If you own or run a small business, acquiring customers can be one of your biggest ongoing challenges. Word of mouth is great, but it is slow. Most advertising requires a big commitment with no real guarantee of success. And there are a thousand agencies with a "secret formula" who want to lock you in to service contracts.

In light of the many challenges and complexities of marketing a small business today, it's not surprising that so many small businesses have turned to daily deals. On the surface, Groupon seems to offer the following advantages:

Access to a huge mailing list
It’s fast - depending on the demand for your product or service and the strength of your deal, you can generate lots of traffic on a moment's notice
No need for an agency or internal marketing department… work directly with your Groupon rep and they do everything, including write your ad copy
You don’t need to have a Ph.D. in internet technology
Pay only when someone becomes a customer

Daily Deal True Colors

Unfortunately, when evaluated on a cost-per-acquisition (CPA) basis, daily deals often prove themselves to be unprofitable and unsustainable.

Here’s how it works for most businesses (unless you are Starbucks or Apple, in which case you get special treatment and this doesn’t apply):

Thus, the typical net revenue is 25% of your normal ticket price.

Additionally, most small business owners and managers I talk with have experienced the following challenges:

Daily deal customers tend to be “deal seekers”, who just come for the discount and fail to convert into a profitable long term customer.
The influx of unprofitable customers drains resources and time that could be spent elsewhere to grow the business (opportunity cost).
The deep discounting of daily deals erodes margins and raises cost per acquisition, often at the expense of retaining more profitable existing customers.

Is there a right way to do daily deals?

Daily Deals are here to stay and they can be a viable component of a larger marketing strategy. If you are considering trying Groupon or Living Social, I have two suggestions before you jump in with both feet:

Do a comparative analysis first, looking at other popular acquisition marketing channels such as Paid Search (e.g. Google Adwords) and Social Media advertising. These channels can also produce fast results and usually for a much lower CPA.
Make sure your offering, margins, transaction frequency and the like allow you to generate a positive return on investment.

In order for Daily Deals, or any deep discount, to be viable, here are some important criteria:

Criteria 1: Customer Lifetime Value is significantly Greater than Transaction Value

It’s not uncommon for acquisition costs to exceed initial transaction revenue. In many business models, particularly subscription based services (your wireless phone service, for example) break-even occurs after some number of months. In these situations, growing too fast can cause cashflow problems. However, if cashflow and financing options permit, and if you are confident in future non-discounted transactions, you could theoretically be negative on the initial transaction and still find daily deals to be a viable part of your marketing mix.

Key considerations:

Can you convert the daily deal customer into a long-term customer at the same rate as other customers? Many small businesses have discovered Groupon customers tend to transact only because of the deep discount, and have no interest in becoming a full price loyal customer. Watch customer behavior closely and know what your risks are.
How will you encourage and maximize these future transactions? You may need to think about how to capture and re-market to these customers after that initial transaction with timed followup offers. Case in point: say you have a gutter cleaning business that is highly seasonal. Every fall the leaves fall off the trees, right? Success for you will mean capturing an email address for your deal users so that you can send a series of communications and coupons to return next year. Since you know these are deal seekers, give them an early bird special to "book early and save", before they take the next Groupon from your competitor.

Criteria 2: Your margins are significantly greater than 75%

Most businesses do not meet this criteria. But theoretically, if you had high enough margins to not lose money on the initial transaction, then you could rationalize the daily deal model as a way to create bursts of new customers to cover fixed costs or drive brand awareness and trial.

Key considerations:

With margins this high, think more about opportunity costs. Just because you have the discretionary cashflow to heavily discount doesn’t mean it is the most cost-effective way to promote and grow your business. What other lower cost marketing channels could be tested?
Since daily deals can reach a large number of consumers in a flash, think about the best timing for your offer, like when you have capacity just before a period of high seasonal demand. This strategy can help you pull customers away from competitors before they transact and build your market share, without cutting into your bread and butter.

Criteria 3: You have excess capacity and variable costs are low

I see a lot of deals coming from Yoga outfits. If the studio is yours, and the instructor has been paid, there is little to no incremental cost to add participants until the studio is full. So why not fill the class with a captive audience of prospective customers and give them a great experience. Just make sure you know what your conversion rate needs to be, especially if you are incurring any costs (e.g. adding extra classes) to accommodate your daily deal customers.

Key Considerations:

Be aware of the deal seeker, and track conversion rates!
Be careful that the sudden influx of new customers doesn’t compromise your ability to delight your current profitable and loyal customers.

Criteria 4: Make sure the offer works for your business

As we’ve discussed, Groupon's baseline offer structure isn’t profitable for most businesses. I don’t like the notion of not having complete control of my offers. Your margins, fixed vs variable cost structure, capacity, cashflow, competitiveness, etc. are all unique to you and should be the sole drivers of your offer strategy. So know your bottom lines and be prepared to negotiate. Here are some creative offer types you can consider:

Promote offerings that tend to lead to additional up-sell purchases.
Flat $-off offers can entice customers to upsell to a more profitable price point in order to get the full value of your deal.
Multiple visit offers can help drive the loyal behavior you are looking for and limit cost exposure on a per transaction basis.

Case-in-point: "Loss leader" strategies have been around advertising and marketing for a long time, and can work with daily deals. Let's say you have an auto repair shop that specializes in European auto brands. It can be a challenge to get Mercedes Benz owners to trust an independent shop. So promote a deep discount on an oil-lube-filter service. Everyone needs oil changes, and the there's little risk to trial of this service. Once they are in your shop, it's likely additional services may be needed, and you get a valuable opportunity to convince the customer you deserve their long-term business.

Additionally, watch out for cannibalization. It’s one thing if you can break even on incremental sales driven through the deal, but if existing customers, or customers who would have found you regardless of the deal, end up getting and using the offer, this is called cannibalization, and will have the effect of a 75% revenue LOSS. This is a big risk with heavily discounted offers.

Conclusion

There are lots of gotchas with the daily deal model. Think twice about jumping in without due diligence. There are lots of other ways to promote your business more cost-effectively.

Next week I’ll be posting a follow up to this article, discussing a much more foundational and essential marketing strategy every business should prioritize: Growing Your Business Via Your Current Customer Base.

What's been your experience with Groupon or Living Social? Have you found other ways to make it work for you?

Please post your comments below.