Recent valuation reports continue to highlight the success Groupon’s business model. It’s hard to argue the benefit for the 70 million consumers that have signed up to date – the opportunity to experience a wide variety of products and services at deep discounts.

But what about the organizations providing the deals? Research about the negative impact of services like Groupon is starting to surface.

Erosion of Price and Profitability

The problem with Groupon from a strategic perspective is the ripple effect that results from a promotion model purely focused on price.

As the frequency of Groupons increase price integrity will tend to diminish, resulting in a decline in profitability. There is also the chance that the number of new customers getting exposed to your business declines. With each Groupon you are essentially conditioning your existing customers to only frequent your business when there is a deal.

Esther Dyson wrote a great article about the Groupon Paradox. In it she describes how price erosion can take place:

“The logic is simple: Merchants are encouraged to use the deals to attract new customers, who in theory will return at full price. But, in what seems to be an increasing number of cases, customers come for the deals and then leave for deals offered by other merchants through Groupon. So the number of “new” customers attracted by cheap prices increases, and the number of loyal customers decrease as shoppers prefer to become “new” again for whoever offers the best deal.”

What are the long term profitability implications of using Groupon? How many new customers does your business need to get to justify every Groupon promotion? Let’s take a look at a fictional business example.

Groupon price erosion

Let’s analyze a restaurant that offers a $40 deal for $20 and gets 300 redemptions:

Groupon cost scerario

In this scenario, the restaurant is setting the ROI goal to equal the gross profit level of day to day business at full price. In order to do this 50% of the 300 Groupon redemptions would have to become repeat customers that dine at least once. However, the more people that became regulars, the lower the ROI goal. For example, if a regular customer dines 2 times per year, the ROI goal for the Groupon promotion would be 75 new customers or 25% ($6,000/$40 avg/2 visits per year). Is it reasonable to expect 25% of Groupons will turn into regular customers? If not, every subsequent Groupon promotion will further erode this businesses profitability.

Erosion of the Brand Experience

The nature of Groupon redemptions also poses some operational challenges. If your business is not prepared for traffic spikes from an inventory or service point of view there is the possibility of damage to the brand experience. That’s the irony, by focusing on price you run the risk of eroding the very thing that helps build equity and value beyond price – customer experience.

Effective Tactics

Maybe Groupon doesn’t make strategic sense for your business. But it can still be effective when used tactically and in relevant situations. Here are a few examples:

Advertising – Diverting some existing advertising budget to a Groupon promotion can be an effective (and measurable) way to build awareness, especially in new markets. For example, if you’re opening a store in a different region, your business can use Groupon as a market launch tactic. You benefit from the traffic lift at store level and are less susceptible to price erosion due to introductory nature of the promotion and the fact that it’s a new market.

Inventory – Groupon is a great way to help move excess inventory. You will likely be ready to offer discounts so a Groupon deal could be a good fit – but be sure to compare the commission costs vs. inventory carrying costs. If Groupon can help your business speed up turns on expensive inventory it’s likely a worthwhile tactic.

Seasonality – Groupon can be a good tactic to use if your business experiences severe seasonal fluctuations in sales. In this case an “off-season” promotion will either attract new customers or act as a reward to existing customers that support your business during peak times.

In what other situations can Groupon be used as an effective tactic? I’d love to get your thoughts. Also, if your business has used a daily deal service like Groupon please feel free to share your experience in the comments.

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About Mark Smiciklas

Mark Smiciklas

Mark Smiciklas is a Digital Strategist, author and President of Intersection Consulting; a Vancouver based digital marketing agency that teaches organizations how to leverage the dynamics of the web to achieve business goals. Mark is also the managing editor at Solopreneur.ca and is an established marketing and social media practitioner recognized for his visual thinking and practical strategic approach. You can connect with him on Google+.

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Comments Policy

Comments on Social Media Explorer are open to anyone. However, I will remove any comment that is disrespectful and not in the spirit of intelligent discourse. You are welcome to leave links to content relevant to the conversation, but I reserve the right to remove it if I don't see the relevancy. Be nice, have fun. Fair?

