4 Ways Daily Deal Sites Can Avoid Becoming Toast

A new Rice University study laid waste to the happy assumptions of daily deal businesses such as Groupon and LivingSocial. Most coupon users are first-time customers. Almost two-thirds buy no more than what the deal offered and less than 20 percent become regular customers at full prices. On the surface, that would seem like all she wrote for this industry.

But that it's premature. There's plenty of evidence that some daily deal companies can survive. And the promotions can actually work for the merchants that use them. But the deal companies must adjust how they do business and relate to their merchant customers.

Uh, they've been a bad deal all along
What's striking in that the results are a surprise to anyone. Rice associate professor Utpal Dholakia's analysis over multiple daily deal sites only confirmed what common sense suggested: When you offer a 50 percent discount and then split the proceeds with the deal company, the merchant operates as though offering a 75 percent discount. It's almost impossible to make money that way:

1. You don't make enough revenue to cover the cost of the goods or services, let alone overhead to make them available.
2. The only way to make the promotion pay off is to either upsell people into bigger purchases, increasing your margin dollars on the deal, or get them to become long-term customers who, over time, are profitable.

Dholakia showed that businesses often don't get the results they need with the daily deal promotions. In a study of 324 businesses across 23 markets using promotions on one of 5 major daily deal sites, 55.5 percent broke made money, while 44.5 percent either lost money or broke even. Close to 80 percent of the customers were new to the business, but less than 36 percent spent more than the deal. Not even 20 percent became full-price return customers.

At that rate, of course many companies didn't make money. And that leads to problems for the daily deal companies.

They don't stay around much anymore
There was actually a forerunner of how the current dynamics can hit a deal company in Groupon's own financial filings in preparation for its IPO. The following important rates were already on the decline:

• revenue per subscriber
• conversion rate of customers into subscribers
• revenue per customer
• deals sold per customer
• revenue per deal

With all the deal outlets, consumers are feeling fatigue and the novelty factor is over. People spend less and, more importantly, businesses push back on the deal companies. Who can afford 50 percent of the money to go to what is essentially a glorified advertising outlet?

According to Dholakia, slightly under half the companies would run another daily deal -- and, remember, more than 55 percent of them made money. Even for the ones who make something, it's not enough to overlook the entire experience. That's high turnover, and, as marketing studies have shown in the past, bad experience gets about twice the word-of-mouth of good experience. Expect small business owners to partly poison the prospect pool for the daily deal companies.

Is it time to write off the industry? By no means.

Rumors of daily deal death are exaggerated ... some

Don Young at Daily Deal Media had a positive take on Dholakia's numbers, and for a good reason. Although there's plenty of bad, it shows that there are possibilities for the industry. For more than half of the merchants to make a profit on a price promotion is impressively high. And, currently, nearly 73 percent of the merchants have no loyalty to the daily deal site they used.

Put all this together, and it suggests a number of ways that a daily deal site might ultimately succeed:

• Learn what works. There is nothing new in a coupon business. They were the stuff of Sunday papers and periodic mailers for years. Study businesses that have succeeded in the past, learn the principles, and apply them. Or look at what is effective today. Dholakia recently co-authored a recent study that was generally ignored: an in-depth look at a daily deal that worked. The more a company can make things work for the merchant, the better a chance it has of staying in business.
• Get lean quickly. There are hundreds of daily deal companies, and more coming into play. The combination of merchant disappointment and the law of supply and demand will drive down costs. The winners will know how to operate in a lean fashion and help the merchants.
• Become an advisor. Too much of the daily deal business seems driven by salespeople who are more interested in pushing their personal bottom line than that of the merchants. Focus on what works for the merchant and make money by making them happy. According to Dholakia's solo study, some factors can increase the chance of monetary success for the merchant. Unless the deal company can get a reasonable merchant retention, it will have great difficulties.
• Carefully pick potential clients for their chance of success. Daily deals have overdosed on spas, bars, and restaurants, and they tend to be worse repeat prospects than average. And yet, health, services, and special events often do well. The site should analyze its own data, talking to customers, and find a sweet spot and where it might be over-exposing a class of business. Beware of salespeople who want to score the easy client.

Last but not least: Be open to an acquisition or merger. There are simply too many deal companies and consolidation will happen. If the terms are right, a deal company should consider selling and starting a different type of business -- preferably something away from the me-too strategic playbook.

Related:

• 4 Reasons Groupon is Like Goldman Sachs and 1 Reason It's Not
• AOL Patch-Amex Deal Takes on Groupon -- and Could Hurt It a Lot
• Groupon Loses So Much Money, It Needs Its Own Daily Deals
• 3 Reasons Groupon and LivingSocial Have Nothing to Fear From Facebook

Image: morgueFile user veggiegretz, site standard license. Erik Sherman

Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.

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