OpenTable (OPEN) stopped its daily deal offers after concluding that fine dining restaurants are better served by real-time revenue management systems that restrict discounts to off-peak periods. OpenTable's rejection of Groupon (GRPN)-like offers may be a reasonable case study for problems that Groupon may face in other verticals.
Ironically, on the same week of the Groupon IPO, OpenTable announced the cancellation of their “Spotlight” daily deal program. When Spotlight was launched about 15 months ago, many investors concluded that it would be a huge success and a boost to earnings. Indeed, the number of deals sold, particularly for the more popular restaurants, was impressive. To expand the program, I imagined that OpenTable account executives would just make a quick phone call to their long-standing restaurant operators, set it up the deal over the phone and OpenTable would send out an email to their massive list of fine dining patrons. However, OpenTable remained in a cautious test mode and only offered Spotlight for one or two restaurants per week in a only a dozen or so markets, despite many more restaurants wanting to do Spotlight offers than OpenTable would allow. Then CEO Jeff Jordan reiterated on multiple conference calls that OpenTable was gathering feedback from restaurants and consumers. They also talked a lot about the competition in the daily deal space and how they felt it was incumbent on them to be innovative on behalf of their restaurant clients. This sentiment is reflective of OpenTable's long-standing strategic decision to serve restaurant operators first and diners second. The CEO's comment, “We have determined this offer [Spotlight] is not one that resonates with the majority of our restaurant base,” clearly reflects this focus.
In my view, here is why Groupon-like daily-deal discounts are less than optimal for fine-dining restaurants:
Rational Consumer Behavior – It is exceedingly easy for people to create multiple identities and purchase multiple daily deal discounts. Imagine a regular monthly guest of a restaurant who purchases 12 offers, each worth $25 in savings, for a total saving of $300 per year. In absence of the daily deal, the whole $300 would have been profit to the restaurant. While the intent of the program is to attract new restaurant patrons, all it takes is a few regular diners whose rational behavior is to maximize their buying power but who unwittingly appear to reduce the restaurant's profitability. Repeat usage like this usually is undetected. But in fine dining, the hostess or restaurant owner are usually out on the floor greeting guests and mingling – they know the identities of their regular guests. Even if only one or two regular guests redeeming multiple discounts are detected, the operator will feel like they are being taken advantage of and will quit the program, even if the discounts provide enough new regular guests to increase their overall profitability in the long run (pdf).
Restaurants Are Fragile Operations – Restaurant profit margins are thin. Kitchen labor and food preparation is carefully scheduled. Sudden increases in guest counts are often not desirable since it stresses the real-time manufacturing ability of the kitchen which might lead to service delays and/or reductions in product quality. Daily-deal programs issue a large number of discounts over a short period of time which creates rapid increases in kitchen demand. Imagine a restaurant with 20 tables that turns a good profit even when only 15 of the tables are seated during a particular time. After selling a daily-deal, seating the empty 5 tables increases demand on the kitchen staff by 33% and may reduce service and product quality – a result which is unacceptable to guests who pay $75 or more for a meal. Restaurants are challenged to increase kitchen capacity through added staff and/or equipment to meet this new demand, which may prove to be short lived. Other service business that lack a manufacturing component without strict time constraints may be better suited for daily deals.
Fine Dining Culture – Certain fine-dining restaurants aim to create an image where all of their guests feel like they are dining among their peers, especially high income diners who are not incentivized by discounts. Through discounting, operators may increase the demographic mix in their restaurant which in their mind may not be desirable.
Guests Fail to Spend More Than Face Value – Daily deal vendors often claim that guests will often spend far above the face value of the voucher. In reality, some studies suggest that about 41% of redemptions are very close to the face value. Even worse, some of these guests might spend less than face value and therefore insist on not paying tax or tip which creates uncomfortable discussions or worse, fails to compensate the server for their work.
OpenTable is attentive to the needs of its restaurant clients and was unwilling to risk long-standing client contracts and relationships by introducing promotional programs which may not serve their best interests. While these programs clearly attracted diners and was a source of profit, OpenTable has a history of being very disciplined about changing their business model in any way.
