Daily Deal Businesses’ Secret Weapon – Merchant Acquisition Metrics

When it comes to the daily deal space, those who follow the online advertising and online customer acquisition space like us tend to focus on just that – the media spend. Customer acquisition comes in two parts, though – the end user and the merchant. As an aggregator, there are really three distinct parts of the daily deal business, the last being the matching of merchant to user. It has been through the clever use of persuasion principles, e.g., social proof and scarcity, that daily deal sites have been so effective at generating a substantial revenue per user over the lifetime of that user being a subscriber. Without the the merchants, though, all their wonderful editorializing and curated local discovery would be for naught. It’s that merchant piece that is the emphasis here, because it is the unsung hero that enables superior economics for the continued purchase of media.

Daily deal sites are only the latest in a long list of companies who have looked to serve and build successful businesses in local markets. The online space has had no shortage of attempts, but it wasn’t until the model Groupon refined that any of the online serving local offline businesses gained significant traction. It was Groupon that unintentionally introduced the concept of pay for performance advertising for local businesses. The prototypical local merchant is one who is cash strapped, and as a result the perfect candidate for a performance model, but historically, they are too small for a marketing services firm to make money off them in a performance fashion. Unlike more sophisticated merchants, such as Amazon, local merchants tend not to have a site, or if they do, it’s certainly not one optimized for conversion. It’s why ReachLocal can get away with a percentage of spend, because once the click takes place, the onus no longer resides with the marketer. Working backwards, a pay for performance model almost dictates that the transaction take places on the marketers sites, which is the case with daily deal businesses.

As you can guess cost per new merchant is not an openly discussed item in the daily deal world. There is a lot of comparison between the cost for a merchant to acquire a new user by varying channels but not the cost to get that merchant. The data that I’ve heard suggests the cost per new merchant can, not surprisingly, vary widely. It can come in at a few hundred dollars and go up as high as a few thousand. Most local businesses, though, seem to target an average cost per new merchant at around $500, which most likely means it costs them closer to $1000. Let’s assume though that it costs them $500. To break even on that $500 they would need to make $2000 in gross revenue on average per client. Most would like to make at least $3000 to $5000 per year, but with local businesses it becomes a challenge. You are asking them to spend money, and getting them to spend often means not being able to lock them into contracts. As a result, the typical online company selling to merchants spends a fair amount of money after the sale, keeping them happy enough to hit their target revenue per new customer.

The deal sites have lucked into completely different economics. It still costs them about the same amount to acquire a new customer, but the better ones can make far more per merchant and do so all in one shot. Their favorable margins help, but the real trick is the aggregation of customers. A merchant who advertises on other channels, be it online or offline, gets customers in piecemeal. With deal sites, they get commitments in one shot. By being marketed to a large list at one time with a short timeframe in which the user can purchase, a merchant can receive hundreds to tens of thousands of transactions. For example, a deal that ran in Los Angeles offered $20 for $40 Worth of Food and Drinks at The Melting Pot. The deal sold 5000 vouchers at $20 for a gross revenue of $100,000. There is virtually no chance that this one location would have been able to acquire an average of 15 customers per day on any other channel, certainly not on a performance basis and not at a $30 CPA ($20 in free food, plus up to $10 for the deal site). The same goes for Lottinvilles Restaurant & Bar in Oklahoma that sold 2100 vouchers for $15 for a $30 deal. No other medium would come close to offering a local restaurant $15k in revenue (50% of $30k), but plenty would want to sell them to spend thousands per year for non specific results.

Looking over a sample of proprietary transaction data, we have the average Groupon revenue per deal for February 2011 coming in at $11,000 in the U.S., a number which is probably well lower than actual. That makes the comparison of daily deals sites versus other locally focused online businesses all that more illustrative. Even at a 40% margin, that gives Groupon close to $4500 per deal gross profit. If their costs are higher on average, say $1000 per deal, it still leaves the company with $3500. They probably spent one-third on customer acquisition, call it $1350 on average; including that, though, they have more money than many locally focused businesses make per customer. Scale definitely plays a factor. A deal site than can generate $10,000 comfortably has far more latitude with respect to what deals they can accept from merchants, and as a result their cost per merchant acquisition. That doesn’t mean Groupon runs only good deals. Hypothetically, if a “bad” deal generates $7,000 in a smaller market while a “good” one generates $50,000, and the former meets the bare minimum, it gives Groupon, or another at scale in a vertical, a huge advantage. A smaller player might only make $7000 (because they have 1/10 the user base) on a good deal. They couldn’t run one that only makes them $1000 to $2000, or if it they did, those deals wouldn’t move the needle of their business to allow for growth.

In our opinion, the merchant acquisition metrics is one of those accidental discoveries that added rocket fuel to the daily deal fire. The true breakthrough on the part of the more successful deal sites, though, has less to do with the economics and more to do with their ability to leverage them and to scale. It is one of the many reasons why we remain bullish on the industry despite the hype and challenges they will no doubt face as the model matures.