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3 reasons Groupon is bad for your business

3 reasons Groupon is bad for your business Francois Gossieaux

Social buying sites like Groupon and LivingSocial tap into basic human social instincts -- but in ways that some would find manipulative. The first powerful human tendency they exploit is one that has been manipulated by advertisers for a long time -- how we react to scarcity. When an item is scarce, people always attribute a higher value to it than when an item is abundant. It is a basic human reaction that even has a name: the scarcity principle.

The second social instinct that social buying sites tap into is the human tribal instinct -- our drive to want to help and inform other members from our tribes, our friends, our families, or other social networks. Combine the scarcity principle with our innate sense for reciprocity, and you get Groupon and other social buying site bargains that travel around networks like wildfire. In fact, they probably form forces of increasing returns and virtuous circles that reinforce one another -- the faster a bargain spreads, the scarcer it will become. And they don't stop by leveraging scarcity; they add time pressure to it, which triggers a more ancient emotional and automatic reaction in humans rather than the more deliberate, thoughtful, and rational decision that time would allow. Lastly, they combine scarcity with competition, creating an even more powerful mix. In his book "Influence," Robert Cialdini points out "not only do we want the same item more when it is scarce, we want it most when we are in competition for it."

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So yes, social buying sites are social, but they manipulate social instincts and relations for commercial purposes. In effect, they are commercializing the social, which probably cannot be good in the long run.

But perhaps the most important thing to realize about Groupon, the fastest growing company in the world, and other sites like it is that they are bad for your business, bad for the businesses around you, and perhaps most important, bad for consumers in the long term as well.

There are three main reasons for that. I'll explore each one on the following pages.

Coupons trigger people's pleasure side of the brain. That is the part of our brain that gets addicted to things and needs more of the same in order to get the same satisfaction -- things like alcohol, drugs, sex, and now also discounts.

Once people expect a product at a certain price, it is very hard to get them to pay more for it. So if you are going to discount your products or services by 50 percent, you will find it almost impossible to ever get paid what you used to get paid before. Discounts not only destroy your profitability, but they also destroy the profitability for every other business around you; they destroy the profitability for entire geographies or industries.

The world of business is littered with case studies that prove that point -- a recent one being the pet food industry in Brazil. As economic conditions improved in Brazil over the past few decades, more people kept pets, and an increasing number of them fed them packaged foods -- the perfect storm for the creation of a huge new market. The subsequent competitive war in Brazil, however, centered on pricing and discounts to gain market share, and it destroyed the market for all the players. None of the pet food providers in Brazil can achieve profitability that comes anywhere near their profitability levels in other countries. In short, pricing and discounts destroyed the opportunity for healthy profits for everyone.

When you promote a voucher on Groupon, you typically discount your offer by 50 percent and pay Groupon 50 percent of your revenue -- which leaves you with 25 percent of the revenue that you would normally get for your discounted product or service. People buy the coupon, print it out, and present it when they buy the product or service. You can track whether people already submitted a coupon by scanning their coupons, but since most Groupon customers are small mom-and-pop stores like your local fish store, most of them don't have that capability. Even if they had it, it is not hard for coupon addicts to set up multiple email accounts and buy more than one coupon even if there is a restriction for one coupon per customers.

As a Groupon affiliate, you could find yourself selling tons of products and services at 75 percent off from what you normally get to the same people over and over again, for months. Such a business model has to have a severe impact on profitability, and perhaps even on business viability. Not only that, but regular customers, those who have been paying full price for years, are likely to hear about Groupon offers and use them as well -- and there is no way anyone can justify the profitability of existing customers that way, even when making more than 75 percent margin on product or service offerings.

So what happens when profits and margins get eroded significantly? Companies hire less expensive people, reduce staff, start offering less product or service for the same price, or start raising prices on their regular customers, as discussed in a recent Harvard Business School working paper on Groupon in which a restaurant adopted this strategy (PDF). All of those tactics inevitably reduce customer satisfaction and further erode profitability. We've all heard the stories of people who are paying full price for their facial having to wait for hours because a Groupon campaign recently hit, or the local restaurant that had to close shop after a Groupon sale. The virtuous circle that Groupon taps into results in a vicious circle for affiliates, their competitors, and their customers.

