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Groupon and LivingSocial work for consumers, but our local restaurants offer mixed reviews

Talk about gangbusters.

In January 2010, Washington D.C.-based LivingSocial had 33 employees and 120,000 members inside six markets. By last month, those numbers had grown to 1,400 employees and 28 million members across 250 markets internationally.

In an average day, the company adds six employees and an entire new market — say, a New York City borough, or an entire metropolitan area. Each week, it welcomes roughly 1.5 million new members. According to communications director Maire Griffin, LivingSocial is on track to book $1 billion in gross revenue in 2011.

And if you think that's big, meet Groupon. The Chicago-based leader in collective buying launched in November 2008, and with a force of around 1,800 employees, currently operates in more than 500 markets that span 46 countries; as of March, it counted more than 70 million subscribers.

When Groupon filed paperwork earlier this month for an initial public offering, it showed sales in 2011's first quarter nearing $650 million. Though some analysts are crying bullshit, the IPO itself may be worth $15 billion to $25 billion.

All this makes it abundantly clear that collective buying is good for these companies, and popular with consumers. So one might extrapolate that the model must also be good for one of its top merchant bases: restaurants.

But that's where the statistics turn tricky, the evidence grows relative and subjective, and where business analysts, restaurateurs, journalists and public commenters have filled the datasphere with passionate debate.

That's also where this story, limited for digestibility to Groupon and LivingSocial and eateries (versus the oft-featured spas, photography studios and other merchants), seeks to find answers in our local market and beyond. Because really, how probable does it sound that a business with food costs beyond labor and overhead can turn a profit, or at least break even, when typically receiving 25 cents on the dollar with these collective coupons?

But if the model weren't working, why would any restaurant sign up? And how would these companies be exploding?

It's a real pickle, no question.

'Grouponomics'

If you're entirely new to collective buying sites (What? You aren't on mmjdailydeals.com yet?!), the gist is that you sign up for a free daily deal to be e-mailed to you. For example: You're invited to pay $5 for a coupon worth $10 of goods at CiCi's Pizza, which 1,050 area subscribers did on May 27 — a local LivingSocial restaurant record. In LivingSocial's case, you can also subscribe to travel escapes, family deals and adventures, with a home and garden option coming soon.

Anyone can sign up for daily deals in any market, which many regular business travelers apparently do. Griffin likes to share the story of a couple who supposedly drove from San Francisco to Washington, D.C., and planned their route according to LivingSocial deals along the way. (Cheap! Or, um ... clever.)

Neither company will comment on its exact number of current subscribers in the Colorado Springs market, but in late May, a LivingSocial rep told a Springs merchant it had 86,000; it had launched in September. Groupon consumer PR rep Kelsey O'Neill would say that as of January, Groupon had claimed 130,000; it had launched here eight months earlier. With El Paso County's adult population at around 456,500, that could mean at least one in four people locally are savvy to collective buying.

On the merchants' end, they usually split the take 50/50 with Groupon or LivingSocial; so in the above example, CiCi's would get $2.50 after dishing $10 of pizza. To cover the $7.50 loss, it needs guests to spend much more than the coupon amount (referred to as "overspending"), or to become a steady customer who gradually pays the business back and helps it profit through repeat patronage, which is the whole idea. (It should also be noted that many coupon-holders forget to redeem them, which obviously benefits restaurants.)

There's generally perceived to be a decent amount of risk involved, which we'll unpack later, but many merchants are attracted to the fact that they put no money down to do these deals, and instead receive money from Groupon and LivingSocial up front. Groupon sends one payment the day after the deal closes, another in 30 days, and a final payment after 60 days. LivingSocial pays in two installments, one within two weeks of the sale and another a few weeks after that.

A May 4 Reuters article titled "Grouponomics" explains the appeal this way: "No longer do merchants pay money for the privilege of giving coupons away for free in local newspapers. Instead, they receive money — half of the total paid up front. There's something extremely gratifying about being paid to offer discounts to new customers."

And a few thousand dollars, during the slow winter months, can be a blessing for some businesses. Sometimes, it even means the difference between open or closed doors.

The believers

Lanna Hillstrom, owner of the 2½-year-old Curry Leaf, insists Groupon essentially saved her business. Despite offering locally unique and outstanding Sri Lankan food, she endured a rather lean winter, often not knowing if she could hang on.

