Jan 28 2011

Groupon Locusts and the Coming Small Business Apocalypse

Published by at 11:27 am under Uncategorized

Here’s my latest post on the White Horse Blog.

At the dawn of 2011, the hottest trend in social marketing is the “daily deal” Web site, of which Groupon is the poster child. I’m not restricting my ire to Groupon alone here, but since they are the best known, you can take every instance of “Groupon” in this post to mean “any daily-deal Web site.”

Groupon is terrible for small business.

The siren call from Groupon is seductive to the business—no up-front payments for customer acquisition! Affluent, educated, female demographics! Fill your seats or appointment book for months!

But the costs are substantial. Groupon itself is very clear that daily deals are not a money-maker. They are a loss leader, and business should plan to lose money on the offer. The question, of course, is how much does customer acquisition cost in other channels, and how does that compare to the net cost to the business for running a Groupon?

But, most small businesses will have an extremely difficult time creating an apples-to-apples cost comparison. On The New York Times’ “You’re the Boss” blog, Jay Goltz runs through the customer acquisition cost calculations in some detail. It’s incredibly complicated, and fraught with the potential for faulty assumptions.

And herein lies the first huge problem for businesses that use Groupon: it’s not a level playing field. Groupon is a data-driven Web company that has tested and optimized thousands of deals. They know what will make them the most money, what the right tipping point is to guarantee that they will make money, and they have no reason to ever limit the number of deals that are sold.

A small business, on the other hand, has almost no information, and almost no negotiating power. Groupon’s contracts lock in businesses for 12 full months, preventing them from using another daily deal Web site. Groupon starts their negotiations at a 0/100 split (meaning Groupon keeps all of the revenue from each sale).

But, the bigger danger that Groupon brings up is the dreaded Groupon customer. Groupon touts the highly desirable demo of their audience, but the reality is that they rent you their list for 24 hours, and you have no control over who sees your deal.

Groupon offers low lifetime-value customers. By and large, Groupon’s customers have been trained to surf the deal, and have every reason to be loyal to Groupon—and no reason to be loyal to you. Groupon customers know that there’s no reason to go back to the spa that they tried because the next Groupon spa deal is just around the corner. Why would they be loyal to a business, when Groupon works so aggressively, and so successfully, to commoditize every merchant that works with it? Groupon’s pithy writing does not reflect any brand identity of the merchant.

Groupon uses the structure of a daily deal to reinforce that there will always be another great deal—maybe even better than the last one. So, Groupon subscribers become like rats, checking their email for a food pellet. When a really great deal comes along, they get a rush of dopamine just from buying it. In this way, getting the discount becomes a critical part of the buying experience.

Basically, Groupon trains customers to become like a swarm of locusts. They descend in droves to redeem their loss-leading coupons, then flit off to eviscerate the next business. Today a spa, tomorrow a wine bar; over the weekend, a restaurant, next week a sailing class; next month a yoga studio.

Because local businesses are highly fragmented, both in terms of industry and geography, it’s difficult for them to compare notes or band together to counteract this influence.

Besides, the science of discounting says that the price the consumer pays at the first interaction creates a price ceiling that it’s hard to claw back from.

Finally, the overwhelming locust swarm can easily turn off existing customers. If every new long-term customer is offset by an old customer feeling like a chump for missing a deal, and not able to get the service they are used to, Groupon could mean the business sees no net gain in customers at all.

Of course, all of these factors mean that we’re in a crazy, group-buying bubble. The recession has caused small businesses to be willing to steeply discount, and the newness of social networks has allowed Groupon and its ilk to grow quickly.

Expect to see more moderate deals in the months to come, and “deal fatigue.” There are already daily deal aggregators, like Yipit, that cull through the 500-some Groupon clones. And, a secondary market for deep discount sites, such as Dealigee has arisen.

If we have learned anything over the past ten years, it’s that all bubbles burst. And, the quicker the rise, the quicker the fall.

What’s your take on the Groupon model?

22 responses so far

  • Pingback: Tweets that mention Groupon Locusts and the Coming Small Business Apocalypse | Jamie Beckland -- Topsy.com

  • http://www.johnhaden.com john haden

    Jamie’s right…. Groupon is no good for small business! That’s why if you read all of the comments from the folks that actually use the service instead of just have an opinion about it like this d-bag Jamie does… you’ll realize that everyone hates it and why Google was a fool to offer a paltry $6B for the service. Guys like Jamie call themselves Emerging Media Strategists ’cause they have no “real” job title… so they invent one… this guy is a complete tool!

