Part 1: Deciding If This Is Right For Your Business
Online Couponing: What’s New, What’s Not?
Group buying has been around forever … that’s why some of our parents booked travel through AAA, and some of us old guys still buy group life insurance through our employers. Group selling reduces the seller’s costs, hence group buying reduces the buyers’ prices. Getting discounts for buying in a group is not new.
Customer acquisition through couponing is not new either. Procter’s Tide and Lever’s Surf engaged in coupon wars for decades, each trying to tempt the other’s customers to switch brands by placing price and the sense of a bargain ahead of brand loyalty.
Of course, the combination is new: with Groupon and a host of competitors consumers can sign up, form an instant group based on nothing but their willingness to accept a price break, and receive online discounts.
Many examples from the history of business show us that in steady state, couponing is a fool’s game, as are many forms of discount-based promotions: for decades both Procter and Lever found themselves gearing up for promotions, paying factory staff for overtime, shipping stuff out to merchants, who … then … stored it. At its worst, discounted purchases accounted for over 95 per cent of detergent sales, with everyone trying to buy everything on discount every time.
So, what can we say about online couponing? A fool’s game or a great launch strategy? Both, of course.
When Does Online Couponing Work?
We really want to know whether or not the owners of businesses that use online couponing are better off afterward. We can assume that the owners of online couponing businesses are always better off if they have been used; that’s why they appear to be such attractive investments. But are they better for their clients, the business owners who use them? This short guide is intended to help small businesses assess whether or not to engage in a group buying campaign.
Two dimensions appear especially useful in classifying the value of a group buying promotional campaign: high or low marginal costs and high or low possibility to grow the market. Combinations of these factors will be obviously good, obviously bad, or ambiguous; where they are ambiguous, other factors must be considered.
When marginal costs are low (each new sale costs you almost nothing) then discounting is sometimes useful; when marginal costs are high, then group selling can be extremely dangerous. Marginal costs are extremely low when you have idle capacity, or when most of your costs are fixed costs (rent or equipment and staff salaries) rather than per customer costs (ingredients in an ice cream shop).
When the prospects for future market growth are high, then promotion makes sense in general. That’s one of the reasons that truly new product launches (anything from couponing the old Trac II Razor to the early discounts for new Amazon online book customers) makes sense. You promote to grow the market quickly and preempt competitors, and then harvest your share of the larger market over time. Planning for new product launches usually figures that growth will be high once jump-started, especially for businesses where customers benefit from the presence of other customers (as with AIM instant messaging, email services, peer-to-peer file sharing, and anything that enjoys a network externality).
Some combinations are obviously good ideas: When things have low marginal costs, and their growth opportunities are high, promotion makes great sense. Each new sale offers you at least some profit even after promotion, and you can harvest more profits from your new-found customers’ repeat full-price purchases as the market grows. Most new launches of consumer products fall into this
category. Promote away!
Some combinations are obviously bad ideas: When things have high marginal costs then you don’t earn much on each sale, and discounting results in a short-term loss. If growth opportunities are limited, then you also should not expect to be capturing lots of customers as a result of a promotion war; you’ll just
be swapping customers with your competitors. You lose on the promotional discount, and won’t have an opportunity to harvest later unless you really think you will capture more customers through couponing than your competitors capture from you. Be afraid of this. Be very afraid.
And some combinations should make you think (1): Using promotions to launch a high marginal cost product in a growing market may be a good idea or a very bad one. Early Palm customers really had no idea what a PDA-Phone was or why we needed one; 30-day free trials eliminated customer uncertainty
and accelerated the launch, giving Palm a strong early position. Google today likewise sees an opportunity to claim a piece of another emerging market, that of very powerful smart phones, and is aggressively promoting the Droid. The Palm launch was successful, in part because few were returned. The Google launch is likely to be successful for a variety of reasons; essential to its success is the ability of Google, manufacturers, telecoms providers, somebody, to fund the launch until contract fees, app sales, and other revenue sources are sufficient to cover the early costs of the launch. Not everyone can survive expensive give-aways.
And some combinations should make you think (2): What about low marginal cost products in mature businesses? This is, of course, the most dangerous category because it appears so seductive. Each coupon looks to the vendor as if it will produce at least some net profit because each new customer produces significant increase in revenue, even if profits may not be large after the cost of couponing is counted.
So you text your friend and colleague, and tell him you’re hungry. The GPS on your phone knows you’re at 37th and Walnut in Philadelphia, someone in the ecosystem of your smart phone knows your colleague likes Thai food, and you get a carefully targeted, personalised coupon for $20 at Pod, about a block away. While the operating margins of all restaurants are pretty brutal, the actual food costs of any individual meal
are quite low. You go to Pod, you each have an order of Shrimp Padh Thai, and you split an order of rock shrimp and a bottle of San Pellegrino, which now costs you only about $35 plus tax and tip. Your colleague is from out of town, you’re not loyal to Pod, and this is a new sale, one the restaurant would otherwise have lost. Of course they come out ahead; how much could some noodles and a few shrimp cost? And of course
you come out ahead too … you would have chosen someplace cheaper, less trendy, and possibly not quite as good.
Is It Really This Clear? Not Exactly.
Are things usually this clear cut? If you are in a low marginal cost business with high growth opportunities then coupon, and if you are in a high marginal cost business without growth opportunities then don’t coupon? Not exactly.
Determine if you really have excess capacity. Suppose your spa is only 80 per cent utilized during the week but you are 100 per cent busy on weekends, or that your restaurant is 100 per cent booked between noon and 1.30, and pretty empty afterwards; coupons without restrictions on when they can be used may end up only replacing loyal full price customers with a temporary surge of price-shoppers.
