Question

Supply chain case study ch 16

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. 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 60 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 percent discount coupon for a product or service offered by a local business. The deal was broadcast by Groupon 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 regular 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 drop in price could be attributed in part to the higher marketing costs and the negative publicity from some retailers who had used the daily deal. Some complained that “the financials just can’t work,”2 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 very popular blog post by Jay Goltz on the New York Times3 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 were choosing 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:

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 customer 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 (= 3000 * 17.50) from Groupon and additional revenues of $25,500 (= 3000 * 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 (= 3000 * 0.85 * 85 * 0.40). The restaurant thus lost $8,700 on this deal. If viewed as advertising expense, it was necessary to evaluate the number of new repeat customers that the deal brought in. Given that 2,550 (= 3000 * 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 (= 1275 * 0.6) new customers to the restaurant. If 10 percent of them would 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 acquired Savored, a restaurant reservation engine, in September 2012. Savored offered discounts of up to 40 percent at upscale restaurants aslong as customers made the reservations online in advance. Restaurants could vary the discount offered by time of day and day of week, with larger discounts for less popular times. Restaurants could also vary the number of tables available at the discount price. Savored suggested times when discounts should be offered after studying a restaurant’s traffic patterns. 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 night discount at 11 p.m.4 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.

Study Questions Use the spreadsheet & excel :-

1. Assume a variable cost of $10 per table and an average spending of $60 per table. With the daily deal ($60 for $30 coupon), Groupon provides Mr. Chang with a revenue of $15 per table. The analysis provided in the New York Times blog indicates that Mr. Chang makes money ($5 per table) through the daily deal (rather than incurring advertising expense). Do you think the analysis has included all aspects that need to be considered? Should Mr. Chang go ahead with the daily deal given that he can advertise while making a little bit of money per coupon?

2. With Savored, Mr. Chang can limit the number of tables he allows for the discount price. Assuming he makes the same revenue with Savored per discounted table as the daily deal ($15), do you think the ability to limit the number of tables at discount has any advantages? Would you prefer to use Savored or the daily deal?

3. Would you prefer to use Savored or the daily deal? Why?

Answer 1

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Assume a variable cost of $10 per table with an average spending of $60 per table. With the daily deal ($60 for $30 coupon), Groupon provides Mr. Chang with a revenue of $15 per table. The analysis provided in the New York Times blog indicates that Mr. Chang makes money ($5 per table) through the daily deal (rather than incurring advertising expense). Do you think the analysis has included all aspects that need to be considered? Should Mr. Chang go ahead with the daily deal?

The first analysis involves the case where customers purchase Groupons ($60 in dining for $30) and make dinner reservations at the Golden Dragon. The Golden Dragon receives revenue of $15 for each Groupon and incurs a variable cost of $10 per table. The analysis presented in the case from the New York Times blog would indicate that Mr. Chang comes out ahead because he gets the advertising of Groupon while earning a small margin of $5 per table. This is not entirely correct because any time a table is reserved for a customer with a Groupon it cannot be used for a full paying customer who would have provided revenue of $60 per table. Thus, it is important to understand how many regular customers are turned away (resulting in a lost margin of $50 = 60 – 10) when tables are reserved using Groupons.

We show the results for the case when 10 tables are reserved using Groupons in Figure 1. Our analysis assumes that any tables reserved using Groupons do not affect demand from regular customers. The demand for regular customers is normally distributed with a mean of 60 and a standard deviation of 30. Capacity of the restaurant is 100 tables.  

Since 10 tables are reserved using Groupons, only 90 tables remain for regular customers. The 10 tables provide a margin of 10×5 = $50 from Groupon. For the remaining 90 tables, the expected profit is calculated to be $2,875, where p = $50 ($60 - $10) is the margin per occupied table, c = 0 is the cost per idle table and s = 0 is the salvage value per idle table. The total expected profit is thus $50 + $2,875 = $2,925. The expected number of idle tables is 32.5 and the expected number of regular customers turned away is 2.5.

Number of Groupon Tables (Cell E16)	Margin from Groupon (Cell E19)	Expected Profit from regular Customers (Cell E20)	Total expected profit (Cell E21)	Expected number of regular customers turned away (Cell E23)	Expected number of idle tables (Cell E22)
0	0	2,936	2,936	1.3	41.3
2	10	2,927	2,937	1.5	39.5
10	50	2,875	2,925	2.5	32.5
20	100	2,773	2,873	4.5	24.5
30	150	2,619	2,769	7.6	17.6
40	200	2,402	2,602	12.0	12.0
50	250	2,119	2,369	17.6	7.6

Observe that profits are maximized if only 2 tables could be reserved for Groupon customers with the rest being saved for regular customers. In reality, customers with Groupons are likely to make their reservations earlier. If more than two customers make reservations using Groupons, the restaurant will have fewer empty tables but will also have lower profits as shown in the table above. It is important to recognize that the cost of using Groupon must include the loss in profits because regular customers cannot get a table. Thus, even though Mr. Chang makes $5 from each table with a Groupon he makes $567 (2,936 – 2,369) less if 50 tables use Groupons compared to not using Groupons. His restaurant, however, is much fuller with the Groupon sale. There are only 7.6 empty tables on average if 50 tables use Groupons whereas there are 41.3 empty tables if Groupon is not used. The use of Groupon fills up the tables but does not necessarily increase profits.

With Savored, Mr. Chang can limit the number of tables he allows for the discount price. Assuming he makes the same revenue with Savored per discounted table as the daily deal ($15), do you think the ability to limit the number of tables at discount has any advantages? Would you prefer to use Savored or the daily deal?

Targeted use of Savored where Mr. Chang can limit the number of tables allowed at the discount price can be very effective. The previous analysis shows that if all days are alike and a customer making reservations using Savored only provides revenue of $15, it is optimal for Mr. Chang to set aside only two tables for Savored customers. As the margin provided by Savored customers grows it becomes optimal for Mr. Chang to set aside more tables for them. The use of Savored can help Mr. Chang increase profits in all settings if he manages the number of tables set aside for these customers as shown in the table below.

Savored Discount (%)	Revenue from Savored per Table (Cell E7)	Optimal Number of Tables Committed to Savored Customers (Cell E16)	Total Expected Profit (Cell E21)	Expected Number of idle Tables (Cell E22)
75	15	2	2,937	39.5
50	30	32	3,220	16.2
40	36	42	3,442	11.2
25	45	56	3,878	5.7

The discount offered on Savored decreases from 75 to 25 percent, it becomes optimal for Mr. Chang to set aside more tables that can be reserved using Savored.

Would you prefer to use Savored or the daily deal? Why?

Savored is a much more effective way for Mr. Chang to use his restaurant capacity because he can adjust the number of tables he makes available at Savored. Savored is something that can be used on a regular basis by Mr. Chang to increase profits by supplementing the flow of regular customers. In contrast, the daily deal can hurt profits if these customers book up tables before regular customers who then must be turned away. Limiting the number of tables offered at discount is the key to success in this setting.

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