ 11:40 am

  3. Does it make financial sense for Whole Foods to do a Living Social deal?…

    Under the types of terms that most small businesses are faced with from LivingSocial and Groupon, the answer would be: hell no! They would be selling $20 gift cards for $5. Under the terms that Whole Foods likely got for this deal: hell yes! LivingSoci…

    Trackback by Quora — September 14, 2011 @ 12:40 pm

  4. The offer had a pretty impressive uptake. Over half a million coupons were sold in the first 78 minutes!

    See it in in chart here:

    http://datagenetics.com/blog/september12011/index.html

    Comment by Nick Berry — September 14, 2011 @ 8:48 pm

  5. Justin, there’s no way they spent $10 per customer. Aside from Rocky’s correct assessment that ~10% of them went out for free and some went to “cheaters” — which raises the average cost to at least $12 — there is the larger issue: The most likely buyers of this were already Living Social customers. The offer went out such that it was live by morning Pacific time (so says sources, my e-mail is time stamped 5:11 am Pacific time) and was half sold out in the first 80 minutes. Of those people, it’s safe to assume that 90-95% of them minimum were Living Social e-mail subscribers. What percentage of those were already “customers”, i.e. people who had bought? At least half? The second 500,000 was more interesting, but still consisted almost entirely of people who already receive LS e-mails. Even if the percentage of new customers there was 2/3 — and that seems pretty implausible — it’s hard to imagine this generated more than 500,000 new customers. And it easily could have generated fewer than 250,000. Multiply the cost by 2x and it’s $24 per customer (very Groupon-y). Multiply by 3x — which I suspect is still generous in that it’s 330k customers but still >$11 million in spend — and you are looking at $33+. I suspect, truthfully, that it worked out to $40 per new customer. And I suspect they are absolutely the worst kind of customers Living Social could get — just ask Rocky. They seem desperate to push those other metrics as well as the top line.

    Comment by Mark R. — September 15, 2011 @ 12:34 am

  6. [...] A great post from Rakesh Argawal sums it up nicely. Basically, because LivingSocial (and other daily deals companies such as Groupon) takes such a huge cut of these transitions, merchants are squeezed to the point that the ‘deal’ is not profitable and fails to drive repeat business. To quote Argawal: If the deal is structured like other such deals, it’s a customer acquisition tool. As a grocery store (even a high-priced one often referred to as Whole Paycheck) Whole Foods doesn’t have the margins for deep discounts. It’s operating margin is 5.5%. A more mainstream chain like Kroger has operating margins of 2.7%. [...]

    Pingback by Why the economics of LivingSocial/Whole Foods-like deals suck for merchants « Adility Blog — September 16, 2011 @ 1:29 pm

  7. [...] revenue reporting is also less susceptible to gaming by the company. Tricks like buying gift cards at full price and selling them for half off won’t help a company’s revenue [...]

    Pingback by Groupon’s cost of revenue is soaring « reDesign — September 24, 2011 @ 3:52 pm

  8. [...] here for Related LinksThe economics of LivingSocial/Whole Foods-like deals Free List Building Google, google trend, google trends, how to use google trends for internet [...]

    Pingback by How to use Google Trends for Internet Marketing Part – 2 | How Do I Build A List? — September 24, 2011 @ 6:17 pm

  9. [...] September revenue growth was largely driven by the Whole Foods deal, a deal in which I believe LivingSocial sold Whole Foods gift cards for about half what they paid for them. Of course people  bought it! It doesn’t reflect the fundamental value of the LivingSocial [...]

    Pingback by Why I agree 100% with Groupon on obfuscating its Deal Counter numbers « reDesign — October 10, 2011 @ 5:12 pm

  10. [...] this isn’t a statistical anomaly. This also comes during a period when LivingSocial ran an expensive publicity stunt with Whole Foods to drum up user [...]

    Pingback by U.S. daily deals traffic down more than 50% according to Compete « reDesign — October 14, 2011 @ 8:21 am


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