Then April brought 755 Groupon sales, $5 for $10 at lunch or $7 for $15 at dinner, and an immediate rush of business. Around 80 percent of the 200 or so who've thus far redeemed (the coupon doesn't expire until Oct. 2) have overspent by around $10, and many who saw the deal didn't buy, but then came in anyway.

"It's totally worth it," she says. "I've got new customers coming in the door like you wouldn't believe, and now they're hooked. I've got people calling in lunch orders at 10:30. I can barely get my food prepared on time."

Opb&j co-owner James Killebrew also feels good about his April LivingSocial sale of 668 vouchers at $8 for $16 in food. He wasn't a fan, though, of his August 2010 Groupon experience.

Even though he sold 693 spend-$4-to-get-$8 deals (10 percent of which were never redeemed), Groupon attracted too many "coupon people," he felt.

"The majority of the Groupon people spent just up to $8," he says. "They'd hold up items and say, 'How much does this cost? How much does that come to?' They didn't tip. They were real cheap. Our feeling was, 'We'll never see these people again.'"

By contrast, LivingSocial patrons who've thus far redeemed have generally overspent by around $6 or more. The deal was structured at $16, to be spent in a single visit; Killebrew's average sandwich costs $6, so users, many of whom had never visited Opb&j before, have brought friends and family in with them.

Most importantly, Killebrew believes he's reached more people through LivingSocial because of its superior use of social media. The company offers a secondary deal where if a user who buys a coupon posts it to his or her Facebook page or tweets it, and three others buy the deal because of that, the initial user gets it free. So naturally, it's more likely to go viral in a world of deal-seekers. "Now I'm reaching people I never would have reached," says Killebrew.

"You really need to look at it as an advertising tool, not as, 'Oh, my restaurant is going to make a bunch of money from selling these.' I don't know how much it would otherwise cost me to reach this many people ... I don't know where else I could go and find that service."

When, but not if

As illustrated on the right, other area restaurateurs have plenty to say about their own collective-buying experiences. But looking for a more big-picture view, we also sent out a query on a journalist-source database. It read simply, "Are collective-buying sites good for restaurants?"

The dozen-plus replies we received from "business experts" of all stripes were encouragingly redundant and enlightening (see some here), and raised a range of peripheral questions and disclaimers.

We opted to follow up further with Mark Chussil, the Portland, Ore.-based founder and CEO of Advanced Competitive Strategies, who has offered business war games and strategy simulations over the past 35 years to the likes of Fortune 500 companies.

Being a model-and-simulator guy, Chussil made it clear right away that "perceptions and anecdotes don't answer the question," and that counting overspending and trying to track repeat business won't yield a truly useful result.

"The assumption that at 25 cents on the dollar you lose money may be false," he says. "Think of airlines that sell tickets dirt-cheap. The airplane is going anyway; if it has empty seats, it's better off selling at any price above the incremental cost of carrying that one person, considering fuel, the transaction cost and so on. They can say it's worth it.

"The same may be true at a restaurant: What is the cost they carry when empty or full, considering staff, rent, insurance and all their systems?"

His list of equation factors goes on, and drives at comparing the collective-buying risk with its alternatives: doing nothing at all, or putting money into other advertising, joint marketing or loyalty programs that also yield debatable results.

"It won't be the same for every restaurant," he says. "The cost structures are different, as are the patronage and profit margins. There won't be one answer for every restaurant."

So does it really take a guy with an MBA from Harvard to tell us something so basic and, in some ways, unsatisfying?

"Yes, I'm afraid so," he says. "It's good for some, not for others, and as with many things in life, it depends."

Rather than asking if Groupon and LivingSocial are good ideas for restaurants, he finds it more pertinent to ask when they're good for restaurants. "The latter asks what it depends on. And that's what we can use models for."

Inspired by the discussion, Chussil built a "crude and incomplete" spreadsheet that he later shared. Among his "discoveries": Coupons can help if food costs are low and margins high, and hurt if their users displace regular, full-price-paying customers.

The heathens

Another "cost" that restaurants should weigh is the potential for setting up negative behavior patterns with current and new clientele.

