A year ago, the calculus of a daily deal seemed simple: A merchant partners with a provider, offers a discount to a large opt-in audience, and then watches its customer base explode. Groupon, unquestionably the alpha of the pack (see sidebar, next page), continued to assemble a portfolio of clients and customers that culminated in 2011 revenues of $1.6 billion, up more than 419% from the year prior. It appeared as though the coupon site and its ilk represented a way to forevermore populate small businesses with a stream of enthusiastic consumers.
But the math is more complicated than that. Despite such robust growth, Groupon lost $256.7 million in 2011, worse than expected. Privately held LivingSocial, which is 31% owned by Amazon, had $558 million in losses on just $245 million in revenue. And they were the fortunate ones. In the last half of 2011, even as Google and PayPal ramped up their own coupon offerings, the world bid farewell to 798 deal sites (7.61% of the industry) due to consolidation and closure. "When any new channel opens, there's a gold-rush mentality," says Jay Weintraub, who runs Daily Deals Summit, an industry conference. "We're in a healthy period of reassessment now."
Though the daily-deals industry generated almost $3 billion in 2011, the attrition of both providers and merchants is justifiably amplifying questions about its sustainability—as well as who's at fault for deals gone wrong.
"Not all merchants are savvy in running their business," says Julie Mossler, director of communications for Groupon. "They don't have time to harness ROI or understand their customers. That's where we come in. We don't think of ourselves as a deal provider anymore. We're a merchant partner."
But even as sites switch the focus from sealing deals to helping clients develop lasting relationships with customers, their reach is limited. Notes Tim O'Shaughnessy, CEO of LivingSocial, "Ultimately, it's up to the merchant to offer a great experience so a member will want to come back." True as that may be, it doesn't stop merchants from blaming providers when deals don't work out. In a January survey by Susquehanna Financial Group and Yipit of past deal-participating businesses, roughly half said they did not plan to do another offer in the next six months. And as the following examples make clear, that restraint may well be the best approach for many of them.
CELADON & CELERY
Offer: FLOWER-ARRANGING CLASSES
Success level: HIGH
"You want to have something bigger to offer customers than what brought them in," says Ivie Joy, cofounder of Celadon & Celery, an event-planning and flower-arranging business in Los Angeles and New York. "That's the only way they come back." C&C's deal is on flower-arranging workshops: Normally $300, a coupon brings the cost down to $99. Then, once buyers—mostly women—arrive, Joy can sell them on other services. "When women come in for a class, we show them how we could help with their wedding," says Joy. "Often they wind up booking us to do the flowers." The average spend for the weddings C&C does is $10,000. By offering a deal on a unique experience in a nonsaturated, $35.2 billion market (flowers), the company is able to build a customer base with little concern about competitors playing vulture with a similar deal.
Being a successful partner also allows merchants to negotiate better terms. In the standard model, a merchant agrees to sell, say, $100 of goods or experiences for $50, and then splits that $50 evenly with the deal site. After the brisk sales of C&C's first offer, Joy was able to haggle LivingSocial down to an 80/20 split—offsetting more of the $200 markdown.
SHELSKY'S SMOKED FISH
Offer: DISCOUNTED FOODS
Success level: SO-SO
"They're all shitty deals for us," says Peter Shelsky, of Shelsky's Smoked Fish in Brooklyn, New York. "LivingSocial's clientele is a little higher-end. Groupon has the bargain hunters. They only want to spend the coupon value, and they're often rude—which is amazing because you're basically giving them stuff for free."
Shelsky's first deal was a $15 coupon for $30 worth of food. He says he came out ahead, but only because 30% of the coupons were never redeemed. This is the "breakage rate," another factor for merchants to consider. LivingSocial pays based on deals sold rather than those redeemed, so Shelsky got paid for the coupons he didn't service. Conversely, rival site Gilt City keeps the amount of unredeemed coupons.
In January, as the Super Bowl neared and winter dragged on, Shelsky did a deal with Groupon: He offered a $20 coupon for $10, a $45 for $20, and $160 for $55. Groupon sold 1,064 coupons, and Shelsky's took in more than $11,000. "It helps pay the bills," he says, "particularly in winter, when cash flow is slow. But busy season? Or holidays? Forget about it."
Offer: CHEAP CLASSES, FREE GEAR
Success level: SUB-LOW
In 2009, Lisa Bridge bought successful Manhattan yoga studio Yoga Sutra from its founder and relocated it to a less-expensive space. The move took longer than expected, and when it reopened, construction was still going on. Students fled. To stanch the bleeding, Bridge began offering deals from several sites at once. The discounts were intended for first-timers, but so many were offered, and through so many sites, that buyers could effectively become regulars at a discount. To keep pace with offers from other studios, Yoga Sutra even began pricing deals at more than 50% off. Meanwhile, existing students were crowded out, and no new instructors had been hired to accommodate the rush. At the front desk, confusion reigned: Did the LivingSocial deal offer a free mat? Or was it Groupon? Wait—has this person been here before?
"Rather than focusing on members, management catered to the deals people," recalls a former desk manager. "But people who bought deals rarely stayed on. If they did, they bought an offer from a different site and never paid in full." In December, Bridge, who did not respond to requests for comment, filed for bankruptcy.
A version of this article appeared in the April 2012 issue of Fast Company magazine.