The Groupon Phenomenon — Is It Sustainable?

While the Groupon model — the idea of getting a $50 meal for $15 — is clearly compelling to consumers, does it work for the retailer?

Harvard University’s “Working Knowledge” (a FREE weekly e-zine – http://hbswk.hhb.edu — with a with a wealth of valuable information) ran an article by Carmen Nobel entitled “Is Groupon Good for Retailers” in its Jan. 10, 2011, newsletter that included 52 comments.  The source document, which was available in the article is a working paper entitled “To Groupon or Not to Groupon:  The Profitability of Deep Discounts” by Benjamin Edelman, Sonia Jaffe and Scott Duke Kominers.  Edelman is an assistant professor in the Negotiation, Organizations and Markets unit at Harvard Business School.

As a way of background, Google offered the founders of Groupon $6 billion and they turned it down.  Forbes calls Groupon “the fastest growing company in Web history” and predictions are for an initial public offering (IPO) before the end of 2011.

The Groupon business model is simple.  They offer consumers vouchers with major discounts of up to 90 percent off the regular cost.  When redeemed, the establishment pays Groupon 50 percent of the vaucher’s revenues.

Edelman, co-author of the paper, writes “With the economy lagging, consumers are increasingly responsive to discounts.  And Groupon has found a way to feature small businesses that haven’t traditionally advertised on-line.”

The major questions about the viability of the Groupon concept focus on the sustainability of the business model:

• Will people take advantage of the deep discounts and never have anything to do with the retailer?
• What does the business model do for existing loyal customers?
• How well does Groupon work for an established retailer like The Gap?
• How should retailers follow-up on the new business generated by Groupon?

Long-Term Benefits of Groupon to Retailers

One comment to the Carmen Nobel article focuses on the sustainability of Groupon.  The person offering the comment was a senior consultant identified as Peter.  He writes:

“My belief is that Groupon’s model is unsustainable.

“This is why. The discounts are too big and the cut to Groupon is so high that it would appear that most businesses would lose money on Groupons. So if they lose money on the Groupon, the hope is that they will have generated interest in their business and perhaps some future customers. But I don’t think the evidence for most businesses suggests this. A lot of people buy Groupons because they get the email and feel a sense of urgency to get the deal. This means it’s probably not something that those people would buy ordinarily, and probably not something they’d buy at full price in the future.

“Groupon is doing well right now, but I don’t see this success, particularly the growth, continuing in the long term. They want to go public? Why would any long term investor buy this stock? Groupon will likely reach saturation quickly, and then begin the inevitable decline. Remember there are many competitors out there; they may not approach the penetration of Groupon but they will surely dilute the value – most likely by driving down the percentage share that goes to the coupon company, or at the very least, limiting its growth….”

The Affect on Loyal Customers

In the main article, the question was raised:  “How does the service affect business with existing customers who historically have paid full price?”

Edelman’s answer: “We’ve seen two main effects. First, some discount voucher services send users to merchants en masse. The day after a Groupon is released, hundreds of buyers tend to swamp a small business unprepared for the rush. That barrage of customers can disrupt service to full-price customers, who may end up waiting for service. That said, we don’t think this kind of disruption is inevitable; other services have found ways to spread customers over time. For example, Restaurant.com sends customers on an ongoing basis rather than all at once.

“Second, full-price customers may be unhappy when they realize others are getting large discounts. We’ve all had the experience on an airplane of talking to a nearby passenger whose fare was vastly different. But that’s a new experience at local retailers. Existing customers might “revolt,” becoming less willing to pay full price once they realize that others are paying less.”

How Does Groupon Work with Established Retailers

One of Groupon’s major forays was with The Gap, where 400,000 Groupon vouchers were redeemed.  Edelman’s comments:

“Discount vouchers seem to be most compelling for merchants with a low cost of goods sold, and with a highly perishable product. Restaurants fit the bill in that ingredients are often just 30 percent of menu price, and every hour a table sits empty is lost revenue that can never be recovered. So too for spas, gyms, hotels, and many other services.

“Retailers of durable products, like manufactured goods and clothing, are in a somewhat different position. Typically, their business requires a higher cost of goods sold, giving them less room to discount.  And if they don’t sell a product one day, they can hold it in inventory for future sales, so marginal business is less urgent for them.

“We’re not prepared to say Gap’s Groupon was a mistake. Getting customers into Gap stores with a Groupon might lead to big sales—above and beyond the voucher value. Plus, those customers might tell their friends. And we suspect that Groupon charged Gap less than its usual fee.  Still, Gap might have been able to run a similar promotion itself, without going through Groupon; Gap’s established brand would have attracted substantial consumer interest. Other large merchants can also handle their own offers; the Groupon-style brand and infrastructure are most valuable to smaller firms.”

The Need for Follow-Up Marketing

Linda Rouyer, Principal of Source Solution Group, a business marketing and resource consulting firm based in Orange County, California, made the following comment relating to need for Groupon retailers to follow-up on the initial offer.

“Something I think that all retailers can do is to use the influx of new visitors as an opportunity to spring board into a more complete and sustainable strategy.  I don’t know about you but I have never had a retailer reach out to me after I used a groupon???  Why not? – some of them where pretty good – but with so many options in the market place if you are not extraordinary then you better have a good solid marketing plan to stay connected and top of mind to those who have experienced you.

“I think using groupon as a stand- alone strategy in today’s market is not going to deliver a sustainable result.   But think of it like this – there was a day (and some still do) that people regularly spent huge amounts of money to have ads in magazines or newspapers – this static imprint was a far cry from having a live body in your establishment – with an opportunity to begin a relationship.