To Groupon or Not to Groupon?

Groupon has taken the local deal market by storm, growing quickly to $2B in revenue (depending on how you define “revenue”).  The local deals company has also created massive buzz and is now preparing for one of the largest IPOs in history.  As a “pricing person”, I get a lot of questions from small business owners about whether they should run a Groupon.

First, let’s look at some of the positives:

• You get money “upfront”.  Groupon pays you over a period of 60 days or so.  Depending on how quickly your customers redeem the Groupons, you can get a short-term cash infusion.  Of course, if customers redeem right away, you could actually be negative on cash.
• You get massive exposure.
• You get customers in the door with a chance to upsell.

Now, let’s look at some of the negatives:

• You’re giving up a ton of margin.  You’re giving a big discount, plus Groupon takes about half of what’s left.  This means you need 75% gross margin just to break even.
• You get exposure, but you don’t get contact information– Groupon owns that.
• The customers you get in the door are, by definition, either price buyers, or your regular customers who would have paid a higher price anyway.  In other words, you’re attracting exactly the wrong kind of new customers, and devaluing your offering for your best customers.
• Legal issues.  Groupon’s contract prevents you from running deal with competitors, even if Groupon doesn’t run your deal.  So you’re locked in with Groupon without knowing if you’re getting anything in return.  In addition, state laws about gift cards may or may not apply to Groupons, which might invalidate the expiration date of the Groupon, pushing your liability out to seven years.

So, if you still want to run a deal, here’s what you need to do:

• Set a cap on the number of deals that can be sold.  This limits your liability.
• Instead of running the deal for anything, place restrictions on what/when/where/how people can purchase.  This way, you promote high gross margin items, or boost sales in low-traffic times.
• Make sure you understand the contract, including exclusivity and payment terms.
• Run the numbers.  Look at your overall profit and monthly cash flow based on Groupons sold at the “tipping point” when a deal goes live, the maximum deal number, and part way in between.  Include the items sold under the deal, the percentage of new versus current customers, the cost of what they buy, and expected add-on and follow-on sales.
• Compare these numbers of alternative promotional strategies.  You don’t want to run a Groupon just because their sales rep happened to call you.  Do it if it’s right for your business.  Given the cost of the deal (whether through Groupon, LivingSocial, ScoutMob, or any of the other deal sites that are popping up like weeds), what else could you do with the money?  Hold a special event for your best customers and their friends?  Send a coupon to your own mailing list?  (Then, even if you offer a deep discount, at least you don’t have to split the rest with the deal vendor.)  Run traditional advertising?
• When you make the comparison, consider not only the one-time numbers, but the types of customers you are attracting.

You may be thinking that I’m very negative on Groupons and similar deals, but that’s not true.  They just need to be used strategically.  In fact, I took advantage of a Groupon recently to sign up for a Thai cooking class at a restaurant that is still in soft launch mode.  Business is slow as they work out the kinks, and Groupon was a great way for them to attract attention and get people to taste the food.

Unfortunately, the growth pressure on the deal vendors, especially if you’re about to go public and are losing money, is to sell as many deal on as favorable terms as possible for the vendor, regardless of whether it’s the right thing for the local business.  Your customers may be getting a great deal, but are you?