Summary: Groupon, and its “group buying” counterparts, have been all the rage in e-commerce, but is it right for your product? Here we’ll look at the types of products and strategies where these platforms do, and do not, make economic sense for merchants.

With all of the recent hype around the spurned $6B acquisition offer of Groupon by Google, and the holiday shopping season upon us, I thought I’d share our experience at Lime Tree Cove, with promoting our products through group buying.

In considering, researching, and executing our campaign we learned a lot, and wanted to share our experiences and views of what types of products / services are best suited, and which are not.

First, a breakdown of group buying economics

By “group buying”, I’m referring to the numerous services that showcase discounted products and services; usually done with a minimum number of people accepting, in a “deal a day” model that targets specific local markets. While there are a host of sites offering this service, such as Groupon, Eversave, Living Social, BuyWithMe, Woot, getsugar, Tippr, and more, there may be subtle differences, but the general model works as follows:

• The consumer receives a 50% discount on the list price of the product
• Of the remaining 50%, 50% of that goes to the site
• So effectively, you’re selling your product at a 75% discount

For more information you can go here, but for all intents and purposes, you can expect to give a pretty steep discount, and not all types of products and business models can stomach this. So let’s look at who, and when, this type of promotion works best and worst…

When Groupon makes sense for you, as a merchant

The group buying economics are harsh, and the time-limited nature and hyper-promotion of the deals may overwhelm, so its clearly not for everyone, in all situations. Here are some scenarios that we had, where we could take advantage of the “group buying” benefits.

1) You have “expiring” inventory

It’s no accident that restaurants comprise nearly half of Groupon’s inventory, and OpenTable is also getting into the act. Imagine on Monday nights, during off-peak hours, there are lots of empty tables that if it isn’t used, are worth zero. Likewise, whale watching boats, that have seats that are either filled or empty once the ship has sailed (literally and figuratively). This is great inventory to burn through group buying.

2) You have an experience good with a high potential lifetime customer value

When introducing new products and services that are heavily reliant on “experience”, it is helpful for consumers to get a trial version — this is why you see companies hand out packs of chewing gum on street corners. By giving customers a “taste” of your product, you’re hoping to “acquire” this customer, and make your product their preferred choice going forward. The effect of this is to use Groupon as your “customer acquisition” vehicle, which even if costly, the “lifetime value” of that customer will be recouped once they return repeatedly and purchase at full price.

David Skok has a great post on the economics of customer acquisition costs and customer lifetime value, if you really want to understand how best to leverage these economics.

3) You want to create initial awareness quickly to leverage word of mouth marketing

This approach works if you’re entering a new market and are willing to subsidize educating a group of lead users. The idea is that with a passionate core group of customers, you can leverage their influence to attract other customers in their social network, and/or to influence retail or other channels that covet that initial user base. The best part of Groupon is that people love to talk about what a great deal they got, and so this approach can help seed your product and expand from there.

4) You have an array of complimentary products

When your product experience can be improved with other products you offer, you have the potential to increase the average order size of every single Groupon redemption. You can see this strategy in action in the fast-food industry, where “combo meals” subsidize the price of the burger with high margin complimentary products, like fries & a drink. Therefore the additional, high-margin products offset the small Groupon margins with full-priced sales of complimentary goods.

5) You want to liquidate excess capacity or inventory

Groupon may be a good option for you to quickly clear out inventory that’s sitting on the shelf. Another derivative scenario is that you have a factory with “excess” capacity, or has not reached minimum efficient scale; then having a quick way to sell off that additional inventory is extremely helpful.

6) Other reasons

Group buying may also be a consideration for those that have ridiculously high margin businesses, have high fixed cost leverage, or who want to reach a specific demographic efficiently (predominantly females aged 18 to 34). Of course if you have more than one of the reasons above, that’s also a good indicator.

Merchants who should approach Groupon with caution

You have an uber premium / luxury product

For those super high-end retailers, Groupon may not make sense. The “deal of the day” model may erode the sense of scarcity and exclusivity, so common with luxury goods. Consequently the short term gains may serve to degrade overall brand perception.

You operate with thin margins

For those merchants who find themselves in negative margins with Groupon, and cannot guarantee the offsets we spoke of above, don’t do it. You’re not a web company, and its not about “eyeballs”; these are real merchants with tangible products / services that cost real money to produce / deliver. If you’re not set up properly the results could be disastrous.

You are throughput constrained

Since the Groupon audience is so large, there is the chance that you can make more sales than you can actually deliver on. There is certainly some wiggle room, in that customers can redeem their voucher over a set period of time, so sales can be spread out…and then, there is the chance they don’t. So make sure your inventory management, personnel, and fulfillment operations are all ready to go. Also, ensure that an influx of new discount seeking customers does not negatively impact your existing customers.

Our experience with group buying

At Lime Tree Cove, we did a promotion with Eversave, a Groupon competitor. Although we may not have gone through this thinking, in as much detail as we have here, the results we saw are as follows:

• Created initial awareness and a passionate group of early adopters
• Our best source of gathering new customers is from our existing customers, either through gift-giving, or via word-of-mouth; an effect well captured in group buying.
• Showing evidence of market traction, helped us access new retailers and markets in a much shorter timeframe.
• We subsidized the cost of our applicator devices with our accompanying spice line, which 90% of customers chose to do.
• We reached our core demographic (women 25-55) very efficiently.
• We did a low-downside experiment, and now have more experience to help us going forward.

Hope this helps you in deciding whether your product / service can be kicked into high gear with this new wave of group buying sites…or at least help you understand what all the fuss is about.