  • http://commetrics.com/?p=14363 Urs E. Gattiker

    Mark

    Thanks for sharing this important information. But I wonder, if I have to reduce my price from 100 to 70 (Euro, Dollars, etc.) and then give them a commission as well…. Hard work and not beneficial for a restaurant looking at your numbers.

    So what am I supposed to do as a retailer or a bookshop? Try it or refrain from doing so.

    If you predictions are correct (see calculations) than there is little in it for the business participating. In turn, will business refrain from using Groupon and, in turn, what about the latter’s valuation?

    Thanks for sharing.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Urs. I believe that Groupon can be an effective tactic under the right circumstances. But vendors really need to question their motivation, look closely at the business value (and real ROI) and understand how this type of promotion effects brand perception. As more businesses begin to question the long term value of group buying services I wonder if companies like Groupon will start focusing more on education – and making sure vendors are a good fit for these types of promotions.

  • http://www.hanelly.com hanelly

    Great post, Mark. It’s nice to see an argument that puts a higher (and logical) barrier to entry to a bandwagon. When something new comes along there’s a class of people who think you’re a fool for not adopting it – you counter that with logic, the most powerful weapon in the universe. Nicely done.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Andrew. I agree that there is likely some pressure for vendors to adopt Groupon. As mentioned, as a tactic I think it can serve its purpose well. However, the more you dig into the ROI and other dynamics, the less sense it makes as a long term strategy.

  • http://trafficcoleman.com/blog/official-black-seo-guy/ Black Seo Guy

    Mark..The Groupon system is a first for me and I think its something I can pass on to some offline business..

    “Black Seo Guy “Signing Off”

  • http://www.pivotcon.com Christina Buquid

    Thanks for posting an article on the economics behind social commerce. A lot of what people are blogging about are the specific metrics and how to improve your brand’s social crm…but I rarely see an overarching analysis on SM economic theory. Bravo!

    One question – where did the $3000 commission come from? Does this mean that groupon takes out 50% of gross sales?

    • http://SocialMediarology.com Jeremy A Williams

      Christina, the standard fee for working with Groupon is 50% of total sales. So if you’re offering a hotel room that’s typically $200/night through Groupon for $100, you (as the hotel) keep $50 per room while Groupon keeps the other $50. I know some larger or regional companies can work out other deals with Groupon, but I believe the 50% deal is pretty standard for Groupon.

    • http://SocialMediarology.com Jeremy A Williams

      Christina, the standard fee for working with Groupon is 50% of total sales. So if you’re offering a hotel room that’s typically $200/night through Groupon for $100, you (as the hotel) keep $50 per room while Groupon keeps the other $50. I know some larger or regional companies can work out other deals with Groupon, but I believe the 50% deal is pretty standard for Groupon.

    • http://socialmediaexplorer.com JasonFalls

      Because I’ve asked specifically both of Groupon and customers of theirs
      based on experience, I can tell you that Groupon takes 50% plus transaction
      fees. The business winds up with 48% (ish) of the money. LivingSocial is a
      bit better (60% is returned to the customer, I believe) and TryItLocal is
      even better – 70% goes to the business and the local Chamber of Commerce
      receives a commission as well (it runs through local chambers).

      • http://www.pivotcon.com Christina Buquid

        Thanks Jason! That is such a rip. Now we need a startup that comes in and rebuilds the concept of brand loyalty for merchants post-groupon. Or maybe a groupon-like company with emphasis on continued loyalty vs. price point..

        Countering Dyson’s argument I just read ted leonsis’ take on grouponomics http://www.tedstake.com/2011/03/27/a-gentle-groupon-reality-check/

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for dropping by Christina – glad you enjoyed the post.

      My experience with clients supports Jason and Jeremy’s comments below. The Gaps of the world may be able to negotiate better commission rates, but small businesses will likely pay 50%. That being said, fees for other group buying sites may be lower, particularly with regionally based services. I would encourage vendors to try to negotiate rates.

