Why Deep Discounting Hurts Small Businesses
The constant search for new customers to help fill in the future sales pipeline is crucial to any business. The easy and most popular new customer acquisition strategy is to dive into a discount craze of the daily-deals and offer your products or services in daily discount sites/apps at 50% off your regular price.
However, going this route could mean the end of your business. This is different from the story you may have heard from companies like Groupon that claims that 80% of their campaigns are immediately profitable, and they will give you new ways to get exposure and scalability with their 50+ million active users. And the truth is that the exposure is there, however, as exciting as it sounds, this promise is flawed and reality tells another story.
On the other hand, the daily discount companies are not doing well and that is an indicative of this business model is not sustainable. Livingsocial was sold to Groupon in 2016 for $0. Also, Groupon, once valued at $16 billion, it is now less than $2.4 Billion and it is trading at about $4.7 per share. Groupon has experienced a decade of decline and no signs of strong recovery. In the Death of the Daily Deal article published by Knowledge@Wharton from the University of Pennsylvania, highlights that “Groupon, once named by Forbes as the fastest-growing company in the history of the web, has also become a shadow of its former self” and attributes their business model as unsustainable.
Then, the question comes, if the Daily Deal is flawed and not sustainable, then Why are there still other companies using similar strategies to promote their businesses? As important as it is to benchmark your business against others, it is also important to ask questions about what best fits your business needs, and how you can most effectively reach your target audience with the maximum lifetime value and still make a profit. Deep discounting offers the mirage of a large number of new customers and high revenues, but can also damage your bottom line. Consider these six reasons why deep discounting hurts small businesses:
1. Deep discounts attract the price sensitive customer with no brand loyalty
A Rice University study found that only 35.9% of Groupon customers spent beyond the deal value, and just 20% returned for another purchase at the full price compared with Groupon’s own claims that 91% return or plan to return. This is not only a considerable discrepancy, but also an indication that daily-deals attract mostly the price sensitive customer with no brand loyalty, and to an extent, the bargain addicts.
The Psychology Today's article, Can Bargain Hunting Be Addictive?, highlights how bargain hunting releases dopamine and the "feel-good effect", making it addictive to many consumers. Many merchants decide to ride the bargain wagon with the hope of attracting new customers and repeat buys, and justify the high cost of these deep discounts as marketing costs. But, Can your small business justify the high marketing cost of this channel with no return on investment? And most importantly, Are you attracting your ideal customer, the one that will be loyal to your brand?
At the other end of the spectrum, you are educating your customers to pay low prices for your products and services. The chances of them coming back to pay full prices are slim and if you were them, you would wait for the next deal in Groupon. These price sensitive customers are discount lovers, so they will continue to use Groupon to fish for the next deal. They will come back to Groupon, not you.
2. You could end up cannibalizing your existing customers
Daily Discount apps are available to everyone including your existing, loyal customer base. These companies won’t protect you from cannibalizing your existing customers, those who have been paying your full prices and telling their friends about you. Also, add to the mix the new customers that were willing to pay full price for your product or service, but they will pay you at a discount. Again, you will be educating your customers to fish for deals like the Groupon lovers and most likely, they will learn to wait for your next deal you have available, so Why pay full price? Also, your customers may draw the conclusion that you are charging higher that you should for your regular prices if you are able to offer such deep discounts.
Instead of incentivizing existing customers to buy more form you and build more loyalty for your brand, the message you are telling them is that is better to go to discount sites to get the best deals from you as it doesn't matter if you are a long time customer than a new one. Instead, consider how the high fashion uses discounts with their existing clientele. They promote any excess inventory to their loyal customers, making them feel appreciated and elite. The reality is that the acquisition cost for a new customer is much higher than keeping a customer loyal. Your efforts would be best spent considering up-selling strategies to increase your revenue and cultivating your exisiting relationships.