You cannot build a lasting competitive differentiator based on pricing -- pricing is the only differentiator that can be copied by others in a matter of seconds. Plus, it does not help you build loyalty. If customers buy your products based on price, they will go wherever the best price is. Coupons only make sense if you can attract new customers and if you can get those new customers to buy more products at full price -- and clearly that is not what is happening. According to a study by Professor Utpal Dholakia from Rice University, only 13 percent of Groupon users buy additional products at full price. Not only that, but as Dholakia points out, there is "abundant academic research (PDF) showing that price promotions erode brand value and have few, if any, beneficial long term impact for business."

The sales tactics of Groupon and other social buying sites are not all that different from those used by manipulative marketers who used to sell us timeshares or other products and services in the past (i.e., creating a sense of scarcity combined with time pressure and competition). However, they deploy those tactics on social platforms where the rate of word of mouth and the speed of basic contagious human reactions, such as panic or flight, are much higher than they were in face-to-face environments. When the dust settles, buyers will see right through those tactics and put the businesses that employ them in the same category as used car sale lots and timeshares -- environments where there is always a winner and a loser and that people would rather avoid unless they have no other choice.

In addition, considering the disastrous long-term economics and the lack of competitive differentiation offered by discounts, small businesses should do everything they can to steer clear of transforming their long-term customer relationships to dealings based on pricing. Find your consumer tribes, and try to understand how you can provide value to those communities. As a small local photographer, for example, go and take professional pictures of the local high school sports teams once a week, and post them on a secured community site for parents to view them, download them, and buy framed versions of them. In the process you might not only generate new business, but also mobilize a tribe of parents that could be valuable for other businesses in your area.

As a massage therapist or a small spa owner, offer your best customers the possibility to invite their friends for a free massage. That is truly social -- allowing people to give friends or family a free and valuable gift for a service they know well and think highly of (not one they know nothing about and bought on price only). Not only will you increase your chances of repeat business, but you will also keep 50 percent more revenue than you would using Groupon. To ensure a healthy business outlook for you and all your competitors, you need to base your business's value proposition on value and trust -- not price and discounts.

Francois Gossieaux is co-founder and partner of Human 1.0.

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Through his role as a co-founder and partner at Human 1.0, a marketing innovation strategy firm that works with leading brands, and his role as a Senior Fellow and Board Member at the Society for New Communications Research (SNCR), Francois has...

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to leave comments.

Commenter: Albert Maruggi

2011, August 28

and now for the really, really bad news. This is essentially the WalMarting of the American economy, and dare I say the Freemium model which social media types are so apt to embrace. In the last 25 years we have undermine brand premium pricing, (even the beloved Nordstrom also is located in the Mall of America with Nordstrom Rack ) and built a crazy expectation that everything costs next to nothing. Well greedy consumers apparently win out over unwitting employees. What the hell are we thinking, the less we pay the less we get paid. Or conversely the less we charge the more we need to sell. What has all this really done? It's allowed most of us consumers to buy into the concept the people, yes people are worth very little in the grand scheme of things. So enjoy your 50% off. Maybe you got that patio furniture and someone got laid off. Or maybe you got that deal because they raised the price 100% the previous week. In either case, distracting consumers with price to manipulate behavior is an age old tactic that creates a race to the bottom. Happy landings.

Commenter: Richard Fisher

2011, July 29

Hi, points are well taken. Because it's relevant, and pretty useful for merchants who are fearful of doing Groupons, you should know that there are merchant agencies that will work for you for free, and get you better revenue splits with the deal sites. Full disclosure, I founded one of these, dealVITA.com, but we have pull with the deal sites since we represent a lot of merchants at this stage. We're getting some merchants 80-20 splits (not the 50-50 that was described)... again, we're entirely free (just a fee to the deal sites). It's ridiculous the time burden and cost these deal sites put on businesses. Sorry for the plug, once again, but a site like dealVITA wants to help.