  • http://SocialMediarology.com Jeremy A Williams

    Great post. I’ve heard of more and more companies that are losing money even when (or because) their Groupon deal was wildly successful. It’s great for consumers – getting a lot more for every dollar, but Groupon’s current business model can’t sustain forever.

  • http://SocialMediarology.com Jeremy A Williams

    Great post. I’ve heard of more and more companies that are losing money even when (or because) their Groupon deal was wildly successful. It’s great for consumers – getting a lot more for every dollar, but Groupon’s current business model can’t sustain forever.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Jeremy…and for your example below. I agree that sustainability is in question. If the value isn’t there for businesses, logic would dictate that repeat promotions will diminish and “supply” will shrink. I wonder how this will manifest itself – maybe Groupon will adjust deal frequency from daily to 3 deals/week or eventually a bigger weekly deal?

  • http://moderncopystudio.com Vince

    I like the Erosion of the Brand Experience paragraph. Might using Groupon also erode confidence if you position yourself as a premium or high/end product or service? Are you now a discount product/service? Are you too hungry for new customer and therefore not in demand?

  • http://twitter.com/cjtheisen Chris Theisen

    Glad that this sentiment seems to be making its way into the maistream more and more. Ive been saying this for a while about Groupon. Its like any new technology or service, you better do some discovery and due dillegence instead of just jumping on the bandwagon. I still think there is an opportunity for a smart company to use Groupon to their advantage. If they have backend systems that integrate well throughout their business they could easily track, re-market and re-engage the customers who used the Groupon. The true value of Groupon isnt in the new customer acquisition, its in the re-marketing and targeting opportunities the redemptions give you. Leverage it properly and its a win, rest on your laurels and say the Groupon campaign or offer was a success at the redemption stage and you are bound to fail or not see return.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks Chris. Great point about looking at Groupon data as a business asset and using it for ongoing engagement after the promotion. This adds another element to the ROI calculation.

  • Laurence

    Hi Mark a good article. Its good to see some empirical evidence to support what a lot of us have been thinking. The model works very well for Groupon, but for many businesses it generates a loss. The huge discounts, encourage bottom feeders with little or no loyalty. It is a similar scenario to those e-tailers who use Amazon as their main marketing route, leading to poor brand recognition/support. They also suffer a very low repeat purchase typically less than 10%.

    I notice that some later entrants has created a more balanced discount agreement with the purchasing businesses, which paradoxically will result in a slower growth for them and make it harder for them to compete with Groupon. Nevertheless now that there is growing competition in this field we may see Groupon reduce their demands now they have established their market lead.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Laurence. I agree that the model doesn’t necessarily facilitate loyalty – customers are encouraged to keep trying new services.

      Regarding competitors, I know the imitators that have sprung up in major Canadian centers are aggressive in their fee structures and more open to negotiation. A know a small restaurant chain that got their commission rate cut to less than 20% using a regional group buying service. There can be a trade off with respect to list size and quality but the lower fees make it more palatable for vendors to test the waters.

      As far as Groupon letting up – with so many mouths to feed I don’t expect fee reductions for small businesses any time soon :)

  • http://www.pjmullen.com/ PJ Mullen

    I agree, regular or long term use of Groupon by a business is an untenable situation. If the business in this scenario were a new restaurant, then the argument could be made that they might not yet have the traffic to generate 300 covers at the full price. Chances are they are offering some sort of deal through other channels to attract business to build awareness. That would make sense in the near term.

    However, I think even Groupon knows that the deals they are offering can’t last forever. They do offer a “do it yourself” situation where you don’t get the same distribution that the national deals get, but you also don’t pay the 50% commission. From what I’ve read they can run between 10 and 30%, which is more palatable. In the long run the discounts will also have to be less extreme. The 50-90% stuff that I’ve seen will have to retreat to more reasonable levels.

    The only thing this analysis doesn’t take into consideration is how many groupon offers were sold. The analysis is based solely on redemptions and while I’ve never seen any data on that, I can guarantee that they aren’t 100% redeemed. The business gets their cash up front based on how many were sold, not redeemed. Hypothetically, if the business in this example sold 400 groupons and had 300 redeemed (so, 75% redemption rate), then they had 100 that weren’t. Granted, it only would add back about $1,000 to the profit in this scenario (100 unredeemed X $20 X .50) and the use of Groupon would still result in a 66% reduction in potential profitability.

