Is Groupon’s Greater Value in Behavioral Psychology?

by on June 6, 2011

The monetary value of Groupon is a hot topic as their IPO nears. Some people are pro: “Why Groupon’s Biggest Critics Are Short-Sighted.” And some are con: “Memo to SEC: Groupon Has No Competitive Advantage, Stop Its IPO” (h/t @jontalton). At least one person is calling the social giant a Ponzi scheme.

But, as I’ll get to shortly, I’m struck that Groupon’s case history is enormously valuable outside of social coupon considerations, in the behavioral psychology of markets.

It’s true that competitive social coupon Davids may learn something heartening (or not) from criticism of the Groupon business model: Business Insider reports that just 19 percent of Groupon’s 83 million “customers” have bought a Groupon. Here also is a chart of Groupon’s revenue vs. losses.

So, the social Goliath may not be hard to knock down with the right pebble of value capture. (In Seattle, Tippr has just acquired DealPop from Whitepages.com, perhaps marking, GeekWire speculates, the beginning of a wave consolidation in a wildly proliferating market. We profiled DealPop last August.)

A Rice University study claims 40 percent of businesses who’ve used Groupon would not do it again. Why? Seattle food blogger Ronald Holden has written extensively on Cornichon on Groupon’s mismatch with restaurant industry margins. While certain sectors (salons, spas, yoga studios) appear to have the margins to fund the use of Groupon as advertising to opt-in shoppers, it’s not at all clear that coupon shoppers are as interested in daily spa treatment offers as they are in daily deals on hot dining spots.

This raises a few, but substantial questions about a) the actual size of Groupon’s pool of potential consumers, b) the actual size of Groupon’s pool of potential business buyers, and c) the social coupon space’s susceptibility to a tragedy of the commons. (As to that last, if the social coupon “works,” and customers are acquired, there will be less reason for businesses to use social coupons as they’re currently structured. On the customer side, it’s already become a tragedy of the email inbox, which fills with spa and salon and yoga deals.)

Tippr's deals of the day

While Groupon is clearly worth something, it’s not at all guaranteed, as they say, that past performance ensures future success. For my speculative money–which is exactly $0, full disclosure–the hyper-competitive social coupon market has already robbed Groupon of its power to dictate the most favorable terms possible. And given the depreciating value of email databases, its head start in customer acquisition comes with an expiration date.

No, what is most fascinating to me–and seems underreported–is not Groupon’s value per se, but the revenue that it has generated from the small business sector. While many armchair analysts are eager to tell you how running a Groupon sale should be considered an advertising cost, not a simple discount, what’s incredible is that Groupon has found a way to separate small business owners from their money at all.

The most valuable lesson that social coupons can teach us has to do with the use of behavioral psychology for selling to small businesses. That has long been the holy grail of anyone in B2B: the sheer size of the market is tremendous. But until Groupon, that market had also been known by the sheer reluctance of small business owners to part with their cash for any reason, let alone marketing and PR.

Before Groupon, to generate real traffic, a retailer might have had to cut prices 50 percent and pay for an advertisement. This the small business owner hated to do. Bootstrapping makes for incredible stinginess with actual cash when the outlay is in advance of a promised sale. The sense of risk can be heightened in proportion to a lack of trust in the potentially snake-oil-selling marketer, but in general a social coupon’s magic is in its micro-payment approach to the advertising/customer-acquisition budget. (Or so it appears.)

Notice that with Groupon, the cost (and its pain) is bundled and contained within a multitude of sales transactions–risk, meet much more immediate reward. Social coupons have already extracted an incredible amount of cash from small businesses, but only on condition of a sale (a lure so potent that some business owners have been driven to near bankruptcy by it). Behavioral psychology will tell you that people value not losing money more than gaining it, and Groupon’s success-so-far bears this out.

What is the most salient feature of the social coupon, after all? It’s not the coupon idea. It’s not online delivery. It’s not steep discounts. All of these were available before. (Even the massive audience Groupon provides was around in one form or another.) It’s the transposition of the sequence of events (the small business owner and Groupon make a sale…and then Groupon takes the lion’s share). You could call it misdirection: Watch this sale! says Groupon, and the smiling business owner fails to feel the difference, that it’s not really their sale anymore.

Notice that the small business owner still has to take the marketing theory on faith: These customers will return, spending like sailors! (Not that this doesn’t happen–but Groupon’s ability to guarantee conversion rates is not, I suspect, much better than anyone else’s.) So the main thing that has changed, really, is simply that Groupon has deferred charging for this trial-offer form of advertising until that first sale is made. It’s still the small business owner’s money, but it’s associated in time with the benefit of making a sale.

(Timing is key on the B2B side as well as the consumer side: nothing motivates a business owner like an immediate uptick when business is slow, and the purchase cut-off creates a sense of scarcity for the customer when, in point of fact, there’s an over-supply.)

A canny business owner will still sit down and pencil out break even points, but psychological appeal (and/or recessionary desperation) is evident in the amount of small businesses who clearly haven’t. And this is what is different: small business owners flocking to try social coupons as a form of advertising, when an up-front payment would dampen their ardor significantly. Groupon, of course, doesn’t assume extra risk for nothing–that’s why they have been able to get the lion’s share that a more competitive field is clawing back.

Again, it’s the timing and automation of the micro-payment process that matters here, because without that, Groupon would be spending even more than it does on sales staff. Chalk up one more thing that newspapers–the industry that can’t out-design Craigslist–should have done, but didn’t. As critical as people can be of Groupon’s model, it remains true that they don’t get paid unless a sale occurs, and then only in proportion to the sale price; newspapers, who already had coveted local audiences, were not willing to take even that chance.

Still, the great Groupon experiment stands right up there with the App Store as a paradigm shift in investment and payment, one that takes into account the hard-wired in human nature. Groupon led the small business horse to water and made him drink. Who’s next? What other sectors are limited by psychological barriers, rather than purely financial ones?

One thought on “Is Groupon’s Greater Value in Behavioral Psychology?

  1. The really key to how this industry grew was the simplicity “One offer, one day.” delivered directly to you. Then, when clones started popping up, growth rates had to accelerate to justify investments for continued growth, that principle vanished.

    Is it possible, with volume and scale, to return to that with preferences (geo, verticals or both)? yes. Will Groupon do it? No. Will LivingSocial– probably, but they’re not dumb enough to go IPO.

    As a side note: I’m pretty sure Groupon went IPO because they can’t raise more monies and Round 1 went to paying off the first 10 investors. (tens of millions)