Would “back to basics” be a superior business model for Groupon?
Posted on December 31, 2013
To finish the year with a blog post, we recently discussed Groupon’s business model on HBR blogging network. Not long ago, there was this multi-billion dollar company called Groupon that was going to revolutionize the business of bargains, whose founders turned down a $6 Billion offer from Google. Yet the revolution never came.
To turn its fortunes around after a long period of performing below (admittedly inflated) expectations, Groupon changed a core element of its business model sometime last year. The discounts available through Groupon coupons used to be subject to a host of restrictions, (e.g., “the deal is ON if at least 100 customers subscribe”), but now most Groupon coupons can be used any time, any day.
Will this change turn the company’s fortunes? Actually, it could turn out to be the nail in Groupon’s coffin. As we argue in a recent paper (and in this accompanying interview), behind Groupon’s spectacular rise and fall is a story of a business model that misaligned the incentives of Groupon and one of its key constituencies.
The sustainability of a business model depends on its ability to make all concerned parties better off. In the case of Groupon’s discounts, customers certainly get value by enjoying deep discounts and Groupon does well the more its discounts get used. A more interesting question is whether the merchants supplying the discounted goods and services also benefit: What do they get out of participating in a Groupon program?
Academic research has consistently found that running a deal using Groupon (or one of its competitors) has two main implications for a business: more customers in the short term but lower favorability ratings. Hence, short-term gains in traffic come at the expense of a lower future traffic and the overall value proposition to the merchant remains unclear.
Here is where restrictions come into the picture. Nearly all service businesses face seasonal demand (think of restaurants, theaters, museums) and are often unable to serve all customers in peak periods (e.g., weekends). Ideally, business owners want to restrict discounts to off-peak periods so that some demand shifts from peak to off-peak periods. And if demand in off-peak periods is too low, they will want to close down the business on these days.
With unrestricted discounts (as is now typical for Groupon) customers with discounts will come in droves during peak times, and the profit of the merchant may even decline since regular customers are substituted with coupon-bearing customers. Think about it: filling a restaurant’s capacity on Saturday evening with Groupon customers is probably not the savviest business decision.
But by having discounts limited to low-demand periods the merchant can be sure that no full-price paying customer is replaced, and by having an activation threshold, the merchant can be sure that the deal is active only when demand is high enough in an off-peak period to justify the business staying open. A win-win-win for all parties.
So why do most deals on Groupon and other similar web sites feature no time restrictions, and why are an increasing number of web portals removing activation thresholds? Because, unfortunately, what is in the interest of the business owner is not in the interests of Groupon and its competitors. Groupon and other web portals get a cut of total revenues channeled through the deal so Groupon gets nothing if the deal is not on. That is, with no activation threshold and with deals active always, Groupon itself gets the best deal… And the merchant gets a raw one.
But a business model that imposes this kind of misalignment is not sustainable. Unless Groupon restores the restrictions, the prospects for its long-term survival are dim, as the bigger, better-known merchants themselves can fairly easily offer structured discounts directly. Interestingly, there are signs that this might happen: time-restricted discounting has been reintroduced into Groupon Reserve.
This may seem like a backwards step. But the hard truth is that without restrictions, Groupon is definitely dead, if not today, then tomorrow or at some point in the not too distant future. Of course, it may not survive without restrictions either because perhaps this was just a revolution that was never meant to be.
Credits: the research paper by Simone Marinesi, Karan Girotra and Serguei Netessine “Operational Advantages and Optimal Design of Threshold Discounting Offers” can be freely downloaded at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2306108.