In a recent article that can be found here, TechCrunch columnist Rocky Agrawal outlines how the Groupon model works and why it might be the next economic “bubble” in the near future. While this may be a bit extreme, Groupon and Living Social programs can be a huge danger to a small, local business taking advantage of a daily deals program. On paper, a daily deal can seem like the win-win situation. However, when you dive in deeper to the Groupon model, the reality is starker. If you haven’t already run a daily deal, the business model works as follows:
This system is sold on the basis that the merchant doesn’t have to pay upfront for marketing. The truth, however, is that the merchant does have to upfront for increased inventory, staffing, or overhead. On top of that, it will be days, even months before you receive your half of the deal proceeds.
Since a daily deal affects so many areas of a business’ realm, we’ve put together several items to consider before running you run a daily deal.
Always do the math before signing up for a Daily Deal
Suppose that you’re a merchant who sells widgets. The widgets cost you $7 a piece, and you can sell them in your store for $10 a piece. You want to sign up for a Groupon, so you run a deal with a minimum of 1,000 units for the deal to be active, and purchase 2,000 units in case.
Groupon terms are typically the following:
- You promise to sell your product at 50% (or similar) off retail
- Groupon will take 50% of the gross profit
- Groupon takes all the money from customers and disperses you money in the following intervals:
- 33% at 5 days
- 33% at 30 days
- 33% at 60 days
If 2,000 coupons are bought, you know the following facts:
| Revenue | Losses | Total | |
| Your inventory is worth: | $20,000 | ||
| You will spend full cost on inventory: | $14,000 | ||
| You will sell your inventory at 50% off retail: | -$4,000 | ||
| $10,000 | |||
| You will give Groupon half of the value | -$5,000 | ||
| Leaving you with the following receivables: | $1,667 | ||
| $1,667 | |||
| $1,667 | |||
| Total incoming cash flow: (at the end of 60 days) | $5,000 |
You take home $5,000
Groupon takes home $5,000
You lose $9,000 of inventory cost, 64% of cost, 75% of retail value!
Groupon has assumed $0 risk while you have assumed $14,000 risk, with a guaranteed $9,000 loss.
AND you have no guarantee that those customers will turn into repeat customers.
So, not only are you losing money simply purchasing the inventory before the Groupon, your assets are tied up in that inventory, and you won’t be fully paid until 60 days out. Even with net/30 terms on your inventory, you’ll still be stuck with a bill of $9,000 to be paid out of pocket.
You just paid $9,000 for 2,000 untargeted customers who may or may not return to buy full-priced inventory.
Now, this is a very simple example, and the math is different for service companies, but it’s clear how important it is that you know the importance of what risk and loss you’re assuming.
The risk assumed is substantial, and the costs could be enough to bankrupt some companies.
Daily Deals is the same as paying someone money to give them cheap product at a loss
In the previous example, you would essentially be paying Groupon $5,000 for to undercut the value of your products with the potential benefit of new customers. Your initial customers will likely be gained at a loss, with potential for them to return at full price. But, how many of them will return?
Daily Deals don’t necessarily mean return clients
When signing up for a daily deal, it’s extremely important to keep your client base and their behavior in mind. Just because you get a short-term infusion of immediate customers, you won’t necessarily keep all, or any, of them as return clients.
For example:
If you are a brand new restaurant with an excellent menu and already reasonable prices, you very well may see many return customers as a result of the deal. However, if you offer a very selective product that is on the more expensive end of the spectrum, or you sell a long-lasting product, you may not see any return customers at all.
Also, the market that subscribes to both Groupon and LivingSocial may or may not be your target market/customer. According to the LivingSocial website, 83% of their users are younger than 50 years of age, with 70% being female. Groupon’s user base is similar, stating that “the majority of Groupon users are college educated, young females” on Grouponworks.com.
If you’re selling monkey wrenches, this is probably not the market you want to be reaching.
Daily Deals do mean a short-term cash infusion, at a long-term loss
While paying a company such as Groupon or LivingSocial to give away your product doesn’t always make sense, it does equate to a short-term cash infusion. If you’re a particularly cash-strapped organization, this might be a solid boost to get you back in the game.
Keep in mind, however, that this equates to a long-term loss and you will still need to upfront the man-hours and inventory.
If you’re doing your marketing right, you shouldn’t need a Daily Deal
Groupon is perceived as a marketing tool, and it can potentially be. However, if you’re marketing is being run correctly already, you should have no reason to run a Groupon to begin with. You have the opportunity to take advantage of word of mouth, online measurable, print, banner, radio, tv, event, or gureilla, marketing (the list goes on and on) before running a Groupon. For the cost that it takes to run a Groupon, you can run a substantial local marketing campaign that will get you long-lasting, measurable results without under-cutting your branding.
If you’re offering a product that people truly do want that meets a true need, you can find your customers without Groupon using better, proven marketing methods.
Daily Deals undercut your branding
Your pricing policy, your product design, your store layout, your logo, etc are all designed to build your brand. Pricing policy and the effect that it has on the human psyche is a large, complex decision and running a Groupon could damage your brand and pricing policy substantially.
What you’re telling your customers when you run a daily deal is that your product/service/food is so undeserving of the full price that you have to cut the price in half to make it worth it.
Think about the companies you’ve seen running a Groupon or Living Social deal. Have you ever seen Louis Vuitton run a Groupon? How about Mercedes Benz or Express clothing? I would put money down that you never will, and the reason is that their brand is built on the perceived value of their products. A Louis Vuitton purse doesn’t cost $1,000 to make, but people will pay that because the value and image perceived is worth the extra cost.
If Louis Vuitton were to offer their purses at $500 off on Groupon, the mystique, exclusivity, and image of the entire brand would be severally damaged. If you have a brand that is built on perceived quality, you could be waging psychological warfare on your own profit by undercutting it with a daily deal.
Daily Deals can work for you if:
- Your costs are less than 25% of full retail price
- Your target market falls in the Groupon or LivingSocial range
- Your product requires return visits for full value to the customer
- Your branding isn’t built upon high perceived value
- You can handle a large influx of customers
Daily deals can work out for you if you have a very specific business model. If your costs fall under the 25% threshold, then you can actually make money by running a deal and gain from the potential increased customer base. If you don’t meet most or all of these catches, I would seriously think twice before running a daily deal.