Commenter: Tamara Jacobs

2011, July 26

It seems that the fundamentals of how to do business were periodically forgotten when this article was written. For starters, small businesses and new businesses especially, have to get people 'in the door' if word about their company is going to spread. Limited-time, cost-saving promotions has always been the most effective way of doing this - 50% off your first yoga 3 yoga classes; free internet marketing consultation, book now; purchase one massage and get the second one half off. How and why would anybody try something new, or better yet, leave their existing service provider, if there is no cost incentive? Secondly, the principle reason why social media has been so widely embraced by brands around the world, is because they have recognised the power social influence has on purchasing decisions. The truth is, marketers have always known this but since the evolution of all of these social platforms, word-of-mouth marketing is able to spread further and faster than it ever has before. People are sharing more today than they ever have before. Brands seek the opinions of their consumers and are willing to make them public at the risk of getting a bad review because they are such a powerful marketing tool. There would be little to no interest in social media from the perspective of brands, if they didn't believe it could be commercialised. Thirdly, scarcity has always been a major driver of interest. People are wired to want things that they don't think they can have- this dates all the way back to Adam and Eve. The entire luxury industry is build on rarity and aspiration. As for companies never being able to ask for the original price again - how can that possibly be? All consumers understand what a sale is, what a one-time offer is. The point is to get them in the door, let the product or service sell itself and then go back to charging your regular rate. Moreover, the companies that are featured on Groupon have given them their consent. They aren't just handing out freebies without the permission of the service or product provider! Personally, I think that social buying sites like Groupon are making business possible for small indies around the world, while giving consumers something to get excited about and share with their peers. They are using the available technologies to profit from existing trends and have created a successful business model in doing so.

Commenter: Doug L

2011, July 25

The world has moved on post economic meltdown. Businesses have to adjust to this. Some already are by reducing the contents of their products but charging the same prices whilst hoping customers don't notice, offering products on 'sale' whilst reducing the size overly disproportiontely (and then returning the price to the original price but not the contents. These will suffer in the long run. Most people know its an economic game and not some altruistic society. People want value for money with an honest relationship with a brand. The clear message is for businesses that need to use Groupon is that they are not offering value. Get the offer right (by managing both sides of the cost / price relationship) and Groupon would be history. Not sure how you can end with a call to give away product. That is just bad business. If the recipient values the service why give it to them for free? I love the 'opportunity cost' saving of not paying Groupon 50% of the revenue. You get to keep 100% of exactly zero..........

Commenter: Kevin Wells

2011, July 25

Francois, I would disagree with you on a few fronts. 1 )I think it is a mistake to make generalizations about Groupon and daily deals sites in general as they may or not be helpful to brands both major and minor. Certainly your example of pet food firms in Brazil is interesting but mostly because it illustrates a full scale price war by major brands in action--it most certainly does not illustrate the results of a restaurant owner looking to increase foot traffic by offering a Groupon. In the case of the pet food firms--there is no where else to go to buy pet food. There are thousands of restaurants in a major metro area. 2) These models started with a scarcity concept but have evolved away from that. When is the last time you actually saw a meaningful quantity limit on a consumer deal? The original intent was to get your friends to buy the deal so it would "tip". It was a clever way to do two things--grow membership in the daily deal site, and two drive incremental units sold. The retailer had very little to do--if anything-with the deal tipping. If you asked the average small business owner whether or not they needed 50 units of something to be sold to make them happy--the likely answer would be "25 would be just fine! Customers--especially new ones--are always welcome" 3) The idea of giving away a free masage to one friends is interesting but flawed. Without some commitment from the consumer, a free thing is valued at--well, zero by the consumer. By making the consumer get some "skin in the game" no pun intended, the service retains value. Just because you got a great deal on a suit at the Macy's summer sale doesn't mean you always expect to get the same deal when you walk in the store. Discounts drive traffic. It is up to the merchant to deliver enough value to convert a "tester" to a "regular" customer. That has always been true. Groupon, Living Social, etc have just created a large scale system for moving possibly qualified customers through the doors of business. Should Gucci, D&G, Cartier and other luxury brands offer daily deals? Likely not. Should the bar down the street with a new tapas menu? Likely so.

Commenter: Spencer Broome

2011, July 25

Couldn't agree more. Ultimately, when you take a step back and look at the business model, Groupon is not a solution for growth, especially in the long-term. But like your article points out, there are even negative short-term aspects of the service. I think more and more people will begin to realize this as the "deal" fad goes takes its course.