Determine if you can capture customers and grow your business, even in a low growth market. If you are a player with smaller market share and excess capacity, and your product is as good as your competitor’s, promotions that discourage brand loyalty can work to your advantage; that’s why Lever, the smaller detergent company in the US, promoted so aggressively against P&G, working to equalise the two companies’ market shares. Better yet, if you have smaller market share but a superior product, then promotion is likely to grow your share at the expense of your larger competitor. But don’t let ego cloud your
judgment; if your product is new and better, then you may attract share, but if it’s been around for a while and customers have not responded, they may be telling you something.
And, of course, determine if you have to do this, for no other reason than your competition already is doing so. A senior executive in a telecom firm once said, “you can’t be any more disciplined than your least disciplined competitor, and if your competitor is having a sell-below-cost-and-hope-to-impress-Wall-Street promotion to grow market share, you have to match him.” Unfortunately, one reason to coupon in business where you may not be able to grow the market is that one or more competitors are already doing so.
And don’t forget cross-selling and upselling. I may get you in with a discount on the most basic package, and then successfully sell you expensive add-ons. I may get you into my restaurant with a discount on food, but hope to sell you wine or beer without discounting. Some discounters have learned how to target,
attracting big spenders who are most amenable to cross-selling and upselling; others have not.
Part 2: How Can Couponing Go Very Wrong?
In Part 1, we described how businesses that have low marginal costs (for example, ingredients are cheap) and high growth potential (for example, the first KFC in China) can benefit from promotions. We
described other sets of conditions that can make couponing either very attractive, or very dangerous. In this post we describe how an online couponing promotion can go very wrong.
But First, How Is This Supposed To Work?
Restaurants and night clubs are “low marginal cost” businesses. Yes, they have rent, and they have to pay the chef and the staff, but the cost of their food is pretty low, and they don’t pay the chef or the waiters or the landlord any more just because another customer comes in. As long as coupons get them new business, couponing would appear to benefit everyone.
So, Who Benefits, And Who Loses?
Of course, if Thai Singha House loses enough customers to Pod, it is going to start discounting also. It may get some of its old customers back, but it will also get new business; some customers who previously ate across the street at New Delhi can now afford Thai Singha House, and they may discover that they prefer Thai curry to Indian curry. Just getting back the same number of customers that they lost is not enough for Thai Singha House, since the customers they got through couponing are receiving substantial discounts; so let’s assume that they get some multiple X of the number of customers they lost to Pod. They’re working a little harder, but they’re still doing OK financially. Notice, we are assuming that the original coupons at Pod did not create people who eat lunch; it shifted a few to Pod from other establishments. We are also assuming that the other restaurants cannot afford to lose too many customers, so if the number of people switching because of coupons becomes noticeable, other restaurants will have to respond with programs of their own, if only out of self-defence.
Is This Form Of Couponing Really A Partly Free Lunch For Everyone?
If Pod gets some new customers by switching them from other restaurants, those restaurants will have to respond by couponing as well. Since the new (replacement) customers they attract are not paying full, undiscounted prices, those restaurants will need to attract more customers than they lost, but they can still do so.
But what about New Delhi? It’s just lost some customers to Thai Singha House, and it gets a sales call from a coupon vendor who explains what is happening and offers them a couponing plan as well. So pretty soon they’re couponing too. They capture customers from the sandwich shops down the street. Since they’re attracting customers paying discounted prices, they need to attract some multiple, call it X, of the customers
they lost to Thai Singha House, which was X times the number of customers Thai Singha lost to Pod.
The sandwich shop, or someone else, is going to have a problem. At some point there won’t be enough customers who want lunch to provide customers for the last restaurant in the chain. Remember, couponing does not create people to eat lunch, it just shifts them, and at each repetition in the chain we need to do more shifting because the new customers are discounted customers replacing full price customers we lost to someone else’s discounting. This can’t go one forever; in fact, it’s the classic reason why chain letters and Ponzi Schemes collapse.
Could Something Really Go This Wrong?
OK … so we know that coupons should be used only for incremental business. We know that coupon vendors should usually advise mature businesses not to get started in coupon wars. We know that no coupon vendor should ever coupon a business’s existing customers unless it wants to maximise the intensity of a coupon war. And we know that coupons should be used only sparingly. Once I see enough customers using coupons all around me, I would have to be a damn fool not to use them myself, and at some point everyone will be trying to use coupons. Restaurants will raise their prices to compensate for the fact that everyone is getting a discount, and rather than everyone being better off, no one will be better off except the coupon vendors.
How do you keep couponing from getting out of hand? Coupon vendors could make sure that usage does not get too large, and they could impose restrictions on their customers (business owners should not issue too many coupons) and on which consumers they serve (coupons should not go to a business’s existing customers). They could manage the scale, and make sure coupons are used only where they can generate new business … in short, they could exercise considerable self-discipline. But why would they do that, and limit their own incomes? How much simpler would it be just to start a couponing war and harvest the resulting couponing profits? Indeed, early evidence suggests that coupon vendors do not always discipline themselves or even accept discipline from their customers.
We Didn’t Say Couponing Systems Were Bad Investments
We didn’t say couponing systems won’t earn money for their investors. We think they may be very bad news for restaurants and merchants if used unwisely, but the worse they are for restaurants and merchants, and the larger and more essential they become, the more valuable these systems will be for their owners and operators. They combine the most profitable attributes of serving a drug addiction with those of a chain letter. What more could an investor ask for?
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