OpenTable has essentially already replaced its Spotlight trial through a partnership with Savored.com. This program is different from Spotlight in the following areas:
The offer is the right to receive a 30% discount on the total amount of the bill for a one-time charge of $10.00.
The 30% discount is strictly associated with a specific reservation time slot that is suited to the needs of the restaurant. Essentially, this is a dynamic pricing model where restaurants can utilize price discovery to sell capacity in their restaurant at times when utilization is typically low such as before 6pm or after 9pm, or perhaps on Monday – Wednesday when guest counts are lower.
This capacity utilization plan solves many of the issues discussed regarding fragile restaurant operations. With Spotlight offers, guests could just show up as walk-ins and request a table. With the 30% off deals, the guest is required to book a reservation so the kitchen knows in advance and can prepare accordingly to step changes in demands, not the temporary and unpredictable increases in demand that follow Groupon-like discounting.
Since the 30% discount right is associated with a specific reservation also made through the OpenTable system, the server for that guest can check the electronic reservation book and discretely apply the discount to the check without the guest having to the suffer potential embarrassment of presenting a “coupon.” This feature could be a boon to chivalrous young men of modest means who want to impress their companions at fancy restaurants – only needing an excuse to make the reservation for dinner early or late.
Restaurant servers are essentially commissioned sales representatives. They receive a gratuity in the range of 0-25% of the check depending on their service levels. Most servers would prefer to work with a manageable number of tables and provide great service and receive high tips. A well run revenue management program may provide smoother overall operations which increase server income. Plus, servers will be hoping to recapture goodwill from the 30% discounts in the form of higher tips which may off set slightly lower guest checks. Happy servers making enough money to earn a good living makes for happy restaurant guests who come back.
Participation rates in the OpenTable 30% off deals are very high. For example, 42 restaurants in New York participate in this program on a continuous basis. Thus, the program appears to be highly accepted, at least for now. Real profit contributions can be precisely measured if the server records the actual amount spent by the guest in the electronic reservation book. While some patrons may shift their reservation to an earlier or later time to obtain the discount, in doing so they might be freeing up a full-price, peak-time table that will be reserved by another full price guest or will be taken by a walk-in guest that potentially would have been lost if they had been asked to wait for a table or turned away. Alternatively, many restaurants may not need new customers per se but instead may realize better yield management from seating more overall diners by just filling seats off-peak. Cost of goods sold for most restaurants closely resembles their food costs which are in the range of 30-35% and most kitchen labor is allocated to the entire service period which makes it a fixed cost. Therefore, a more steady flow of diners might just eliminate smoke breaks for kitchen staff or other non-productive uses of employee time.
Groupon will be challenged to implement a time-specific offer for fine dining through their GrouponNow! Program that can compete with OpenTable's 30% offers. While Groupon can install similar electronic reservation book systems in restaurants to inform Groupon users of discounted, empty tables, OpenTable will not likely allow their reservation data to be easily shared with 3rd party competitors. OpenTable's rejection of the Groupon-like offers is also a clear warning sign for Groupon's long run success with merchants from other verticals as merchants become more knowledgeable about how to utilize daily-deal offers to drive profit in their business, not just the certain arrival of “new” customers bearing discounted gift certificates. As OpenTable has shown, each vertical served by Groupon is likely to have highly specific needs and Groupon may lack the focus to serve any single vertical optimally before the incumbent software vendors beat them at their own game.
While high subscriber growth for Groupon is easily achieved by helping people save money, it is the merchants who must continue to recognize the value proposition of giving so much product or service away in a daily deal offer. Groupon's unique merchant counts grew by 0.2% to 78,649 in Q2 from 78,466 in Q3 despite massive investments in SG&A. This suggest that Groupon's merchant prospects may be rejecting the merit of participating in daily deals. In view of OpenTable's merchant centered evaluation and rejection of daily deals, the fact that merchants may finally be catching onto the unfavorable economics of daily deals should be less surprising to Groupon investors. As a deal broker, Groupon won't have a business unless they can continue to source deal inventory.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GRPN over the next 72 hours.
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