So much has been written in the last week about the litany of pros and cons the partnership between the Gap and Groupon has created (NPR: here, CNN: here, everyone else: here) that I almost decided to scrap this post (/hates being a talking head).  But, I think we’ve got a little data that supports retailers loving these promotions… (WARNING: This is going to take a while)

You will never see Save-A-Lot on Groupon (and now I have infinitely jinxed myself).

Groupon asks too much from it’s “deal” suppliers to make it economical for a traditional grocer to partake in it’s program.  If the reports are correct, and odds are they’re within -20%, Groupon asks for half of all revenue generated from a single Groupon.  Want to sell a $50 Gap sales voucher on Groupon?  Sell it for $25 and Groupon will take half ($12.50) and the Gap will take half ($12.50).

The topline analysis is easy: Gap’s taking a 75% (retail) hit on those purchases.  Let’s say, for sake of argument, Gap’s bannerwide net profit margin is 18% (generally, assuming that retail margin is around 30 – 50% at the Gap; NYSE:GPS currently books an 8 – 9% profit margin, but let’s assume that also accounts for their experimental banners and R&D costs, so we’ll use the elevated percentage of 18% for the (seemingly) more efficient banner). So under that assumption, for every dollar that is being spent at the Gap, $0.18 is being put back into the coffers at NYSE: GPS (covering overhead and retail expenses).  So the corporate marketing bigwigs work with that percentage in mind when shelling out a program like this.  My Their ROI is based solely on that profitability figure (not on awareness or some other bogus “measurement” that we love to shell out when it comes to really expensive programs, see also: Television Advertising).

So I need that 18% to work for me when I’m arranging the costs of this program.

So the bad news: Groupon sold 441,000 of these $50 vouchers.  That’s roughly $16.5MM in retail sales that my company won’t register ($37.5 x 441,000).  Or, about $3MM in lost profit to GPS. That’s a pretty big number to tame.

The eternal optimist in me knows that with all bad news comes intrinsic good news.  First the easy stuff.  I’m making $5.5MM in cash up front ($12.5 x 441,000) through the sale of the Groupon.  That accounts for about $1MM in net profit, great for one day’s work (let alone how good the cash flows feel on the balance sheet, if for only today [we know accounting doesn't work like this, but for sake of optimism, let's roll with it])!

So at the end of the day, with no shoppers yet to hit the store, I’m $2MM in the hole (on the profit side).  I’ve got a lot of work to do in the upcoming weeks to recoup my investment, but I have faith that my shoppers’ are going to really impress my boss with their uncanny ability to simply spend more money at the Gap.

441,000 Groupons are going to account for 441,000 trips to the Gap.  Let’s be modest and say that 60% of those trips were going to happen anyway (I would venture to say that is a relatively conservative estimate) and that 40% is new, incremental business.  For sake of argument, let’s say that 175,000 of those Groupons are garnering new business (either folks who wouldn’t ever shop at the Gap, or would have spent more at another retailer).  Here’s where the money starts to roll in…

The Groupon awards you the $25 after you spend $50 (retail) in store.  The secret retailers don’t want you to know is that nobody ever spends just $50.  It’s near impossible.  Want to try and use your $50 Groupon on a $49.50 pair of jeans? ERRREH. Sorry, honey. We need you to buy more.  (Damn you! Pre-tax offers!)

The consumer needs to find $50 of something to only spend $25.  But every penny more than that $50 is new incremental money going through the registers.  And fact is, with offers like this one, the consumer has a price point in mind that she’s willing to spend (usually about $50 to begin with).  So let’s say for sake of argument, that the incremental buy is $25.  That for every Groupon redeemed at the Gap, the basket data shows an average transaction of $75 (again I believe this to be conservative in estimation due to the programs and numbers we have seen on the retail level previously, definitely not apples to apples, but will serve as a general standard).

So we’re left with 175,000 new purchases and $25 in incremental spend per Groupon. $4,375,000 in new revenue generated because of this one promotion, or roughly $787,500 in net profit.

So the marketing gurus over at Gap netted roughly $1.8MM in profit due to this promotion.  Unfortunately, they lost out on about $3MM of profit, so they’re about $1.2MM in the hole.  A nasty hit to the budget line to say the least (keeping in mind we were incredibly conservative with new store visits and incremental purchases at register).

But let’s see where they might have made it up.

Let’s say Groupon didn’t hit them with their typical 50/50 split (God love ‘em (Groupon) if they figured out how to sell the Gap on that).  But let’s assume the Gap knew their offer would be a cash cow to Groupon and they were able to negotiate terms somewhere around the 80/20 line.  This would still have netted Groupon a little over $2.2MM in revenues for the day (and their operating margin has to be through the roof, I’ve got to assume close to 80 – 90%), meaning Groupon probably made $2MM for one day’s work.  Not too shabby.  Not too shabby, at all.

And the Gap begins to recoup it’s investment.

With the Gap taking in $20 per Groupon purchased.  You see their revenue from the promo rise to $8.8MM.  Right off the bat you see them make $1.6MM in profit from Groupon sales alone.

Let’s assume that 50% of the Groupons are for purchases that otherwise wouldn’t have happened (up 10% from our original assumption), and that scarves were looking really good in the merchandising set, and the incremental buy ends up being $30 (up $5 from our original incremental mark-up) accounting for $6.6MM in incremental spend in the store or roughly $1.2MM.

With the negotiated Groupon rate, and the higher incremental buy figures, we’ve managed to create $2.8MM in profit for the Gap.  Damn, we’re so close!

Now, to the big secret of couponing and giftcarding. The spooky reality is that gift cards and online promo companies really make their money in non-use.  That’s right, that after a year or so your Groupon sits idly, never spent/thrown away/or out of mind for eternity.  You think to yourself, “who would let $25 in cash go to waste?” I’d ask you to document all of the gift cards you’ve received over the last 5 years and let me know the balances remaining on them…

Let’s assume that a mere 2% of these Groupons are never redeemed in store for one reason or another.  That’s roughly 8,000 freebies for the store. Let’s say the Gap did get a negotiated rate at 80/20.  That’s $160,000 in pure cash to the Gap.

What’s $2.84MM + $160K… A cool $3MM in profit to the Gap. ROI = 1.  There’s worse things in the world (see again: Television Advertising).

Now, think if the Gap is really making 24% on every dollar spent in store, or that 75% of those Groupons were new trips, or harbored a higher incremental spend…now we start to see a profitable marketing program.  Kill the medium if you want, but there’s method to this madness.

Maybe this entry shouldn’t be titled “In Defense of Groupon,” rather “In Defense of Marketers”.  My goal here is not to defend the medium, rather systematically approach marketing the way it should be approached.  With concrete sales data, realistic estimation and objectionable return figures. But, what do you think…a lot of work for negligible returns? Am I missing the value of the buzz and sales spikes in store?  Is Groupon out for blood and unruly with it’s cut of the pie?  Let me know in the comments below (and I give you a whole lot of credit for making it this far…).

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