  • Pingback: Tweets that mention Groupon Locusts and the Coming Small Business Apocalypse | Jamie Beckland -- Topsy.com

  • Pingback: Tweets that mention Groupon Locusts and the Coming Small Business Apocalypse | Jamie Beckland -- Topsy.com

  • http://www.ahmadalia.com Ahmadali

    Hi Jamie,
    You make several excellent points.
    However, I’m not sure I agree with your overarching conclusion that Groupon is not good for small businesses.
    I think the issue is far more nuanced.
    Groupon wouldn’t be doing as well as it is if it wasn’t providing some value.
    But you are right: there are problems.
    Groupon must recognize that their real customers are the merchants – not the subscribers.
    In the long-term, if they don’t take care of their customers, they will have issues.
    If there is a lock-in clause as you describe, that’s a terrible thing – and does not bode well for their future.
    And a 50% margin is just too onerous. It will only lead to resentment later.
    But hey, the system is setup to incentivize them. All they have to do is keep it up until their IPO.
    I write about these issues in my paper, “Undressing Groupon”, in which I try to cut through the haze to really expose the essentials of the business model. For instance, I talk about how the deal activation threshold (the tipping point) has a purpose that is completely different from what people believe; the “collective buying power” is really a myth; and Groupon’s incentives are misaligned with their merchants’.
    Here is a link to the paper:
    http://www.ahmadalia.com/blog/2011/01/undressing-groupon.html

  • http://redesignmobile.com rakeshlobster

    Jamie-

    Even that analysis in the NYT showing how small business should calculate affect of Groupon had a serious flaw. It didn’t consider the revenue loss by existing customers who use Groupon as a cost.

    I think that’s a big deal. If 40% of Groupon buyers are existing customers, then I just lost 78% on them for no reason.

  • http://www.jamiebeckland.com/ Jamie Beckland

    Good point. Many Groupons are now restricted to “new customers only.” That’s pretty easy to enforce for tango lessons, but impossible for restaurants.

  • http://redesignmobile.com rakeshlobster

    That tends to piss off a lot of loyal customers.

    As someone who knows the economics of Groupon, I’d be embarrassed to use one at a place I frequented. But I bet most people don’t realize how bad a deal it is for the business.

  • Ccdb19

    In my industry, residential cleaning, there is a trail of businesses that have been put under by these deal web sites. Yet there always seems to be someone willing to try it. Our labor costs generally runn at 55% after payroll taxes so getting 25% of the list value gaurantees a loss before overhead on every transaction. Some companies have sold 2,000+ of these at a loss of $50 each. One larger company actually managed to honor all the coupons that came in. They got 6 regular customers (bi weekly service is the life blood of a cleaning service) as a result and the jury is still out on how long they will stay.

  • http://www.buckheadmassage.com Buckhead Massage Company

    My experience has been a nightmare and I have been calling Group on the DEVIL! It was a choice I made but I went off on them the next day after my deal ran because they did not have a rep for me here in Atlanta. They don’t care about return business because they are going to sell and have been planning on it since day one. I was in shock and horror when I saw my business had sold 2,800 massages before noon last July. they wanted me to keep going. they asked me to go to 3,000!! Can you believe that? I almost had a nervous breakdown. I could say so much more. : (

  • http://www.buckheadmassage.com Buckhead Massage Company

    I never use those either, even with my favorite places and even though I am now broke from using Group on. Okay, one white lie. I did once for skydiving but that is a bucket list thing and if I like it I will return for sure. And it was a local company not Group on.

  • http://www.buckheadmassage.com Buckhead Massage Company

    I dislike Group on very much and think they are they are so freakin GREEDY and customer service sucks!

  • http://www.jamiebeckland.com/ Jamie Beckland

    Sorry to hear this. What was your experience working with your sales rep? What were the terms of the deal? Would love to hear more.

  • Larryherz

    I have ran 2 groupons at my restaurant and learned more each time. They are more helpful now in there advice than at the beginning. The first time the split was 50/50, the second time i agreed to a one year exculsive for 60/40 but they added credit card fees. The first time I let each person buy as many as they want, not realizing that my regulars would buy 10, and sold 500. The second time I limited to one per person and sold 1,800. The problem is I was redeeming 50 a day for the first 2 weeks and some of my regulars couldn’t get in. Next time I will limit it to 1,000. The majority of groupon tables are young couples who have never even heard of my restaurant and they average $17 over the groupon. I actually break even on them with the discount.

  • http://www.jamiebeckland.com/ Jamie Beckland

    Good to hear that you are having a good experience, Larry. How easy is it for you to get a third offer from Groupon, especially with a hard cap of 1,000?

    Also, what is the value of the Groupon? Is it $17 over a $10 bill, or $17 over a $100 bill? That makes a big difference…

    Finally, were your regulars embarrassed to redeem so many Groupons in your first go round?

  • http://www.jamiebeckland.com/ Jamie Beckland

    Ahmadali,

    What a great paper! Really interesting stuff, especially the conclusion that Groupon is, at best, a transitory system.

