Even before Google bid $6 billion to buy Groupon, the online coupon startup, earlier this week, the media and businesses alike were trying to make sense of this innovative new promotional tool. Forbes anointed Groupon “the fastest growing company… ever,” and there are stories aplenty about businesses that are besieged by new customers when they enlist Groupon to offer huge discounts to customers who sign up for the daily email blast.
Consider the suburban Boston barbecue chain Blue Ribbon BBQ. When Groupon offered $15 worth of barbecue for $7, more than 16,000 people bought the deal—–meaning the chain sold $250,000 worth of barbecue in less than 24 hours. [Note: Due to an editing error, a previous version of this article incorrectly stated that the promotion gave Blue Ribbon $250,000 in new revenue in 24 hours.]
But for the businesses that are using this service—and ultimately, for Google, which is betting big that Groupon can continue to grow profitably—there’s a big unanswered question: are these highly-discounted promotions really good for your company? As a pricing strategy consultant, I’m hearing this question constantly as small businesses struggle to figure out whether the strategy that’s driven Groupon’s growth to date really makes sense for them.
The answer depends on your ultimate goal. Do you want to use these promotions to sell products and services to price sensitive customers? Or do you hope Groupons will be a loss leader that allows you to sell other higher-margin products? Or are you betting that that once consumers try your product, they’ll pay full price in the future?
For many firms, the first strategy can make some sense. Every company should offer “backdoor” discounts aimed at attracting customers who are interested in their products but refrain from purchasing because the price is too high. Businesses need to find ways to offer discounts to budget conscious customers while minimizing cannibalization of full-price purchases. (Anytime a customer who would have paid full price takes advantage of a discount, potential profits shrink.)
Undertaking a Groupon-like promotion can be a great back door discount distribution: tens of thousands of thrifty consumers have signed up to receive (and review) discount emails and are willing to prepay for the deal. It comes at a steep cost, however, since Groupon typically takes 50 percent of the revenue customers ante up. But if you view Groupon as a tactic to garner new customers—the way retailers use outlet stores and restaurants offer “early bird” specials—and are comfortable with the revenue you’re giving up by offering a deeply discounted price, then Groupon can make sense.
Some businesses view Groupon as a loss leader to entice consumers to purchase high margin additional products. I call this the “happy hour hope”: cheap salty snacks (the product or service that is being discounted) lead to high-margin fancy drink purchases. Yes, loss-leaders are a tried and true pricing strategy. However, keep in mind that deal-seekers who take advantage of these discounts are often closely watching their budget. Is it realistic to expect that they will splurge on high margin complementary items such as $8 bottles of Pellegrino or $7 buckets of popcorn?
The last strategy—hoping that people who become one-time customers via Groupon will become regulars—is the shakiest proposition. Think about it: how many times have you purchased a product at a significant discount (50% or more) and then repeatedly returned to pay full price? Sure, some people will return at full price, but be realistic in estimating how many will do so.
Here are a few tips about when and how these promotions can successfully generate future full-price purchases:
Offer a necessity product. Customers need to continue purchasing the product over time, not just once. Zoots dry cleaners recently offered a home delivery promotion that hooked me. I need a dry cleaner regularly, the promotion incentivized me to try Zoots, and I’ll be a full-price customer after the promotion ends.
Ensure your product is a realistic alternative. I may drive 10 miles to reap a 50% discount at a Japanese restaurant. However, since there are many good sushi joints in my neighborhood, it’s a stretch to believe that I’ll drive 10 miles to pay full price in the future. One option for a local restaurant seeking repeat business is to do a coupon mailing in close-by geographic zones (or for Groupon-like companies to tailor promotions by zip codes).
Avoid devaluing your product. Once a rock-bottom price is set in a customer’s mind, it’s a challenge to get them to pay significantly more. Two key tactics to avoid devaluation is to keep discounts reasonable (no more than 20% off, for example) and/or offer the discount on a lower version (“only valid during off-peak times or on basic products”).
While Google may find Groupon’s business model wildly attractive, using these services is not a slam dunk decision for every company. Before facing an onslaught of bargain hunters, articulate your goals, double-check them to ensure they are realistic, and make sure that you aren’t devaluing your products.
Rafi Mohammed is a pricing strategy consultant and author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow (HarperBusiness). His article “Ditch the Discounts” will appear in the January/February 2011 issue of Harvard Business Review.