issued, and no money changes hands. On successful deals, Groupon collects as
much as half the face value of the coupon ($25 in the facial example).^19
The key to Groupon’s successful business plan is no mystery; it involves
just good old-fashioned economics. Besides delivering deals to millions of
potential buyers on its e-mail lists, its discount voucher service offers two
enormous benefits to the local businesses it showcases. First, Groupon serves
an advertising function—it informs new potential buyers (most of whom did-
n’t even know the business existed) of the merchant’s goods and services. A
portion of coupon takers who try the merchant for the first time can be
expected to return for repeat purchases (at undiscounted, regular prices).
For local businesses that otherwise must rely on costly and “clunky” ads in
the local print media, Groupon’s online ability to reach and inform potential
new customers is much more cost effective. Second, using discount coupons
is a powerful means of price discriminating—offering selective (steep) dis-
counts to the most price-sensitive buyers, those who have not yet become reg-
ular customers. Almost by definition, the segment of loyal, satisfied, regular
customers are much less price elastic. Although the merchant discount via
Groupon is steep and attention getting, it is only temporary (unlike the case
of third-degree price discrimination). From the merchant’s point of view, the
key issue is how many new buyers—attracted by the discount—become reg-
ular customers versus how many regular customers grab and exploit the dis-
count for goods and services for which they would have paid full price. The
merchant profits from Groupon’s version of price discrimination as long as
the additional profit from the first group outweighs the forgone profit from
the second group.
Groupon’s current success depends on a number of factors. Like any good
advertiser, it skillfully develops high-profile discount offers to a large, targeted
subscription audience. Playing on buyer psychology, Groupon offers a single
steep discount per day (exclusivity) and stipulates that the deal is on only if
enough buyers click yes (creating the thrill of the deal). Groupon succeeds to
the extent that a new buyer feels she is getting something (which she may or
may not really want) for next to nothing. Network externalities also come into
play. Businesses prefer Groupon because it delivers a large local base of poten-
tial customers. They are willing to grant Groupon an amazing 50 percent of
the discount price because they believe that the positive impacts of new cus-
tomers outweigh the margins sacrificed on regular customers who exploit the
discount. Groupon’s major risk is that the slew of discount imitators will greatly
reduce its pricing power, forcing it to accept far less than its 50 percent and
squeezing its share of local bargain hunters.106 Chapter 3 Demand Analysis and Optimal Pricing(^19) This discussion is drawn from a number of sources including B. Edelman, S. Jaffe, and S. C.
Kominers, “To Groupon or Not to Groupon: The Profitability of Deep Discounts,” Working Paper
11-063, Harvard Business School(November 2011); D. Pogue, “Psyched to Buy, in Groups,” The New
York Times(February 10, 2011), p. B1; and “Groupon Anxiety,” The Economist(March 19, 2011), p. 70.
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