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To Groupon or not to Groupon: The profitability of deep discounts

Abstract

We examine the profitability and implications of online discount vouchers, a relatively new marketing tool that offers consumers large discounts when they prepay for participating firms’ goods and services. Within a model of repeat experience good purchase, we examine two mechanisms whereby a discount voucher service can benefit affiliated firms: price discrimination and advertising. For vouchers to provide successful price discrimination, the valuations of consumers with access to vouchers must generally be lower than those of consumers who do not have access to vouchers. Offering vouchers tends to be more profitable for firms that are patient or relatively unknown, and for firms with low marginal costs. Extensions to our model accommodate the possibilities of firm price reoptimization and multiple voucher purchases. We find potential benefits of online discount vouchers to certain firms in certain circumstances, but vouchers are likely to increase firm profits under relatively narrow conditions.

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Notes

  1. 1 The proliferation of voucher discount services garnered substantial press: a multitude of newspaper articles and blog posts, and even a feature in The New Yorker (Surowiecki 2010).

  2. 2 In a case study, Dholakia and Tsabar (2011) track a startup’s Groupon experience in detail.

  3. 3Byers et al. (2012a) find that a merchant’s rating on Yelp falls precipitously after that merchant offers a discount voucher. Byers et al. (2012b) suggest that this effect may be due to voucher-users’ abnormally high likelihood of posting accurate (rather than biased or completely fake) reviews.

  4. 4Arabshahi (2011) considers vouchers from the perspective of the voucher service, whereas we operate from the perspective of participating firms. Gupta et al. (2012) and Norton et al. (2012) present general case studies of the voucher discounting business model.

  5. 5 Firms know the distribution of consumer valuations and the (common) probability of fit.

  6. 6 While our treatment of advertising includes consumers not being aware of the firm’s existence, conditional upon learning of the firm, consumers in our model receive more information than the firm does about their valuations. Additionally, our work differs from the classical literature on the advertisement of experience goods, as advertising in our setting serves the purpose of awareness, rather than signaling.

  7. 7 In other models, heterogeneity in consumer search costs (e.g., Salop and Stiglitz 1977) or reservation values (e.g., Sobel 1984) motivate sales.

  8. 8 We typically think of δ f>δ i, with firms more patient than consumers, although this is not required for our results.

  9. 9 Modeling multiple consumer populations is a standard approach in the literature on personalized pricing. (see, e.g., Huang 2013 and Deb and Said 2013.) Equivalently, we could consider a large consumer population with probability distributions over relevant characteristics. Our approach facilitates describing how “regular consumers” must differ from the consumers targeted by voucher offers in order for vouchers to be profitable for a firm.

  10. 10 In principle, voucher services are available to everyone. But in practice, some consumers cannot reasonably use vouchers or face significant impediments to doing so. Consider consumers without computers, consumers who disfavor electronic commerce, consumers who decline to buy prepaid vouchers, and consumers who find vouchers “tacky” or otherwise undesirable.

  11. 11Termes (2011) offers some supporting evidence for this fact.

  12. 12 For now, we assume the firm did not consider the possibility of a voucher when setting its price. In Section 4.1, we consider the possibility of price reoptimization.

  13. 13 Introducing γ lets us consider whether firms would want to limit vouchers to only a portion of the G-population. In Proposition 1, we show that firms in fact do not want to do so. If γ<1, we assume that each consumer in the G-population has equal probability of being offered a voucher.

  14. 14 If vouchers have word-of-mouth benefits, wherein voucher-users tell friends who then purchase from the firm, the first reference to r G in each component of Eq. 3 would be replaced by r G plus some factor ω corresponding to the number of friends referred by each voucher user. If voucher-users spend additional amounts η beyond the voucher face value, then p c in each term should be increased by the additional profit from that additional spending. Each of these features would increase the relative profitability of discount vouchers.

  15. 15 By contrast, λ affects p and can therefore affect the sign of Δπ(p ).

  16. 16 There is no closed-form condition for this property in terms of the primitives of our model. Hence, in order to directly relate voucher profitability to model primitives (without imposing specific functional forms for F and G), we must impose stronger conditions such as those used in the statement of Proposition 2.

  17. 17 If r G=r F then δ f does not affect p , so there is no indirect effect and patience unambiguously increases the profitability of vouchers.

  18. 18 This approach facilitates comparison with the results of Section 3.1 because it implies (as we discuss below) that the firm’s optimal price p is unchanged. This approach is also conservative: If we allowed a consumer’s probability of knowing about a firm to be correlated with the consumer’s valuation for that firm, it would be natural to assume a positive correlation (consumers having higher valuations for the firm’s product are more likely to be aware of it), which would tilt results against voucher services. (In light of our predominantly negative results on the benefits of voucher services, it is conservative to make assumptions that favor them.)

  19. 19 The only exception is if firms are much more impatient than consumers, with δ f<β δ i and β not too small, so that α β>δ f r G even though α<δ i r G.

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Acknowledgments

The authors are grateful for the helpful comments of the associate editor, several referees, and the participants of the Harvard Workshop on Research in Behavior in Games and Markets.

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Correspondence to Benjamin Edelman.

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Sonia Jaffe appreciates the support of a National Science Foundation Graduate Research Fellowship and a Terence M. Considine Fellowship in Law and Economics.

Scott Duke Kominers gratefully acknowledges the support of a National Science Foundation Graduate Research Fellowship, National Science Foundation grant CCF-1216095, the Harvard Milton Fund, a Yahoo! Key Scientific Challenges Program Fellowship, a Terence M. Considine Fellowship in Law and Economics, an AMS–Simons Travel Grant, and the Danielan Fund.

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Edelman, B., Jaffe, S. & Kominers, S.D. To Groupon or not to Groupon: The profitability of deep discounts. Mark Lett 27, 39–53 (2016). https://doi.org/10.1007/s11002-014-9289-y

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Keywords

  • Voucher discounts
  • Groupon
  • Experience goods
  • Repeat purchase