Big discounts on Groupon actually damage sales

Not only do daily-deal sites permit a much wider base of potential customers to access products or services, they also allow vendors to add discounts, which are seen as a further incentive to buy. In the U.S., one-sixth of those aged 12 or above register for at least one daily deal service, like Groupon or LivingSocial. However, new research conducted by my colleagues, Kai-Lung Hui and Hong Xu of the Hong Kong University of Science and Technology, and I, indicates that large discounts on sites like Groupon actually hurt the sales of small to medium-sized local businesses and thus work against their promotional purposes.

We analysed the hourly sales of 19,978 product and service deals listed on Groupon.com in 172 cities in the US and Canada. The estimates based on our sample show that if a merchant offers an additional 10% discount on top of 55.6% (the mean discount in our sample), the sales would decrease by 0.63%–4.60%, which translates into a $42–$275 loss in revenue. Indeed, it is not unusual to see discounts of up to 70% or 80%.

This is because, for less well-known local merchants, discounts are often considered a signal of low quality. This effect is especially prominent among credence goods, such as medical treatments and car repairs, because it’s difficult for consumers to know the true value of these services even after the transactions. The potential buyer reasons that if the product or service is good, it doesn’t need such a large discount. This causes people to shop elsewhere, even at rivals with higher prices.

Interestingly, we find that bringing in positive third-party reviews from Facebook or Yelp can lower sales even further. This is probably because people become even more suspicious if a product or service with many positive reviews is still offered with a large discount. This suspicion is reinforced by the difficulty consumers face in getting their money back from deals offered by restaurants or spas, for example, even if they are dissatisfied. As Groupon does not vet the third-party reviews that companies choose to feature on their discount page, the customer reasons that there may be other, not-so flattering opinions which have simply been left out in order to encourage new sales.

So, what can retail managers take from this research? Simply that if they want to use daily deal platforms to attract new customers, they should give reasonable discounts, not excessive ones. It’s also a good idea to use a flexible discount rate, whereby all customers get higher discounts when more sales are made. So, people who purchased the deal early get some of their money back later if certain sales thresholds are reached, which is believed to encourage early purchasers to tell their friends about the deal. And finally, don’t display third-party reviews if you offer a large discount.

Zike Cao is the lead researcher of this study and assistant professor of business information management at Rotterdam School of Management, Erasmus University (RSM)

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