Is Groupon Good for Retailers?
t first blush, the two-year-old online start-up Groupon seems a bit audacious.
For starters, there's the news that the deal-of-the-day website turned down a $6 billion acquisition offer from Google last month.
Then there's the company's business model: selling discount vouchers to restaurants, spas, paintball parties, etc., at a major markdown—up to 90 percent off a retailer's usual prices—and then requiring the retailer to pay a big chunk of the voucher revenues back to Groupon.
But the Chicago-based firm is "the fastest growing company in web history," according to Forbes, and may file for an initial public offering by the end of 2011, according to the New York Times. "Groupon has attracted remarkable interest," says Harvard Business School professor Benjamin G. Edelman. "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 online."
For consumers, there's an obvious appeal to scoring a $50 meal for 15 bucks—especially in a recession. But for retailers offering the deals through Groupon, does the publicity compensate for the deep hit to profit margins? A new working paper, To Groupon or Not to Groupon: The Profitability of Deep Discounts, sets out to help small businesses decide whether offering large discount vouchers is a profitable decision.
HBS Working Knowledge recently discussed the topic with Edelman, who cowrote the paper with Harvard graduate students Sonia Jaffe (Department of Economics) and Scott Duke Kominers (Harvard Business School).
Carmen Nobel: How can a discount voucher service like Groupon benefit retailers?
Ben Edelman: Our paper looks at two distinct benefits a discount voucher service can offer. First, discount vouchers can provide price discrimination, letting merchants reach customers who value the merchant less than the merchant's ordinary customers do. For instance, some customers are willing to pay full price for a given restaurant—great! The restaurant would like to keep charging those customers full price, while charging a lower price to new customers who aren't willing to pay as much but who are still willing to pay something above the restaurant's costs.
Second, vouchers can provide an advertising benefit—announcing a merchant's existence to thousands of consumers en masse, and potentially building buzz among consumers above and beyond sales to the consumers who actually buy the vouchers. This effect is more difficult to measure, but many merchants perceive it to be real. Where it exists, it's an important source of value that a discount voucher service can deliver.
Q: Explain the theoretical model you describe in your paper and how it can help retailers decide whether a voucher service like Groupon makes sense for them.
A: We present a model of online discount vouchers that [offer deals] to consumers who may or may not value the merchant's offering. Importantly, some consumers already know and patronize the merchant, so a voucher discount combines multiple effects—it attracts new customers but it may also offer an unnecessary discount to existing customers.
We then extend the model to consider both the possibility of merchants raising their prices in anticipation of offering discounts and the possibility of consumers buying multiple discount vouchers.
By demonstrating the importance of these factors, and exploring the relationship between these factors, we hope to help retailers predict whether a discount voucher promotion is likely to be profitable for them. Our approach can also help retailers design discounts that better serve their objectives.
Q: You recommend that retailers disallow the purchase of multiple discount vouchers from a single customer, or else run the risk that the customer will never come back and pay full price. Are there some practical steps that merchants can take to prevent multiple purchases?
A: In practice, it's not easy to prohibit the purchase of multiple vouchers. A voucher service can configure its systems so that a single account only lets a user purchase a given offer once. But then users can open multiple accounts—a tactic that consumers have already used at many online retailers. And industry norms let consumers find ways around almost any rule intended to block multiple purchases. For example, even when consumers are limited to a single voucher, they are typically permitted to buy additional vouchers as gifts for others. So if three customers each want three vouchers, each can buy one for himself and one for each of his two friends, complying with the rules but obtaining multiple vouchers.
Q: What are some of the other risks that businesses run when deciding to participate in a discount voucher program like Groupon? What steps can they take to mitigate those risks?
A: Stories abound of consumers who try to game the system. Consider a customer who wants to dine on a weekend using a voucher valid on weekdays only. Some consumers surely make that error by accident, failing to read all the terms and conditions. Sophisticated consumers might try to game the system by posing as customers who failed to read the "small print." What exactly is a merchant to do when a consumer violates one of various small-print rules? Requiring customers to present vouchers before ordering is one solution, but they understandably dislike this approach, finding it especially tacky.
One first step is for merchants to review the exact text to be shown to consumers. Be wary of vague language: "excludes special offers" invites disputes over whether the chef's special and a child portion are eligible; "not valid on major holidays" raises the question of which days are "major." We've been surprised to see such imprecise wording on vouchers, and we think merchants and voucher services can do better.
Merchants should also confirm their legal obligations when accepting discount vouchers. Once customers prepay, they often enjoy consumer protections with regard to gift certificates-including special rules as to expiration and partial refunds. Here in Massachusetts, a gift certificate that is 90 percent used may be redeemed in cash if the customer so requests.