To Groupon or Not to Groupon: The Profitability of Deep Discounts

Executive Summary:

For consumers, online discount vouchers (like those offered by Groupon.com) have obvious appeal: discounts as large as 90 percent. But for retailers offering the deals through the site, does the publicity compensate for the deep hit to profit margins? This paper sets out to help small businesses decide whether it makes sense to offer discount vouchers.

Research was conducted by Harvard Business School professor Ben Edelman, Business Economics PhD candidate Scott Duke Kominers, and by Sonia Jaffe of the Harvard University Department of Economics. Key concepts include:

• For retailers, discount vouchers provide price discrimination, letting merchants reach customers who know about the business, but wouldn’t ordinarily go there without a discount.
• These vouchers also benefit merchants through advertising, simply by informing consumers of a merchant’s existence via e-mail.
• For some merchants, the benefits of offering discount vouchers are sharply reduced if individual customers buy multiple vouchers.
• As a marketing tool, discount vouchers are likely to be more effective for businesses that are relatively unknown and have low marginal costs.

Abstract

We examine the profitability and implications of online discount vouchers, a new marketing tool that offers consumers large discounts when they prepay for participating merchants’ goods and services. Within a model of repeat experience good purchase, we examine two mechanisms by which a discount voucher service can benefit affiliated merchants: price discrimination and advertising. For vouchers to provide successful price discrimination, the valuations of consumers who have access to vouchers must systematically differ from-and be lower than-those of consumers who do not have access to vouchers.

Offering vouchers is more profitable for merchants that are patient or relatively unknown and for merchants with low marginal costs. Extensions to our model accommodate the possibilities of multiple voucher purchases and merchant price re-optimization.

For the full paper, go to http://www.hbs.edu/research/pdf/11-063.pdf

 Source:  by Benjamin Edelman, Sonia Jaffe, and and Scott Duke Kominers, posted August 2, 2011 at http://hbswk.hbs.edu/item/6597.html?wknews=08032011