    I thought of you when I saw this notice about Gmail getting more targeted ads – isn’t that exactly what you proposed?:

    http://mail.google.com/support/bin/answer.py?hl=en&ctx=mail&answer=1217362

  • http://www.ahmadalia.com Ahmadali

    Hi Jamie,
    I just noticed this comment. The Disqus notification was stuck in a spam folder.
    Thanks once more for the kind review.
    I looked at the Gmail link. Indeed, it is what I proposed in my paper.
    Thank you for noticing!
    I’m curious what the merchant side of the equation is going to look like – whether they are going to copy the internalized sales function model of Groupon (which would be a mistake) or innovate with an open externalized local affiliate model as I proposed.
    -A

  • RClay

    Spot-on commentary on the Groupon Phenomena.  I am in complete agreement with the “Groupon Locust” effect.  I would love to add something to your blog post, but it is perfect.  There seems to be a group of business owners that take a “true believer” position in regards to these deals, however, I cannot overlook the pavlovian conditioning that takes place with these business practices.  The entitled/non-loyal/something-for-nothing crowd is always primed to devour and they are increasing.    This is no doubt a bubble and will burst sooner or later as more small businesses become educated or go out of business.  I guess you could call that natural business selection, but I hate the fact that the hard work and value an honest business brings is consumed by the gluttonous consumption habits of deal junkies aided by their suppliers.   

  • Anonymous

    Groupon is clearly all about their own interests with zero retention rate. Clearly their business model won’t last long. In fact, one of my ‘groupon stores’ requires 25 followers, we’re at 21. Who’s to say they’ll even agree to run your promotion to their network if it doesn’t make them the most money?  

    I’d like to introduce this unique website www.MeetABusiness.com, which has been in the works for about a year with 2 other business partners. We do not charge businesses an arm and a leg to offer group coupons, like all the rest of the group coupon sites do. Ours doesn’t charge them anything except for the $9.95 monthly membership fee and a small extra fee if they want to purchase a deal of the day, week, or month, but the first 6 months are free, plus they get all of the other posting and searching benefits offered by the site, which the other group coupon sites don’t offer, such as business resource posting & searching, jobs posting & searching, events posting & searching, networking, and blog posting. The deal of the day feature I think could help you eliminate the ‘expiry’ issue you had with Groupon. Plus you’ll get a free long term backlink in our directory.We have over 300,000 business listings nationwide to date. Again, we are a low-cost alternative (at the moment we’re a “no cost” alternative because we’re free for 6 months) to all of the other group coupon sites that everyone complains are really bad for businesses, because they take so much of the pie from businesses.If you have any additional thoughts, comments or suggestions for the site, we are all ears. Would sincerely appreciate a plug from you on any of your network of sites.

  • Anonymous

    I never use those either, even with my favorite places and even though I
    am now broke from using Group on. Okay, one white lie. I did once for
    skydiving but that is a bucket list thing and if I like it I will
    return for sure. And it was a local company not Group on. More at: http://www.sudeposu.cc

  • Patterson

    I think
    there is a serious flaw in the Groupon business model. Basically over time it
    will kill the brands of its participating businesses and itself along with it.

     

    And here is
    how.

     

    If you are
    a consumer and you get 90% off to visit a store and buy say a massage, what are
    the chances you will go back there again and pay more? In my opinion, zero to
    fractional.  Therefore most if not all sales
    for the participating businesses (through Groupon) are first time customers.
    Well at such huge discounts how are they going to make enough money from this arrangement
    to preserve their image over time? I understand the time value of money
    argument but no amount of volume (the group variable in this equation) can take
    into consideration a 90% discount over time, unless your operating costs are
    like 5 cents to the dollar, which I doubt highly given we are mostly talking
    retail stores. Ultimately by servicing more people for unsustainable returns,
    negative cashflow in other words, the participating businesses will over time
    erode their service quality and ultimately generate bad word of mouth for
    themselves which, given that Groupon is at the top of this pyramid, will in
    turn kill Groupon itself.

     

    Of course everyone
    can avoid this issue if they simply raise capital to hide the losses. But that’s
    only tenable if you have an up and coming IPO on the cards, which I doubt many participating
    businesses have.

     

    Groupon
    however does. In their IPO prospectus they claim that it’s OK to lose a few
    hundred million and blame it on marketing because really what they are doing is
    buying market share in a nascent industry. Really? Coupons is a nascent
    industry? I thought it had been around since 1887, oh that’s right, it has!
    Being a technology enabled service or product (using the web to do business at
    scale) does not mean you invented the industry you operate within.

     

    From the
    outside of the bubble looking in it seems more like simply buying customers with
    no regard for the long term impact. Sound like someone you know? That’s right,
    the participating businesses themselves, poor guys.

     

    I bet you won’t
    see Apple selling iPads on Groupon anytime soon.

  • johnyaeger

    Ahmadali what a comprehensive review of the Groupon as a business model. They probably need to recreate and innovate their business model to address the pressing concerns that are on their gates..