When Does a Visitor Need a Coupon?
Drilling Down Newsletter 113: 11/2010

Drilling Down - Turning Customer
Data into Profits with a Spreadsheet
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Customer Valuation, Retention, 
Loyalty, Defection

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Topics Overview

Hi again folks, Jim Novo here.

Seems like Groupon is all over the news lately, as are different opinions about the effectiveness of Groupon.  Did you know there's an academic study available on this topic?  Very interesting reading, check it out here, see link under the picture and educational background, "Groupon Effectiveness Study".

And the fact is, we often see this kind of thing in database marketing.  The higher the discount, the lower the quality of the customer attracted, and then the subsidy costs kick in with current customers, making the financial outcome even worse.

Subsidy costs, Jim?  What are subsidy costs, and why should I care about them?  This and more about the financial impact of giving the wrong coupons to the wrong people for the wrong products in this issue of the Drilling Down newsletter.

Let's do said Drilling.

Questions from Fellow Drillers
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When Does a Visitor Need a Coupon?

Q:  First off, I very much appreciate you sharing all this wonderful content on your blog and conferences such as eMetrics.

A:  Thanks for that!

Q:  My question is a simple one, but I think the answer may be hard: When does a visitor "need" a coupon?  *Need* would be defined as: the visitor would not have placed an order unless presented with the coupon.

A:  Hmmm...methinks we're going to have to define a few concepts and be clear on the goals to make sure we are nailing this down... visitor versus customer, sales versus profit, etc.  In other words, answer is not hard, but 
could be complex without defining context.

Q:  It's still a mystery to me why so many retailers seem more than willing to hand over all their margins to Groupon or give coupons to basically all visitors.  I am curious whether you would approach this question using  observational data (eg web analytics) or experiments (eg AB testing), or both.

A:  Right - is a mystery to me too!

There are certain situations where this approach might be appropriate, but the problem with much web "marketing" (which often is really just advertising without much thought about marketing) is often there is success in a narrow or special situation.  Then the pundits jump on and say "if you're not doing this you are stupid", regardless of the business situation and / or without recognizing the special circumstances that are driving success.  That's Marketing; understanding why it works, under what circumstances, for which segments, involving which products.

So, for example, if I was launching a brand new service business (restaurant) or a new product that is complex and won't sell without trial (like yogurt that "naturally regulates your digestive system"), Groupon might be 
a slam dunk for a product launch.  No surprise here; coupons are often used to drive trial in product launches because the need is to reduce price resistance and drive sampling.

On the other hand, if my product or company is well known and I have tons of loyal customers, Groupon could generally be a financial disaster if you care about profits.  But if all you care about is response to the coupon, it could be a great success!  Because tons of people who would have bought at full price anyway get a huge discount and you get to sell the product below cost.  Awesome!

What do I mean by this, how can you have high response and low or negative profits?

Here is what I have seen over the years: whenever response rates are abnormally high, it means you have a high percentage of responders who would have bought anyway without the coupon.  This is seen over and over in database marketing, online and offline.  From a financial perspective, it means you have probably given up the coupon value with no benefit, a so called "subsidy cost".

How do you prove this is happening in a promotion?  If you want to really look into and prove these effects, first examine the percentage of response that is from current customers.  If it's high, that's the first clue the discount is cannibalistic, not incremental.

If you want to quantify this subsidy cost a bit more is a relatively simple way, take the customer redeemers as a group and look at their average sales for a few months prior to the coupon promotion, during the promotion, and a few months after the promotion.  Often what  you will see is their spending behavior changed very little during the promotion.  

For example, let's say the coupon is 50% off.  The monthly net spending sequence over time might look similar to this:

2 months prior: $100
1 month prior: $100
Promotion month: $50
1 month after: $100
2 months after: $100

This shows the customers redeeming the 50% off coupon did not change their behavior at all; they simply took the discount and bought what they would buy anyway.  Meaning, the coupon cost is a real cost to the bottom line with no offsetting incremental profit.

