Tony Keller: How group buying sites have spawned a breed of fickle, bargain-addicted consumers that will never pay full freight again

Tony Keller: How group buying sites have spawned a breed of fickle, bargain-addicted consumers that will never pay full freight again

The Price is Wrong

Late last year, Marlon Pather, owner of a midtown meat shop called The Butchers, embarked on an ambitious plan to sell thousands of online coupons. Like other merchants seized by the daily deal mania of websites such as Groupon, he thought that his deep discounting would bring in new shoppers. It did. He quickly became Canada’s biggest coupon merchant, selling 22,000 coupons, worth millions of dollars, in a few months. Pather thought the new customers would redeem the value of their coupons gradually, but they cashed in all at once. By spring, he realized that his loss leader strategy had turned into a straight loss. Customers were lined up around the block, and the fridge was constantly running out of stock. The coupon clients came for the discount—$400 worth of steaks and burgers for just $100—but every time the cash register rang, Pather lost money. And his established clients, who until then had been willing to pay full price, were having trouble even getting into the store.

The daily deal or group buying business is suddenly the hottest sector on the Internet. Groupon, the industry leader, has been described as history’s fastest-growing company, its annual sales ballooning to an estimated $3 billion in only three years of operation. In the first quarter of 2011, the company sold 28 million coupons. The simplicity of the idea has spawned hundreds of imitators, and they all work on the same model: customers pay up front for vouchers offering deep discounts, at prices usually at least 50 per cent below retail. Coupon revenue is generally split 50-50 between the daily deal company and the merchant—which means that a merchant offering $400 of meat for $100, as Pather did, is actually offering $400 of product for a payment to him of only $50. That’s nearly 88 per cent off retail price.

Toronto-based sites such as Dealfind, TeamBuy, Buytopia, WagJag (owned by Torstar) and WebPiggy are fighting for a piece of the action. There are sites targeting niches: Toronto’s Food Scrooge brings group buying to groceries; GroupDudes offers deals for guys. (I missed their coupon for 55 per cent off hockey equipment sanitizing.) Facebook, Google and Amazon are all entering the field. A survey released this spring by the market research firm Vision Critical found that 49 per cent of Canadians had already visited at least one daily deal site.

Groupon’s name is meant to suggest that savings come from large groups of people banding together to buy in bulk. The industry furthers this myth, describing itself as the “group buying” business. In reality, these sites are in the advertising business. Coupons are a great marketing tool. And some coupons, even those promising very deep discounts, can be immediately profitable—but only for certain kinds of businesses. For companies whose main costs are mostly or entirely fixed—such as salaries and rent—deep discounts can be profitable.

That’s why you see so many salons, gyms and dance studios offering online coupons. The marginal cost of adding one more student to a salsa dancing class is zero. The business’s costs—the rental of a classroom, the hiring of an instructor—are fixed. It costs no more to teach 20 students than it does to teach 10, which is why a dance studio that has already charged full price to the first 10 students may still turn a profit on the next 10, even if it only charges them pennies on the dollar. Airlines have long worked on a similar principle, with passengers paying wildly different prices for seats on the same flight, depending on when they buy them.

But a butcher shop is nothing like a dance studio or a half-empty plane. Pather’s main cost isn’t real estate or labour: it’s meat. Pather must buy every steak he sells. His expenses increase in lockstep with sales. If he sells $400 worth of New York strip loin for $50, he loses money. And the more he sells, the more he loses.

Losing money on some sales isn’t necessarily a problem: the largest retailers in the world have been doing it for decades. The loss leader strategy of targeted, limited discounting makes sense when it brings in customers who end up buying other, more expensive goods or services as well. Remember when the phone company gave you that “free” BlackBerry, but only after you agreed to sign a three-year contract? Or look at your computer printer: why is a complicated piece of electronic equipment cheaper than a cartridge of ink?

Pather took a bath on his coupons: he told me he lost “more than $100,000.” That sounds like a conservative estimate. There’s no Internet magic that turns meat sold at 88 per cent off retail into a profitable sale—something Pather’s coupon buyers seemed to instinctively understand. WebPiggy, Dealfind and Buytopia, the sites Pather used for his sale, can’t reduce the average cost of a beef patty. The Butchers had lineups around the block because couponers knew the deal was too good to be true, and they wanted their 10 pounds of flesh in case the place went broke.

The Butchers was a case of the merchant being taken by the customers, or perhaps by himself, but that’s not usually how it goes. As anyone who’s ever tried to haggle for a car has learned, the seller almost always triumphs over the buyer. Lots of customers out there are getting a deal, but for the merchant to be profitable, the deal getters have to be balanced by other customers who aren’t getting a deal—“price differentiation” is the egghead term. Or else what appears to be a discount really isn’t. In a recent paper on Groupon’s business model, three Harvard economists concluded that “as more consumers use vouchers, voucher users necessarily come to resemble average consumers.” In other words, if most people are buying at the deal price, then the deal price is really just the regular price. Which leads to a philosophical retailing question: if everyone’s buying something “on sale,” is it really on sale?

But we all want to feel like winners. So, to play the game according to the rules demanded by today’s bargain hunters, sellers have learned to mark up so as to allow room to discount down. (Paying the price quoted on a hotel website? You overpaid.) They’ve learned to make buyers work a little bit for their savings, sprinkling coupons and Internet deals and secret savings codes among different audiences—some to attract new customers, some to keep loyal ones, and some for the kind of people who are obsessive enough to spend hours trolling online travel forums, looking for a discount code that will chop $50 off the price of a rental car next winter in Arizona. (Guilty.)

Indeed, if Marlon Pather had come clothes shopping with me, I could have saved him all that money. There’s a menswear store in the Annex that I used to visit once a year. I live just down the block, but the only time I shopped there was during the annual street fair. On that day, the store would haul some of its stock onto the sidewalk, marking dress shirts down by two thirds or more. If there was anything worth buying, I’d buy. And for the next 364 days, I’d stay away. Had a deal converted me into what Pather was looking for: a loyal customer? Nope. On the contrary, the deal trained me to be an uncompromising deal seeker. And the more deals I land, the more I’m persuaded never to pay retail. Or at least to shop somewhere that knows how to make me feel like I didn’t.