09/21/2011 11:20 am ET Updated Nov 21, 2011

Buyer Behavior and Daily Deal Sites

If you are interested in IPOs, then you must be wondering if the daily deal sites (e.g., Living Social, Groupon) are a sustainable business. Perhaps more to the point, you should be wondering how Groupon could be worth $6 billion?

At present, we are in the middle of a land grab among daily deal sites. The WSJ reports that one-third have been sold or shutdown this year. The article paints a bleak picture about underlying costs in the industry. Yet, I am still keeping an open mind on this issue mainly because we are in the infancy of this industry and need to see how it shakes out and if marketing behaviors can change.

To that end, a new study by Utpal M. Dholakia, an associate professor of management at the Jones Graduate School of Business, Rice University: How Businesses Fare With Daily Deals: A Multi-Site Analysis of Groupon, LivingSocial, OpenTable, Travelzoo, and BuyWithMe Promotions starts to give us some insights into where the industry is and how marketing might change to improve profitability. As surveys go, the study has a low response rate that always means take the results with a large grain of salt.

The study found:

There is no difference between any of the daily deal sites studied. This is especially interesting since one of the sites was OpenTable, whose clients are exclusively restaurants. Overall, a little over one-half of vendors make a profit from coupons while about one-quarter lose money. It is unclear if the losses are within the expected marketing and customer acquisition costs of the vendors, but I would expect this will be the case going forward as the vendors and daily deal sites mature.

Not surprisingly, there appears to be no customer loyalty to the daily deal sites. Vendors who reported they would have other special deals also reported they might use another daily deal site.

Yet, I am convinced that part of this response is because these deal sites are new and probably need to improve their customer service. More importantly, it appears that real vendor value either in profit from the event or from return customers is isolated to specific behaviors. These behaviors need to be recognized and adopted by a wider range of vendors.

Item-specific sales rock. Close to 80% of vendors who ran item-specific (e.g., a reduced price for a massage versus $20 off a massage) sales said they would do another event. Furthermore, purchasers of item-specific coupons spent three times more than the deal value relative to dollar-based coupons. Item-specific deals were also 50% larger than dollar-based deals.

If the study has a bottom line, it would be vendors must create deals that are item-specific, have a high dollar value, limit the maximum number of deals, and keep the redemption period to three months or less. This is the game-changing behavior that will determine if daily deal sites are sustainable.

I said earlier that the survey should be taken with a grain of salt. Yet, I have faith in the results because the changes in vendor behavior that can dictate higher success rates are exactly the marketing model for flash sale sites (e.g., One Kings Lane, Gilt, Rue La La, So six months from now if the daily deal sites change vendor coupon behavior, we will see a convergence of marketing style between daily deal sites and flash sale sites. We can already see the beginning of this trend in the structure of travel deals offered by both Groupon and Gilt.

I still shake my head at Groupon turning down a $6 billion offer, but I know that this industry is in its infancy with a some serious growing up and hopefully profits ahead.