Bottom line, for every response you lost $50 in sales plus the cost of the campaign, even though you had tons of responses and sales from those responses.  If it was a large campaign, your overall sales for the month net of discounts probably dropped.  Financially, if your cost of goods is 50%, you gave up $25 in profit for every response, minus the per response cost of the campaign.

And, the above behavior is most likely to occur with best, most active customers!  Across all redeemers, you might get $60 or so instead of $50 during the promotion month, but you are still losing money on every redemption - the higher the response, the more money is lost!

This is one big difference between Advertising and Marketing.  Marketing goes beyond Advertising, wants to understand the relationship of specific products to segments of customers, how pricing and modes of distribution affect this relationship, and the profitability of the relationship.

So, with that backdrop, let's try the question:

Q:  When does a visitor "need" a coupon?

A:  If I take your question literally, there is a concept in Marketing called coupon proneness, and it's the classic definition of "needs a coupon".  Essentially, it means the more 
coupons you give people the less likely they are to buy without one. If you can imagine what this looks like over time, it's margin erosion hell.  It's taking the example above, where no incremental profits were generated, and ensuring it will happen time and time again.

From a Brand perspective, always offering coupons means you are teaching people your prices are too high, or there is a tangible reason your company has to "beg" for sales (implies poor service or quality).  Either way, the outcome is not so good for Brand trust and any evangelism that might result.

The exception to the above is among the "never pay full price" segment, who don't buy anything without a discount / coupon.  From this segment, you get the benefit (?) of your coupon offers being spread all over the web, attracting many other "never pay full price" customers who generally have negative net values to the company.  Great, huh?

The end result of this pattern is horrible customer loyalty, margin erosion among current customers, and lots of new customers that are 1x buyers.  This means you have to spend *even more* on Advertising to constantly chase new 1x customers, while at the same time your margins in the current customer base are being consistently eroded.

Certainly not an optimized system!

Some people will argue the "extra sales" they get are worth the price of encouraging the above behavior.  But there are not too many businesses that put sales in the bank, what they put in the bank are profits.  So this is 
very short-term thinking and in fact, you find a lot of businesses that follow this model perform very poorly financially.

So, you ask, when would a visitor "not have placed an order unless presented with the 
coupon"?  The answer is this: when you have "presented" a coupon before, and the 
more often you have done this, the less likely they are to buy *until* you present one.

Sure, you could use A/B testing, but it's not hard to guess what you will find - when you present a coupon, more people buy.  Duh, that's Advertising, right?  But that's optimizing for conversion, not for profits, and conversion can't be deposited in the bank any more than Sales can be.  You have to go further.

For example, if you had the capability to recognize purchase or visit patterns among visitors, you could segment by these behaviors and present coupons on the site only when they were likely to have an incremental rather than cannibalistic outcome.  For example:

1. A new visitor who becomes a repeat visitor X times but does not buy

2. A current customer who has not purchased in over X weeks

and so forth.  You could test for "X" and optimize for highest profitability if you also ran a "null" control group  - where if A = coupon, B = no coupon.  Then look for incremental sales  behavior or "lift" from those offered the coupon versus those not offered a coupon, and run out the profit and loss.  

Of course there are other scenarios, mainly current customer comes to your site because  you sent them a coupon, as opposed to presented one on the site.  Not sure if you 
were including that in your question, but I took your meaning literally.

The scenario with subsidy costs when sending customers a coupon is basically the same as the example above, except you control which customers get what coupon values or if they get a coupon at all.  More info on executing and measuring in that scenario for customers here, and for an example of a company putting this approach into practice, see here.

Jim

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That's it for this month's edition of the Drilling Down newsletter.  If you like the newsletter, please forward it to a friend!  Subscription instructions are top and bottom of this page.

Any comments on the newsletter (it's too long, too short, topic suggestions, etc.) please send them right along to me, along with any other questions on customer Valuation, Retention, Loyalty, and Defection here.

'Til next time, keep Drilling Down!

- Jim Novo

Copyright 2010, The Drilling Down Project by Jim Novo.  All rights reserved.  You are free to use material from this newsletter in whole or in part as long as you include complete credits, including live web site link and e-mail link.  Please tell me where the material will appear.