Here’s the last sentence the LivingSocial sales rep got out before I hung up on him. “You can’t think about making money today…this is a marketing investment in the future of your business!” And that’s when I knew the daily deal was dying.
In 2011, we saw daily deals, led by the meteoric rise of Groupon, go from the newest new thing to yesterday’s news. Restaurants initially embraced the idea, and who wouldn’t. The promise of legions of new customers who had never heard of an establishment dropping by to fill up those empty tables on Tuesdays at 4:30 sounded so good. Of course, this isn’t what happened. Some restaurants were mobbed; others saw those “new customers” once, never to return. None profited and rarely was that off-peak seat filled with a newbie who became a regular, loyal patron.
The success of daily deals site requires two things to keep their legions of penny-pinching fans happy: huge discounts and volume. Huge discounts are needed to hook that cheap audience and huge volume ensures that all of them can participate (remember the deals sites are paid for each transaction).
My experience with the LivingSocial sales rep confirmed this. I called on behalf of my wife’s podiatry practice, exploring the idea of running a deal for custom-crafted orthotics. It seemed like a good target; orthotics are expensive and frequently not covered by insurance. My wife had a new doctor joining her practice, so accepting a large volume of new patients even at a steep discount seemed like a reasonable idea.
It was when we got into the economics that I realized this approach was a very bad deal for my wife . . . as it would also be for restaurants. While custom orthotics run around $600, about $200 of that is for material and manufacturing. The LivingSocial rep pointed to an orthotics deal done in Texas on Groupon— a $450 product discounted to $175. At this price, we’d be losing money on every transaction AND the salesman was pushing for a guarantee of at least 250 units . . . which would have resulted in an immediate loss of over $6,000.
Deal economics for restaurants are even less appealing. A large portion of a restaurant’s cost structure is made up of variables; i.e., each meal has individual costs, from the ingredients, to the cooking, serving and cleaning up. Deep discounts quickly eat through the direct costs (overhead like rent) and then cut into the variable cost, resulting in a loss to the restaurateur. Because the margins for restaurants are so slim, it’s very easy to quickly eat into those variable costs creating a situation in which restaurants are actually paying diners to eat.
I looked at the makeup of the deals coming out of daily deal sites like LivingSocial over time comparing a month in early 2011 (when they were all the rage) to January of this year. With an admittedly limited data set, this is what I found:
· 10% of the deals were for restaurants in both 2011 and 2012.
· There was growth in travel, which now accounts for more than a quarter of the deals.
· The strongest appearances consistently come for offers like “Yoga class” or “One hour massage.”
While I was expecting to see a huge drop-off in restaurant deal activity, it turns out restaurateurs have mostly stayed out of the daily deals world because of the economics of their business. The percentage of costs that are variable are simply too high to make it work.
Now consider the strong categories of beauty and services , where the primary cost is variable BUT that cost is generally one person’s time (a yoga instructor, for example). Ms. Yoga Teacher can either make $60 an hour or $20 an hour, but she’s probably not going to lose money. Now consider travel, the one category that showed extensive growth. The variable costs of, say, a hotel room (a maid’s time to remake the bed and replace a tiny bar of soap) are miniscule compared to the customer’s cost of the room. With these tiny costs, deep discounts, even at volume, make sense. Thus the growth in daily deal travel activity.
We’ve seen the failure of daily deals across many large sites. Last year, Facebook dropped their daily deals, followed quickly by Yelp. OpenTable, which was never able to get daily deals proceeds to cross two percent of their revenue, dropped the business in late 2011. Even the grandfather of daily deals, Groupon, saw its traffic decline by 50 percent during 2011, according to a report in Forbes.
At Urbanspoon, we ran a discount promotion for a month in Seattle with 14 area restaurants offering 25 percent off. We didn’t want to inundate restaurants with diners at popular times, so we limited the deal to off-peak tables. We advertised heavily on our site and added the deal to our newsletter for Seattle residents. The result? Nothing. No change. Zilch. Turns out a discount can’t make people book reservations for times or dates they aren’t interested in.
For restaurants, losing money on a diner is one thing; but making up for it with volume is a direct path to shutting your doors for good.
Conrad Saam is the director of marketing at Seattle-based restaurant information/ recommendation service Urbanspoon (www.urbanspoon.com).