Some Retailers Eat Losses via Discount Sites

More than 60 million people subscribe to Groupon, the discount-coupon website, and the Chicago company says an additional million are joining every week. Shoppers clearly love the 50 percent to 90 percent savings they can snap up on smartphones. Small retailers that partner with the growing site and with such competitors as LivingSocial and BuyWithMe report mixed results.

Rice University marketing professor Utpal Dholakia surveyed 150 small businesses that undertook Groupon promotions from June 2009 to August 2010. He found the promotions profitable for 66 percent of the businesses surveyed and unprofitable for 32 percent. More than 40 percent indicated they would not run such a promotion again.

Groupon takes exception to Dholakia's findings. "We run 900 deals a day and we've repeatedly polled 30,000 merchants, which is everyone we've worked with to date. When we ask, 'Would you want to be featured again or recommend us to another merchant?' 95 to 96 percent say 'yes,'" says company spokeswoman Julie Anne Mossler. She says Dholakia polled businesses too soon, before they had a chance to calculate total return on investment on their deals. "His sample size was really, really small. Besides, we don't position ourselves as a profitability machine," Mossler says.

For some entrepreneurs, the promotions work well. Melissa Carias, 33, has twice offered half-off coupons through LivingSocial, gaining 14 regular clients for her dance fitness studio, Vivafit, in Guttenberg, N.J. "It's so expensive to advertise. This is a way for me to reach new people and it's my job to keep them around so they buy another package," she says.

Doug Burgoyne, founder and president of Frogbox in Vancouver, B.C., was similarly impressed when he sold 55 Groupon discounts for his Toronto outlet's reusable plastic boxes. "The boxes don't make me a penny sitting in the warehouse. So it's worth offering high discounts to attract Groupon and LivingSocial. I will do these [promotions] in every market I go into," he says.

Unexpected Demand, Big Headaches

Some entrepreneurs cite a rush of difficult, one-time customers, lost revenue, and disgruntled employees. A Groupon promotion that Brian and Lisa Wood ran for their Big Ass Sandwiches food cart in Portland, Ore., last spring was decidedly unprofitable. The couple says their business lost $16,000 when they budgeted for 400 half-off coupons but sold 2,000 in 48 hours. "There were a couple days where we had 100 sandwiches go out the window and we grossed $150. I still have a nervous twitch from it," Lisa says.

To complicate matters, the Woods had to close their cart for two weeks during the promotion because of a family emergency. Although they extended the offer on their return, "people threw a fit," says Lisa Wood. "You would have thought we shot these peoples' children. They wrote horrible things on Yelp—and all for four dollars."

Timothy Holt, who owns Weird Fish, a restaurant in San Francisco's Mission District, also had publicity backfire. A miscommunication with a well-meaning employee left the restaurant unprepared to honor a $20-off Scoutmob coupon the first night it was offered a few weeks ago. Within days, Weird Fish had five angry, one-star reviews on Yelp from disgruntled coupon holders. "It was a little brutal," Holt says.

Bob Phibbs, a retail consultant since 1994 who brands himself as the Retail Doctor, was inundated with similar horror stories when he wrote about Groupon last year. He is convinced that these promotions are inherently unfair, and even dangerous, for small businesses.

"A Neutron Bomb for Small Businesses"

"Small retailers don't do a cost-benefit analysis because they want to jump on the bandwagon and get the buzz associated with these things. But you can't change the financials: They want you to give away product at half-off and they split the revenues with you. So you're making 23 percent—after credit card fees—of your normal sales price," Phibbs says. "It's a neutron bomb for small businesses and they're doing it to themselves."

Clearly, online discounts are not going away: Google (GOOG) is testing its own version after having failed to acquire Groupon last year. Dholakia says the viral nature of online coupons makes them far more effective at bringing a large group of new customers to a small business—at no upfront cost—than most will ever get through traditional advertising.

He and others familiar with online coupons suggest business owners carefully weigh the pros and cons, then manage the process if they commit to it.

Recognize they're not for everyone. Dholakia's survey found that high-margin service businesses such as spas and salons were the most successful, with restaurants least successful. Restaurateurs and other lower-margin retailers might consider an alternative model like Blackboard Eats, a service for foodies that asks owners for lower (typically 30 percent) discounts and does not take a cut of the revenue.

Cover your costs. Alicia Vargo, chief executive officer and president of Pampered Passions Fine Lingerie in Englewood, Colo., sold more than 600 half-off Groupon coupons in January. By limiting her offer to non-sale items, she covered her cost of goods sold on most items and has projected a hefty profit from the promotion. For his part, Burgoyne covered Frogbox's costs by exempting delivery charges.

Prepare employees. "Satisfied employees" are the biggest contributor to a successful Groupon promotion, the Rice study shows. Vargo coached her sales reps to up-sell coupon customers and says that so far they are spending an average of $80 in her store. She has already thanked her noncommission saleswomen with a spa day and plans to offer them an incentive program with a Groupon she's planning for early fall.

Negotiate. Compare the discount services, based on factors such as how they split revenues, how much discount they demand, whether they will share customers' e-mail addresses with you, and whether you can cap coupon sales. Dholakia's survey showed that if more than 1,200 coupons are sold, profitability goes down, Yet fewer than 15 percent of the businesses he surveyed had specified coupon sales thresholds

Track results. Groupon recently introduced an application for smartphones and iPads that can track who buys and redeems coupons, giving users real-time statistics on their promotion, Mossler says. "We see people deem their experience much more satisfactory when they actually track redemption and ROI."

Some industries are designing coupon-tracking software to deal with the crush of customers that often follows online promos. Angela Margolit, president of Bluebird Auto Rental Systems in Dover, N.J., explains that the idea was born from necessity: "We developed a software that provides risk controls to our rental car company customers so that the next time they choose to offer a great rental promotion, hundreds—even thousands—of customers aren't left stranded with no cars available to them."

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