    The question we should be asking is will it really matter once Facebook creates Facebook Deals and stuffs them down our throat? :)

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the great insight PJ. I agree with your new business scenario – it speaks to the fact that Groupon can be an effective investment in certain situations. Also, good point about redemption rates – they definitely need to be factored into the calculation.

      There’s some interesting stats embedded in this Quora thread about Groupon redemption rates (lower than I would have expected): http://www.quora.com/Groupon/What-is-Groupons-redemption-rate

      • http://www.pjmullen.com/ PJ Mullen

        Thanks, Mark. Those stats are indeed interesting. I’m actually working with my client (an apparel company that previously has only been wholesale) on putting together a Groupon offering to build awareness for their new online retail storefront. Considering the high margin nature of their business they will actually still make money on a Groupon offering at 50-60% off their projected retail prices. However, since they are a smaller shop I’m thinking that we’ll do one of the do it yourself type deals and promote it ourselves to pay less in commission and so as not to overwhelm their operation. It should be interesting to say the least.

    • Jazyy7676

      i think businesses are going to suffer from these coupons in the long run
      because the public will start to expect everything now at 50% off
      and the businesses only get 25% of the original price
      so businesses will go under if everyone is useing the deals

  • phil

    Love the article, Mr. Smiciklas.

    To me, Groupon is most valuable in its ability to function like a “refresh” button for the company’s image. Regardless of the target market’s preconceived opinion on the company, restaurant, or whatever, Groupon forces the customers to see what the place is actually like.

    I’ll give a personal example to clarify: I recently purchased 2 Groupons to Ingredient in Kansas City. I hadn’t eaten their previously because I knew nothing about the place. I had walked by their locations several times, but the “look” just seemed too “hipster” and “trendy” for me. Aside from the style, I suppose I had subconsciously decided that it looked over-priced. So, I never ate there. Then I saw the Groupon. In this economy especially, it’s hard to turn down what is essentially “half off” meal. So I bought it. I went and I absolutely loved it. I realized that I was way off on my aforementioned assessment of Ingredient. Not only was the food good, but I actually enjoyed the ambiance.

    The takeaway? Groupon was able to adjust my view of Ingredient. In other words, it “refreshed” my opinion. I was unwittingly turned into an Ingredient fan and now I constantly suggest Ingredient to others.

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the great example Phil. One of the promises of Groupon is the ability for a service to “share their story” with new customers and have that positive experience drive repeat business. That seems to have come to fruition in your case. I like the way you described the concept of a brand being “refreshed” in the eyes of consumers – I’ve never looked at it through that lens.

  • http://profiles.google.com/thiscollective James Wallace

    Great post as always Mark!

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks James – much appreciated :)

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks James – much appreciated :)

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks James – much appreciated :)

  • Zzidan505

    Great work Mark!

    • http://twitter.com/intersection1 Mark Smiciklas

      Thank you!

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  • Sarah Tebbe

    This is very interesting and insightful Mark. I have only used Groupon a few different times, and I either got a deal where I regularly go or have never gone back to a place I have used a groupon.

    I live in a large city where there are numerous small local companies like Groupon. After following some of these websites, I realize they have just as good of coupons, or in my opinion better. I don’t think they will ever get to the level of Groupon or Living Social, but makes me wonder why numerous companies are choosing to go to a very local site that does not give them as much exposure.

    After reading this article it makes a little more sense. Thanks!

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Sarah. Vendors need to balance what they can save in commission with what they might lose in reach. Independent group buying sites in larger markets have decent list sizes and can, in most cases, offer good regional exposure.

  • http://www.secretsushi.com/ Adam Helweh

    Mark,
    I am not a fan of Groupon, but I think your list of “Effective Tactics” are solid and effective ways to use the service. During specific circumstances like the ones you list, Groupon and other social buying sites really are great alternatives. Thanks for the great write up.

