Defense of the "Daily Deal" Biz from a VC Funding them...

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?

Excerpt from TechCrunch

Arash Pirzad-Allaei is a co-founder ofKASA Capital, where heads the internet technology development of KASA’s network of websites, including daily deals site Crowd Cut.