Weekly Update

Can the daily deals business be saved?

If you lived in New York during the first dot-com bubble, you remember dodging the army of orange-clad delivery people dispatched by Kozmo.com as they careered around the streets on their scooters and bicycles.

Kozmo was launched in 1998 and promised to deliver pretty much anything at any time to any address in the city, within one hour. It ended up delivering a lot of Häagen-Dazs ice cream at 2 a.m. to people with the munchies. The service died three years later after expanding to eight other cities, leaving behind an abandoned IPO and 1,100 former employees. Along the way it burned through about $250 million.

Today backers of daily deals sites may be experiencing a similar sense of vertigo. Market leader Groupon has pushed back its once keenly anticipated IPO after the company was forced to restate its financials. Its prospective valuation has fallen from as much as $30 billion to $3–$4 billion.

LivingSocial was also heading toward an IPO, but that, too, now looks doubtful. The company reportedly is looking for additional private funding instead. Meanwhile, major players like Yelp and Facebook are getting out of the business altogether while scores of local deals sites are closing up shop.

The similarities between the deals sites and Kozmo’s delivery service go beyond mere irrational exuberance, however. Like Kozmo, Groupon’s business model creates a clash of incentives between the company itself and the customers it’s trying to serve, one that pits volume against value.

Kozmo’s anytime, any item delivery model might have worked if the average basket of goods delivered were big enough. By setting no minimum order size and no delivery charge, however, Kozmo created an incentive for customers to use the service frequently for small orders, which is just what they did.

Online coupon sites typically offer goods and services at 50 percent off retail. The sites then take about half of what the customer pays. That creates an incentive for the deals sites to maximize the number of coupons they send out, without regard to category exclusivity for the merchants, the frequency of promotions or any of the ordinary constraints that marketers and merchants would typically apply to price promotions.

For the merchants, the offers only make sense if coupon-using consumers become repeat customers who go on to pay the full price. According to an increasing number of merchants who have experimented with online coupons, however, that doesn’t happen nearly enough. Instead, coupon buyers simply take their business to the next merchant to offer a similar product or service through the deals sites, a game made easier by the ever-growing number of coupons being offered.

For the business to grow and be sustainable, the interests of the coupon sites and those of merchants will need to be better aligned.

One way that might happen would be to tie use of the coupons to an online payment processing system so that both payment processor and merchant stand to benefit from repeat business. That would create an incentive for the deals sites to target coupons at consumers most likely to become repeat customers.

The data collected by the payment processor could also be used to reward frequent purchasers with future discounts or other incentives.

The pricing of coupons between the merchant and the deals sites is also going to have to change, such that the sites get a bigger cut of the deal in exchange for exclusivity within the merchant’s category of service or goods.

Simply hawking discounted goods and services inevitably creates a race to the bottom, exactly what many merchants are experiencing today with daily deals sites. If the deals sites are to have a role in the future, they need to become market makers, matching willing buyers with willing sellers. Otherwise, there’s nowhere to go but down.

Question of the week

What’s the best way to align the interests of daily deals sites and merchants?