3. Bad experiences for all
MerchantCircle surveyed over 8,500 small and local business owners across the U.S. indicated. The study showed that 55% of local merchants who have run a daily deal campaign said they wouldn’t do it again and 42.4% of businesses cited negative customer acquisition as the primary reason for not offering a daily deal again. For example, there are numerous accounts of customer complaints about Groupon coupon redemption due to the fine print or miscommunications between vendors and Groupon that at the end, affect everyone involved in the process. Also, if a voucher is expired, the merchant needs to accept the voucher indefinitely (as per Groupon's Merchant T&C's, section f and g) towards a product of the same value or less. Therefore, you can have years and years of dealing with unredeemed vouchers. Regardless of the problem, if the customer has a bad experience, your reputation is on the line as well.
Let's don't forget about your employees who have to deal with the customer complaints and the exhaustion of a sudden increased demand, which many times end up in a much lesser tip for them, affecting their income if they rely on it to make their paycheck. They may also be looking for better alternatives. As a leader of your small business, take care of your customers, reputation and the people that make it all happen for you, your team.
4. Additional costs to be considered
When launching at deep discount deal, you can expect many customers. But, How many will arrive in one day? Or one week? There is no possible way to predict that and if you are not prepared, you will end up creating additional operational costs to accommodate the rush of new customers. Anything from paying your employees overtime hours to hiring new ones , last minute inventory purchases, extra work on your end to confirm the validity of the coupon, the pre and post sale prep work and other activities, extra support calls, etc. And there could potentially be more depending on your business.
5. Discount sites are building a powerful database at your expense
The daily discount sites are bragging about the amount of new users they get everyday and their million active users. However, they are getting the best part of the pie. They get to build a fanbase of excited customers looking for the next deal at your expense. Even if you try to get their contact information to start your own nurturing email campaign, most of these bargain lover customers will either politely decline or unsubscribe the first time they get a chance, or just ignore you. Why? First, you didn't attract your ideal customer, you only attracted the price sensitive customers. Therefore, the chances they want to hear about you and what you have to say is limited as they only want discounts. If they can't get more from you, they have Groupon or a similar company who may have your competitor's offer. You are better off working towards creating your own database with your ideal customers that want to hear from you and tell friends about you.
6. Return on Investment? Not really
With a simple math exercise you can quickly find out that there will be a negative Return-on-Investment (ROI) with a deep discounting strategy using a daily discount site. For example, your sell price for a service is $100. Say you offer it at 50% discount, so $50 and you get 1000 customers, the revenue from this promo is $50,000. You pay 1/2 the revenue to the company plus credit card fees (about 6% of the total revenue = $3000), your net profit is $22,000. You invested $75,000 ($50,000 you discounted plus the promotion costs).
Return on Investment = $22,000 (gain from investment) - $75,000 (investment cost) / $75,000 (investment cost) = - 70.66%
Then, you will be haunted with the question on how to replace the money you lost to discounts. If 20% of customers come back (based on the Rice University findings), you would need to sell them at least two times the full price to break even.
The goal of your business is to maximize profits and cash flow, not size. Rather than looking for quick fixes, you are better off identifying the root of the problem blocking the progress, addressing it with strategies that support your business goals, and implementing measures to track your progress and results. Do you know how to drive your profits and cash flow?
Deep discounting can be alluring because of the promise of creating an influx of new customers and fast. However, it just creates a rush and no real return-on-investment that could negatively affect your bottom line . Also, it could ruin your reputation as you scramble to support the increased demand and most importantly, it can potentially cannibalize your loyal customers.
At the end, deep discounts are good for the discount companies and its users, not you. They can offer great deals to customers that love discounts at your expense. You pay them 1/2 of the revenue plus credit card fees and you end up washing the dirty dishes (and paying for it) while they get all the praise. Users are also having a great time at your expense. They can pick great restaurants, services and goods at major discount deals! However, If you thought you were going to see them again, you will need to keep discounting.
There are better alternatives to deep discounting that not only create demand/lead generation, but also have higher probabilities to convert them at a positive ROI and maximizing the lifetime value of each customer. Quick fixes create more problems that they are worth. It is best you spend your time understanding your ideal customers and creating unprecedented value for them while reaching your business goals.
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