Consider it the daily-deal gold rush. First, there was Groupon's much-anticipated IPO in early November, which valued the market leader at $12.7 billion. Now its top competitor, LivingSocial, is reportedly set to close another big round of funding that would put its valuation at around $6 billion. While such nods of approval from Wall Street may offer some validation to Groupon, LivingSocial and the hundreds of imitators their business models have spawned, on Main Street, small-business owners still have their doubts.
"These deal sites call up and claim their service is different from Groupon, but they're pretty much all the same," says Mike Scotese, an owner of Grey Lodge Pub in Philadelphia. Scotese started receiving regular pitches from daily-deal companies about two years ago. These days, they call at least once a week, offering to design and distribute a coupon for the pub's food in exchange for a cut of the sales it brings in. "'No thanks,' I tell them. We're guaranteed to lose money on sales to customers we'll probably never see again."
Many local merchants agree. And that's created an opening for savvy startups looking not to imitate the model, but to innovate.
With the Groupon model, to actually boost a business's bottom line, the thinking goes, daily deals need to attract at least one of two types of customers: Those who spend more than a coupon's face value and those who return after redeeming the deal. But recent research reveals that group-buying services often fail to serve up either kind of customer.
In June, a survey by a Rice University professor polled 324 business owners who ran a daily-deal promotion between August 2009 and March 2011. Fifty-five percent of them made money on the deals, while less than a third lost money. Yet more than half of the surveyed merchants did not express enthusiasm about running one again. And 65 percent of the restaurant and bar owners reported that they were done with daily deals entirely. The main reason: Only 35.9 percent of coupon-wielding customers spent more than a deal's value, and just 19.9 percent of customers returned for a full-price purchase.
Such stats raise "red flags" that indicate a "structural weakness in the daily deal business model," concluded the study's author, Utpal Dholakia, who has published several studies with similar results over the past two years.
"Beginning in 2009 and 2010, merchants were just hopping on the bandwagon and running daily deals without really thinking through what they were doing," Dholakia says. "Now, business owners are becoming smarter about how they run daily deals."
So, too, are the entrepreneurs operating daily-deal sites. A new crop of deal sites now link services to customers' credit and debit cards, allowing operators to track previously untraceable data that reveal which types of deals generate the most repeat behavior.
Some, like Seth Priebatsch, think they may have even cracked the code to the customer loyalty conundrum at the heart of business owners' beef with Groupon and its clones.
In March, Priebatsch, the founder and CEO of location-based startup SCVNGR, launched LevelUp, a daily-deals site that let merchants serve up three increasingly better deals at their location in the hopes of encouraging repeat business. "It worked -- but not well enough," Priebatsch admits, "so we evolved it into something better."
In July, Priebatsch launched a new version of LevelUp. The current iteration is a free rewards service that links to a customers' credit or debit card and works through their phone. Merchants use it to give customers a small discount on their first buy, then reward repeat customers with instant credit toward each future purchase, all through register scanning equipment that costs the merchant nothing to install, then $55/month after a three-month trial.
So far, Priebatsch says he's seen LevelUp customers return to participating businesses 45 percent of the time. He noted that Groupon-wielding buyers, in comparison, only return around 1 percent of the time. (Groupon, which is still in its post-IPO "quiet period," declined to comment on this story, but has since launched its own rewards program with undisclosed results.)
LevelUp users also spend on average 5.8 times the face value of the deals they receive, according to Priebatsch. That stat, plus another datapoint LevelUp collected, may calm some merchants' concerns over offering deals that don't expire: The average LevelUp merchant gives users 17 percent off their merchandise, compared to the much larger discount that Groupon often requires of the merchants it works with.
So far, LevelUp has launched in four different cities: New York, Boston, Philadelphia, San Francisco. It has signed up around 600 merchants and roughly 100,000 users.
That pales in comparison to the 45,665 businesses that worked with Groupon in the first half of 2011, and its more than 140 million users worldwide, or LivingSocial's 46 million users. But such discrepancies may start to mean less, as the perception continues to spread among merchants that it's not how many users you reach, but the rate at which you can convert them into regular customers or get them to spend beyond a deal's value.
"Groupon's model is all about marketing," says Jon Carder, the founder of MOGL, another rewards service that launched this April and targets only restaurants and bars. "They're out to just deliver you a ton of new customers, typically at a loss. Our primary goal is to take a restaurant's existing customer base and get them to come back more frequently and spend more money when they do."
To do that, MOGL offers three separate incentives to customers -- cash back in the amount of 10 percent of each purchase, deposited into a customer's bank account at the end of each month; a food donation to a local charity each time a customer spends at least $20; and a monthly jackpot, typically ranging from $25 to $500, which goes to the MOGL user who spends the most at a location in any given month.
To simultaneously reap the three rewards, customers just link any credit or debit card to MOGL and then use that card to pay for a meal at a participating restaurant in one of the three West Coast cities where the service is currently available. MOGL takes a 15 percent cut of users' spending from restaurants, with 10 percent going back to each customer in the form of cash back, 4 percent going to MOGL, and 1 percent going toward the monthly jackpot.
"We've designed something that's working exceptionally well," says Carder, citing a study that the company conducted on 89 participating restaurants and 2,000 users in the network. "We compared those MOGL customers to the restaurants' typical customers, and our users spent about 71 percent more."
Some experts say the variations on rewards programs are a definite improvement over the original daily deals that existed last year, in part because they're better for the merchant.
"But a key issue still remains," claims Rice University's Dholakia. "At the heart of these marketing activities are discount and specifically price promotions. You're basically giving the customer some financial incentive to buy from you, whether it's on the first occasion or the third occasion. Everything about good marketing practice says that is not a good thing to do all the time. You don’t want to give people money basically to keep them coming back to you. They should come back to you because they inherently value or have some kind of emotional attachment to your product."
"I don't mean to say a merchant should never run a daily deal," he adds. "I'm saying they should be cautious. After all, these merchants are smart people by and large. They learn. If they have a bad experience, they figure out what went wrong, and the corrections have absolutely evolved in front of my eyes over the last few years."