A March article in Slate, titled "The Groupon Paradox: How its coupon business could eventually cripple the merchants that rely on it," contends that: "Prices are likely to erode as consumers come to expect deals. They will wait for sales to buy, and merchants will find themselves competing ever more fiercely. Meanwhile, merchants' brand power will be eroded as consumers look to Groupon (as they do to Orbitz), rather than to the merchants themselves, for the best deals."

The author goes on to say that eventually Groupon will suffer, too: "Its sales force is training thousands and perhaps millions of merchants to use e-mail marketing and coupons," and merchants will eventually tire of "hand[ing] over such a huge share of the revenues."

Look no further than the Margarita at PineCreek to see this very argument in motion. Chef Eric Viedt says he and owner Pati Burleson get calls from Groupon "all the time," and have been tempted. Instead, they decided to test the waters themselves.

In late March, in conjunction with the restaurant's 37th anniversary, 1,400 people on the outfit's mailing list received an offer that the Margarita also posted on its Facebook page: Buy a $50 gift certificate for only $30. They promptly sold 175 certificates, earning them $5,250 up front.

Now, this could be seen as more of a customer loyalty program, on account of it going out to existing customers, but Viedt says he did take calls from new people whose friends had forwarded them the deal.

"When everyone's looking for deals all the time, we have to get on board somehow," he says. "But we didn't want to cheapen our brand, our quality and what we do here."

That sentiment is echoed across town at Jake & Telly's Greek Taverna, where co-owner Jake Topakas was less than thrilled with his LivingSocial experience. Even though he'd negotiated a 60/40 split in his favor, he says guests "weren't the greatest tippers" and tended to spend exactly the $40 deal amount.

"Why downplay your product?" he asks. "Isn't it good enough food service to not only pay full price for, but actually want to, because you know it's well worth it? ... It might be good for a brand-new restaurant that needs promoting, but if you're established, I say, 'Stay away from these deals!'"

But those like Topakas and Viedt may be fighting a losing battle, according to Chussil.

"You don't have a lot of choice," he says. "If you aren't [doing deals], someone else is, and people are already trained."

Who's at fault?

Asked about brand-weakening, both Griffin at LivingSocial and O'Neill at Groupon reached to company demographic surveys to defend themselves.

"We don't consider ourselves a coupon company at all," says Griffin. "We are a local commerce company. For us it's not about driving a coupon, it's about creating an experience."

(Like, umm ... eating?)

Coupon-clippers "are not our audience," she argues, citing high college and grad-school rates, and high household-income figures, among subscribers. LivingSocial's internal surveys also reportedly show encouraging figures; they claim that when subscribers patronize a featured restaurant, 50 percent of them are doing so for the first time; 87 percent generally plan to return; and that they overspend by $33.65 on average. What's more, 97 percent of business partners are interested in running follow-up deals.

O'Neill asserts that 83 percent of its clients overspend, in restaurants by an average of 80 percent — think $18 on a $10 coupon. She adds that about 95 percent of their clients are interested in working together again.

If you go looking, stories from that other 5 percent are out there. Just visit the blog of Portland, Ore.-based Posies Bakery & Café (posiescafe.com) for one from last year that "spread through cyberspace like wildfire," in the words of café owner Jessie Burke. Her tale of near self-immolation, titled "Groupon in Retrospect," inspired 126 comments in a week, including one from Groupon CEO Andrew Mason trying to right the PR nightmare.

Burke, who's been in business around two years, called her deal "the single worst decision I have ever made as a business owner thus far," saying that in addition to some great new customers, she was flooded with "terrible Groupon customers." Much scarier, she claimed that she had to draw $8,000 from personal savings to cover payroll at one point, pinning that as the cost of doing business with Groupon.

Both Groupon and LivingSocial assert that they're careful in setting up and structuring their deals. "We won't just run any old deal," says O'Neill. "We only work with businesses that have a great local reputation. There's an extensive amount of research that goes into it, and an extreme vetting process."

As for how they know that reputation, LivingSocial is proud of a "feet on the street" philosophy. Unlike Groupon, whose reps typically commute from Chicago, LivingSocial has reps living in each market.

"We know what's hot, exciting and what the trends are for that area," says Griffin. "It helps us really work with merchants to figure out what is a deal that will not only entice our members to purchase that deal, but what's going to move that business forward."

