Over at the New York Times You’re the Boss blog, Jay Goltz provides a great example of economic reasoning (ht: Jack B). His topic: how should small businesses think about the costs and benefits of participating in daily coupon sites like Groupon? Participants can see big spikes in traffic, at the expense of slashed margins. Is it worth it?
Goltz deploys many of the standard concepts we professor types teach our microeconomics students: distinguishing variable and fixed costs, the importance of thinking incrementally (i.e., at the margin), etc. But, frankly, he does it in a more entertaining way.
Here’s his basic set-up (but check out the whole article for how this calculation works out):
There are eight key calculations you need to consider to determine whether this is a better advertising vehicle than something else you may already be doing
1. Your incremental cost of sales — that is, the actual cost percentage for a new customer. If you are giving boat tours and have empty seats, your incremental costs for an additional customer are next to nothing. If you are selling clothes, your incremental costs might be 50 percent of the sale price. Food might be 40 percent. In any case, don’t include fixed costs that you would be incurring any way.
2. The amount of the average sale. If the coupon is for $75, will the customers spend more that that? I have seen more than one retailer complain that nobody spends more than the value of the coupon. That’s unlikely but I am sure it can feel that way, and that is my point: Keep track.
3. Redemption percentage. You don’t really know until the end, but from my experience and from what I have heard, 85 percent is a good guess.
4. Percentage of your coupon users who are already your customers. I’m sure this number varies tremendously depending on the size of your city, how long you have been around, and the type of business.
5. How many coupons does each customer buy? (The more they buy, the fewer people are exposed to your product or service.)
6. What percentage of coupon customers will turn into regular customers? Again, it can seem as if they are all bargain shoppers who will never return without a discount, but that’s almost impossible. Is it possible 90 percent won’t return? Sure.
7. What is the advertising value of having your business promoted to 900,000 people — that’s the number on Groupon’s Chicago list — even if they don’t buy a coupon?
8. How much does it normally cost you to acquire a customer through advertising? Everything is relative.