    • http://twitter.com/intersection1 Mark Smiciklas

      You’re welcome Adam. Agreed – businesses need to treat group buying services as a very specific tactic, not a blanket strategy.

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  • Jamie Burke (90:10 Group)

    I think it’s good to look under the bonnet of such a runaway successes. Its consumer proposition is fairly clear, although I still think its targeting poor, but you are right to ask what is the true value for advertisers?

    So firstly well done for playing with the theory here and rooting for the small guy.

    I’ve written a detailed response on my blog (which I haven’t used in 6+ months).

    http://bit.ly/hf6jyx

    I am coming at this from past experience in high-churn promotion lead industries which is usually the race to the bottom that you describe. However I think that experience does and doesn’t apply in the context of your example and Groupon generally.

    To summarise; Groupon’s problem is their average customers aren’t capable of understanding or achieving real value from their platform and they aren’t capable or helping them.

  • http://twitter.com/JeffKryger Jeff Kryger

    I agree with your effective tactics. I do feel that in the long term Groupon and the model is not sustainable, as I think most companies will be one and done. And there are only so many spas in a given metro area :)

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Jeff – Good observation about spas :)

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks for the comment Jeff – Good observation about spas :)

  • http://twitter.com/aDavidCreation David Chism

    I think Groupon can weaken most brands! I agree with the author that returning customers will expect a major discount to continue or they will go elsewhere. Not sure if Groupon is really helping our economy and business growth.

  • http://www.immotionstudios.com Colin

    Great Stuff Mark. The chart above really puts things in to perspective, regarding ROI. Seems that when starting a new business it might be worth doing a promotion once to get the name out but thats it. Huh

    • http://twitter.com/intersection1 Mark Smiciklas

      Thanks Colin. Agreed, a great tactic in very specific cases but, for many businesses, it’s tough to justify on an ongoing basis.

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  • http://www.indez.com Jayne

    nice article…. 2 points that entered my head!

    As an online shopper and devoted follower of bargains, it is a great way of promoting brand awareness and giving the customer a great deal.

    However….

    If you are a 3rd party selling branded items say, then you could be shooting yourself in the foot. Certain big brands ( think hair straighteners, jewellery, fashion) have a minimum mark up price – FOR A REASON – in order to brand position themselves. If you start selling truckloads of branded goods online and at a cut price…. certain brand might just stop supplying you! Be careful!

  • http://twitter.com/TheRetailDoctor BobPhibbs,RetailDoc

    Hi Mark – glad you discussed this important topic. I am not of the opinion Groupon makes sense in any situations. If you have product you want to move out, you run a clearance or 50% off. Its already a dog so it will need something but 78% off means you are losing big time. Further retailers do not offer Groupons on clearance stuff. Typically they are $100 worth for $50 or some variation. I wrote and 11-part blog dealing with the phenom beginning with a case study at http://www.retaildoc.com/blog/groupon-worst-marketing-business/ It’s not just “advertising.” No ad can come back and bite you on the but with flaming reviews across social media how you didn’t treat the dirt-scratchers like royalty.

    • http://profiles.google.com/razchorev Raz Chorev

      Bob, I treat the group buying websites as an advertising platform, only! This is one of the few advertising mechanisms that it is very easy to measure their ROI – if no one buys, the merchant won’t pay for the ad! It is that simple.
      It is also a very cost effective way to engage highly talented copywriters and graphic designers, to send an email blast boasting about your services to hundreds of thousands, if not millions of people, who haven’t heard of you before. Moreover, these people have actually subscribed to this type of advertising – they actually READING the ad! and acting on it.
      Compare it to spending $50,000 (minimum) on producing a TVC, and ongoing fees, which will likely to be ignored thanks to TiVO. Or full page ad in a magazine, which may produce an inquiry or two. You’ve paid a minimum of $10,000 for a single ad, had to repeat it for at least 12 months ($120,000) with NO GUARANTEE.
      That’s how I look at it, anyway.

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  • Legger

    Nice article, Mark.

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