Opinion and Return on Technology

ALTOM: Examining the pros and cons of Groupon

October 22, 2011

Want hordes of new customers battering down your doors and filling your lobby? Groupon says it can get you there. Groupon is a peculiar fusion of social media site and marketing referral site that may well have that kind of power.

Even Groupon’s proponents sing its praises only warily, and its critics can be scathing in their condemnations. Yet, Groupon continues to grow. From nearly nothing in 2008, it now has around 7,000 workers and billions of dollars in revenue. It may turn out to be the fastest-growing company ever seen.

Here’s how it works. A Groupon representative works with you to negotiate a deal for a coupon, usually at a steep discount. Many businesses use coupons, but this is a coupon with several twists. You figure out what you want to offer, and at what discounted price. Say it’s a dog bath for $20 that usually costs $50.

Groupon has millions of subscribers who regularly log into the site or have asked that Groupon send them e-mail notifications of deals. Groupon puts the deal on its page and sends out “one day only” e-mail notifications that your pet grooming shop is offering a dog bath for only $20.

Here’s where the social site wrinkle comes in. If too few people are attracted to your offer and click to buy it, the deal doesn’t “activate.” It just dies. Note that the subscriber has to actually put some money on the table to move the deal toward activation. Groupon trumpets this as “collective buying power” and that it’s a benefit to the merchant because you won’t have just a few straggling coupons coming in, but perhaps hundreds of them. In exchange for driving all this new business, Groupon takes 50 percent of the value of the coupon off the top. That $20 dog bath yields Groupon $10 immediately, and Groupon then sends the dog groomer the remaining $10.

The downside, of course, is that you have to discount very sharply and pay Groupon a lot of money to get all those new customers. The usual merchant discount upfront is 50 percent. The merchant eventually gets half of that back and Groupon keeps the other half, so in effect the merchant has to discount 75 percent to use Groupon’s customer acquisition scheme. It’s here that the first big Groupon controversy swirls: Which businesses should run this deal, and how much should be discounted?

Over time, businesses have gotten savvier about this calculation. For example, companies that deal in luxury items with 200-percent and greater markups may benefit from higher traffic that pays considerably less than the going rate. Those with substantial fixed costs and much lower variable costs do well, too, because higher traffic simply adds gravy to the revenue stream once fixed costs are covered. Our dog groomer may actually do fairly well out of Groupon, because most of the salon costs are fixed. A small bakery might do even better, because its fixed costs are an even higher proportion of its cost structure, and selling all of its treats each day is more important than making maximum profit on each one and not selling them all. It’s also possible that driving more customers in to buy cupcakes might result in selling more rolls, too.

Even so, the deal has to be carefully priced and in thoughtful consideration of the entire product line. A $20 dog bath in a salon where sales of dog trimming services might average $75 doesn’t encourage buying much beyond the initial dog bath. The most successful companies say they use Groupon sparingly, for specific locations and for well-planned promotions. You can tailor the Groupon offer any way you want. Perversely, you might also find that your regular customers are among the biggest customers for your Groupon coupons, too, which is counterproductive and should be factored in.

That brings up Groupon’s other target for critics: retention. Many Groupon merchants have found that the initial surge of new customers quickly falls away. This is actually a common phenomenon with coupons, so that’s nothing new. Savvy merchants, however, are adopting Groupon as only part of a bigger strategy for catching new business and encouraging returns.

For example, your new customers can give their e-mails and other information in exchange for being told about future deals or even special events. Groupon can pull them in, but you have to close the rest of the retention deal yourself. To its credit, Groupon doesn’t lay claim to those swarming customers after they’ve bought their coupons. After that, they’re all yours.

A final caution that successful Groupon merchants often pass along: Staff up. Groupon’s reach is massive, and the influx of customers can quickly overwhelm a business model geared to much smaller and more regular flow. Groupon may be a classic case of being careful of what you wish for.•

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Altom is an independent local technology consultant. His column appears every other week. He can be reached at taltom@ibj.com.

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