January 1, 2011, 12:00 AM

The Groupon effect

Social coupon sites provide a new kind of web marketing tool for merchants big and small, online and offline.

Lead Photo

The Chicago Photography Academy enrolls 50 to 60 students each month in its photography classes. It’s a small school with a limited marketing budget that’s struggled to attract new customers.

Print ads in a local weekly newspaper flopped, and efforts to rank higher in Internet search results produced only a trickle of responses, says William Benson, one of the school’s instructors. Then the school tried Groupon.

An offer of a $120 class for $45 led to the sale of 3,245 vouchers in a day. “Familiarizing that many people with our business would have otherwise taken us five years,” says Benson.

Just over two years old, Groupon has rocketed into prominence largely by opening up the power of the web to small businesses like the Chicago Photography Academy that lack expertise in Internet-based marketing. “It can quickly put them into a league they couldn’t generate on their own,” says Howard Davidowitz, chairman of retail consulting firm Davidowitz & Associates. “Many of these businesses don’t have the time or capital to invest in marketing and generating traffic.”

And the growth of Groupon, and of similar deal sites like LivingSocial and BuyWithMe, has not gone unnoticed by larger retailers, both retail chains and those that sell exclusively on the web. In recent months, several large retailers, including Gap Inc. and Shutterfly Inc., have started working with Groupon and its competitors. The price may be high, but the customer acquisition potential is substantial, they say. And experts say the rapidly growing competition in this arena will inevitably force Groupon and others to charge less.

$6 billion?

Just how big a deal Groupon has become was illustrated by the widespread media reports last month that Google Inc. offered to buy the social coupon site for billions—as much as $6 billion according to unconfirmed reports. Whatever the actual amount, Groupon turned it down and said it would remain independent. Meanwhile, the leading online retailer, Amazon.com Inc., invested $175 million for an undisclosed percentage stake in Groupon’s nearest rival, LivingSocial.

Groupon remains by far the biggest player in this young market, accounting for nearly 79% of traffic to social couponing sites in the week ending Nov. 27, according to Experian Hitwise. And it’s growing fast: Groupon.com attracted nearly 8.6 million unique visitors in November, almost five times its 1.8 million unique visitors in November 2009, says web tracking firm Compete Inc.

For all its rapid growth, the business model of Groupon and its rivals is very simple: Send a daily e-mail notifying subscribers of a local bargain that’s likely to resonate with shoppers, like a $120 photography class for $45. The deal takes effect when a certain number of consumers agree to buy.

The retailer pays Groupon nothing up front. But Groupon typically takes 50% of what consumers pay for the voucher. That means Chicago Photography Academy is providing a class that usually costs $120 and only taking in $22.50. Groupon gets the other $22.50, regardless of whether the consumer uses the voucher.

While offering a service for more than 80% off list price might seem like a deep discount, many merchants, like Benson, consider the promotions a reasonable customer acquisition expense. “We suddenly had 3,000 people want to register for our classes,” he says. “While it will not create a massive profit, it will expose 3,000 people to our business.”

Another satisfied retailer is Meredith Boggess, owner of online-only baby apparel boutique the Initial Baby. She launched her first Groupon offer to St. Louis consumers July 5, a $40 gift certificate for $18, and hoped to sell 100 vouchers. Within five minutes of the offer going live, she met her goal. “The immediate response was incredible,” Boggess says. “We had done print ads and social marketing before, but we never came close to seeing those types of results.”

While she barely broke even when consumers redeemed the voucher, within a few weeks Boggess began to see consumers introduced to her site by Groupon return and pay full price. That’s why the retailer has since run its offer in four more markets. “It greatly decreases our profit margin,” she says. “But it provides unbeatable exposure for a small company like us.”

Not every merchant is so pleased, however. For instance, Yelo Spa in New York City found that only a small portion of the Groupon consumers who bought an offer ever returned to the spa, making the promotion unprofitable. “We were looking for customer acquisition from people who don’t usually go to spas,” says owner Nicholas Ronco. “But most of them came and didn’t return.”

Creating loyalty

Overall, most merchants say they’re satisfied. Of businesses that ran promotions on Groupon between June 2009 and August 2010, 66% said the deals were profitable and 60% that they would work with Groupon again, according to a study by Rice University associate marketing professor Utpal Dholakia.

Dholakia says retailers must think about how to turn someone who responds to a Groupon offer into a steady customer. “Businesses need to ask themselves once you get the customer in the door, then what happens?” he asks. “How do you get them to come back and be a loyal customer?”

One way to build a relationship with a customer is to space out an offer, he says. For instance, rather than offer $60 worth of food for $30, a restaurant could offer $20 of food for $10 over the diner’s next three visits, Dholakia says.

While Groupon initially caught on with local shops, restaurants and spas, national retail chains are also beginning to see its potential to lure new or lapsed customers. The first nationwide Groupon offer came from Gap in August, which sold 441,000 $50 Gap vouchers for $25. Seeking to drive traffic into its bricks-and-mortar stores, the voucher was only valid in stores, not online.

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