Groupon's O'Neill rightfully places some of that responsibility back on restaurants.

"We drive the people to your business. It's up to the business to take advantage of this and say, 'I'm going to wow them with our service. I'm going to upsell them and bring them back again and again to spend additional money that's not discounted.' So business owners have the opportunity to create long-lasting relationships and a whole new customer base using Groupon, and those that take advantage of it and prepare accordingly have great success and come back to run again and again."

And the survey says ...

If you could ever place a number on how many businesses benefit from collective buying versus those who don't, the "Groupon Effectiveness Study" may hint at it.

Done by a Rice University marketing professor last September, the study involved 150 businesses in 19 U.S. cities, spanned 12 product categories in addition to restaurants, and broke out restaurant data from 48 participants individually. Of those, 42 percent reported unprofitable promotions, again citing a prevalence of "deal-seekers."

The larger study found that Groupon promotions were profitable for only 66 percent of respondents. In the end, it concluded, "there is evidence from this study that raises some concerns about the sustainability of social promotions as they currently exist. We believe these promotions are structured in such a way that they give too much value to consumers and not enough value to the small businesses [that] run them."

The subject of sustainability has been broached by many writers, not only because these companies are growing so rapidly, but because competitors like Tippr, Buy With Me, GiltCity and Morgan's Deals are aggressively looking to crash the party.

And now, the heavy hitters are coming, too.

After its failed purchase of Groupon for $6 billion last fall, Google developed Google Offers. It just launched in Portland and will soon be available in three New York City areas, plus San Francisco and Oakland. AmazonLocal launched in Boise, Idaho, the day after Google Offers.

Even more menacingly, Facebook Deals, currently available only in Atlanta, San Diego, Dallas, San Francisco, Austin and six other countries, is poised to mine its 600-million-plus users in a way that had a ReadWriteWeb blog writer in late April speculating that "Groupon and LivingSocial are seriously at risk of being roadkill."

Why? Because of existing popular features like check-ins and shared newsfeeds that could be tied into deals, and the simple fact that Facebook is a data miner's wet dream, full of peripheral demographic information that could better customize deals.

"That info is gold," says the article, "and it's going to be the real killer for Facebook Deals. Not just scale, not just the world's greatest viral marketing platform — but valuable data about each and every customer that can then be used to retarget marketing efforts in the future."

A Facebook representative named Emily White claimed in a May 6 Fast Company article that they are not in direct competition with other deal providers, that Facebook is less interested in "deals for deals' sake," but more interested in "deals that enabled people to do things together."

White outlined how the social nature of Facebook Deals should eliminate many of the deal-seekers, and how users and merchants can interface on Facebook. Of course, the example relates to three friends at dinner, posting photos, tagging the business, and generating feedback for the restaurant in a way that only Facebook's interface allows.

That's the power of a hungry social network.

Deal over

The irony is that Groupon and LivingSocial are already using Facebook, too, as mentioned above with LivingSocial's tell-three-friends deal; Groupon has a Facebook page in each market as well as national pages.

Groupon is supposedly in partnership talks with Foursquare on check-in-based deals, and in addition to partnering with Expedia on travel deals, just launched Groupon Now, a feature showing in-the-moment deals based on your location. (A short introductory video is at groupon.com/now/about.) Again, the example is a restaurant with open tables at lunch: The restaurateur can launch a quick deal to fill seats; users download an app to their smartphone, which displays deals right around them.

This gets back to the query of when, rather than if, a collective buying site can be good for business, and shows that all the jockeying for position should only lead to more innovation.

But will restaurants fare any better, regardless of how novel the approach?

The fact is, they're going to have to, if any of these collective-buying sites are to survive and thrive. If enough restaurants and merchants swear off these services due to poor results, the sites will fade into the obscurity of MySpace.

The encouraging fact for (almost) all parties involved: The people are trained, they want the bargains, and so there's a tremendous and potentially endless demand. Now restaurants just need to negotiate a better split, subscribers need to access their un-cheap sides, and collective-buying sites need to do some cannibalizing to keep their own brands strong.

It's a complex formula for success. But where there's a deal, there's a way.

matthew@csindy.com

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